Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 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