Most Popular
1. It’s a New Macro, the Gold Market Knows It, But Dead Men Walking Do Not (yet)- Gary_Tanashian
2.Stock Market Presidential Election Cycle Seasonal Trend Analysis - Nadeem_Walayat
3. Bitcoin S&P Pattern - Nadeem_Walayat
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
4.U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - Raymond_Matison
5. How to Profit from the Global Warming ClImate Change Mega Death Trend - Part1 - Nadeem_Walayat
7.Bitcoin Gravy Train Trend Forecast 2024 - - Nadeem_Walayat
8.The Bond Trade and Interest Rates - Nadeem_Walayat
9.It’s Easy to Scream Stocks Bubble! - Stephen_McBride
10.Fed’s Next Intertest Rate Move might not align with popular consensus - Richard_Mills
Last 7 days
Stock Market Brief in Count Down to US Election Result 2024 - 3rd Nov 24
Gold Stocks’ Winter Rally 2024 - 3rd Nov 24
Why Countdown to U.S. Recession is Underway - 3rd Nov 24
Stock Market Trend Forecast to Jan 2025 - 2nd Nov 24
President Donald PUMP Forecast to Win US Presidential Election 2024 - 1st Nov 24
At These Levels, Buying Silver Is Like Getting It At $5 In 2003 - 28th Oct 24
Nvidia Numero Uno Selling Shovels in the AI Gold Rush - 28th Oct 24
The Future of Online Casinos - 28th Oct 24
Panic in the Air As Stock Market Correction Delivers Deep Opps in AI Tech Stocks - 27th Oct 24
Stocks, Bitcoin, Crypto's Counting Down to President Donald Pump! - 27th Oct 24
UK Budget 2024 - What to do Before 30th Oct - Pensions and ISA's - 27th Oct 24
7 Days of Crypto Opportunities Starts NOW - 27th Oct 24
The Power Law in Venture Capital: How Visionary Investors Like Yuri Milner Have Shaped the Future - 27th Oct 24
This Points To Significantly Higher Silver Prices - 27th Oct 24
US House Prices Trend Forecast 2024 to 2026 - 11th Oct 24
US Housing Market Analysis - Immigration Drives House Prices Higher - 30th Sep 24
Stock Market October Correction - 30th Sep 24
The Folly of Tariffs and Trade Wars - 30th Sep 24
Gold: 5 principles to help you stay ahead of price turns - 30th Sep 24
The Everything Rally will Spark multi year Bull Market - 30th Sep 24
US FIXED MORTGAGES LIMITING SUPPLY - 23rd Sep 24
US Housing Market Free Equity - 23rd Sep 24
US Rate Cut FOMO In Stock Market Correction Window - 22nd Sep 24
US State Demographics - 22nd Sep 24
Gold and Silver Shine as the Fed Cuts Rates: What’s Next? - 22nd Sep 24
Stock Market Sentiment Speaks:Nothing Can Topple This Market - 22nd Sep 24
US Population Growth Rate - 17th Sep 24
Are Stocks Overheating? - 17th Sep 24
Sentiment Speaks: Silver Is At A Major Turning Point - 17th Sep 24
If The Stock Market Turn Quickly, How Bad Can Things Get? - 17th Sep 24
IMMIGRATION DRIVES HOUSE PRICES HIGHER - 12th Sep 24
Global Debt Bubble - 12th Sep 24
Gold’s Outlook CPI Data - 12th Sep 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

The Passive Investing Bubble May Trigger A Massive Exodus from Stocks

Stock-Markets / Stock Market 2017 Oct 18, 2017 - 08:44 PM GMT

By: John_Mauldin

Stock-Markets

BY JAKE WEBER : The ETF market has experienced astounding growth over the last decade. There are now 5,000 ETFs traded globally with over $3.5 trillion in assets, a more than threefold increase since 2007.


The latest data from ETF.com shows a record $303 billion has already flowed into ETFs in 2017. And this rapid pace of growth isn’t expected to slow down any time soon. It’s estimated that ETFs will hold between $7 and $10 trillion in assets by 2021.

The trend towards passive investment funds may not sound like a huge deal. However, it has vastly distorted the market.

Here are a few of the major side effects caused by passive investing.

Stretched Valuations

Investors became risk averse in the wake of the financial crisis. They wanted to avoid sector specific or individual specific risk. So they chose to just buy the whole index instead.

A passive index ETF pays less attention to the valuation of individual stocks. Instead the ETF will simply buy up all of the stocks to replicate the underlying index. This in turn has led to sky-high valuations for stocks on major indices.

For instance, the Shiller 10-year PE ratio is currently at 30.7. A level only surpassed on two previous occasions just before the Dot-Com Crash and the Great Depression.

When investors are buying stocks indiscriminate of things such as a company’s earnings or basic valuation metrics, it’s a good sign that we’re in bubble territory.

Lack of Diversification

Buying an index of 500 stocks spread across eleven different market sectors may seem like a perfectly reasonable diversification strategy. But in reality, there has been much stronger correlation between asset classes over the last decade.

Much of that has been driven by the central bank policy.

Zero-interest rate policy and quantitative easing made cash very unattractive to hold. When you aren’t earning interest on your cash, then you’ll look to park your cash just about anywhere. This lead to all asset classes rising and falling together.

The ability to evaluate a company’s balance sheet strength, cash flows, and earnings quality to determine something close to fair value is what gives the active manager an edge. When investors stop paying attention to good stock and bad stocks because it buys all of the stocks at the same time, there is no way for an active manager to succeed.

The Collapse May Be Close

As the Fed has been gradually normalizing monetary policy over the last few years, the correlation across asset classes has been in decline. This trend should create an opportunity for active fund managers to start delivering alpha once again.

Which in turn should cause funds to reverse the flows back into active funds.

Source: Doubleline

The fear is that the outflow from passive ETFs could be much less orderly than the inflow has been over the last decade. There has been no price discovery mechanism for passive ETFs. The bull market was built on an automatic bid by stock index investors.

When that automatic bid from the buy-the-dip crowd disappears, there is no telling how the ETFs will perform. Many of these funds have never been tested by real market volatility. A sharp market correction could see a mass exodus from passive index ETFs.

Grab Jared Dillian’s Exclusive Special Report, Investing in the Age of the Everything Bubble

As a Wall Street veteran and former Lehman Brothers head of ETF trading, Jared Dillian has traded through two bear markets.
Now, he’s staking his reputation on a call that a downturn is coming. And soon.

In this special report, you will learn how to properly position your portfolio for the coming bloodbath. Claim your FREE copy now.

John Mauldin Archive

© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in