Therefore, it cannot burst. There's a strong analytical case for the fact that an ETF bubble is not possible, despite what the mainstream news says. Let's examine why:
First some facts courtesy of Bloomberg
ETFs accounted for 30% of all equity trades in the US in 2016 and composed six of the 10 most actively traded securities in the US.
As of last November, there were 1,944 ETFs on US exchanges as of November 2016. Investors traded $18.2 trillion in ETF shares over a 12-month period last year, easily eclipsing US GDP.
The largest ETF, the SPDR S&P 500, had over 100,000,000 shares changing hands every day.
There are leveraged, inverse, inverse leveraged, double leveraged, actively managed and esoteric ETFs. There are transaction fees, tax issues, and capital gains. Similar tracking ETFs are not created equal. Caveat emptor. It requires research. Do it or hire someone to do it for you.
Look at the underlying securities. SYRD is easy: a basket of stocks intended to replicate the S&P 500. I hope you know it does not own the entire S&P 500. A SPDR owns about 1/10 of the S&P 500. A manager picks the basket, and, as I said , not all are created equal.
The interesting news is that the breadth of types of ETFs is only limited by the creativity of Big Financial.
Investopedia says, "Currently, there are 10 spiders that cover the S&P 500, nine of which cover individual sectors of the index. This selection allows investors to place their money in an ETF that covers either the whole market or a specific segment of the market." They also say that the best way to replicate the entire index is to look at the market segments. That's assuming a lot.
I have to say that investors who buy one or more ETFs without doing fundamental research beyond expense ratio can make a big mistake
The facts support the opinion that there cannot be an ETF bubble. Ever. (see below).
Here's what the ETF bubble predictors have said:
In 2017 "all eyes are on exchange-traded funds as the locus of the next big bubble….such a massive amount of investor assets tied up in the relatively small number of securities will lead to said bubble in the coming downturn."
FINANCIAL TIMES CONCURS:
"The tide will also turn for ETFs, as returns from trackers following broad equity indices are likely to be lower in the future than those achieved historically,"
EUAN MUNRO, chief executive of Aviva Investors, warned that there are similarities between the current fashion for ETFs and the damaging bubbles that developed in technology stocks in 1999 and the financial sector in 2006.
They warn that the unprecedented amount of index ETFs trading in the market could magnify, or even cause, flash crashes.
NED DAVIS OF NED DAVIS RESEARCH says, "Over the past year, investors have yanked billions from actively managed funds and plowed more than $234 billion into U.S. stock ETFs."
And that pendulum has swung so far towards passive indexing that there is likely a bubble in it. He concludes that this is a bubble, and one few seem to be realizing or appreciating is happening in their own portfolios.
UNATTRIBUTED QUOTE: "First it was Tech stocks, then Hedge Funds, Mortgage-backed securities, banks, the entire nation of Iceland, Hedge Funds again and so on. It is the opinion of many leading analysts that ETFs are the next bubble to pop."
Are they all wrong? Yes. Remember, mainstream news likes the "Bad News" kind. It gets more readers, so it sells more advertising.
Here's what the "NO way an ETF bubble" experts say:
Roger Nusbaum, an SA contributor and ETF strategist, maintains that ETFs do not cause bubbles. But he concedes that while the ETFs as a class will not pop in a bubble, "It is a good bet that there are ETFs that will track whatever the next true bubble is."
Nusbaum, as early as 2010 said, "There's no such thing as an ETF bubble." He points out that ETFs can't be a bubble because they are tools, not catalysts. "This is why blaming a stock bubble on ETFs is like blaming MP3s for Nickelback or One Direction."
He does get the quote of the day: "ETFs arguably suck up volume from the securities they track like a liquidity vampire." What a great line
Ron Madey, President and CIO of Wealthcare Capital Management which has a sophisticated Goals-Driven process and offers ETF cost-efficient portfolios, says ETFs facilitate asset location, tax management etc., versus more complicated active portfolios, daily portfolio monitoring, regular rebalancing and the development of strategies designed to capture nontraditional value-added through asset location, withdrawal sourcing, dynamic withdrawals and a total wealth approach.
Eric Balchunas on Bloomberg View says ETFs are the securities business's biggest scapegoat. "Exchange-traded funds are being blamed for everything from trading glitches to imminent financial destruction"
Efficient market theorists believe that market participants are rational, and therefore would not buy into asset bubbles if they were readily identifiable.
But the ETF phenomenon is not a "Bubble." Why? Well…
Investopedia says that a bubble "is an economic cycle characterized by rapid escalation of asset prices in businesses followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive selloff occurs, causing the bubble to deflate."
Think in terms of the tech bubble dot-com bubble of the 1990s when Facebook wannabes came and went and the housing bubble in 2007-2008. Think oil, gold, bitcoins. The important thing to notice is that they were NOT bubbles in the investment vehicles that owned the underlying securities. It was in the companies.
So while there may be a tech bubble, a dot com bubble, a bitcoin bubble, an ETF is only the vehicle to get you into the underlying security. Therefore, by definition, it is impossible to have a bubble... Just like MBS didn't bubble. It was a housing loan crisis, and the vehicle went down. If the S&P tanks, SPDRs go down. Blame the greedy.
So, by that definition, there cannot be an ETF bubble. Ever.
The best answer is not to worry about "ETFs" in general. There are too many different types tracking too many segments for ETFs as a whole to collapse, unless the markets and thereby the underlying securities do.
Part of it is semantics. People use the term "bubble" to describe situations in which securities or sectors experience an unwarranted spike in price beyond what their fundamentals can support.
You may have a different definition of a "bubble. You might agree with the "Yes, there is an ETF bubble. You might agree with the "No, there won't" camp. Or, maybe you agree with the "There can't be an ETF bubble, they're just investment vehicles" concept.
The important thing to you is that you have an opinion and I want to hear it, along with the rationale, please. I'll give the results next week before we discuss "Your 100 year life may not include retirement."
You tell me whether there is an ETF Bubble or not. Comments please.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: John Lohr publishes exclusive research on the Marketplace at Seeking Alpha, and evaluates investments and managers on somebodyelsesmoney.com.