ETF Overload: Beware says Michael Burry


Passive investment vehicles like exchange-traded funds (ETFs) and index funds have become incredibly popular, by some estimates controlling at least half of the U.S. stock market.

No less an authority than Warren Buffett recommends investing your 401(k) in an index fund. "I think it's the thing that makes the most sense practically all of the time," Buffett says.

Or not.

Michael Burry, one of the first investors to predict the subprime mortgage crisis (played by Christian Bale in the movie The Big Short), claims passive investing has created a similar bubble.

His reasoning is simple. According to Burry:

... passive investing has removed price discovery from the equity markets. The simple theses and the models that get people into sectors, factors, indexes, or ETFs and mutual funds mimicking those strategies -- these do not require the security-level analysis that is required for true price discovery.

This is very much like the bubble in synthetic asset-backed CDOs before the Great Financial Crisis in that price-setting in that market was not done by fundamental security-level analysis, but by massive capital flows based on Nobel-approved models of risk that proved to be untrue.

OK, maybe not so simple.

Think of it this way: Index funds mirror the performance of anything that can be tracked. The Dow Jones Industrial index. The S&P 500. The Russell 2000.

For example, SPDR S&P 500 ETF (SPY) is a collection of all the stocks in the S&P 500. That means purchasing every stock on the index, regardless of its underlying fundamental value or prospects for future returns. The more money that flows into that ETF, the more people own (at least a piece) of those stocks.

That means some stocks automatically get overvalued: The flow of investment capital into index funds inflows distort prices for stocks and bonds -- according to Burry, just like CDO purchases did for subprime mortgages.

And when the flow reverses? "It will be ugly," Burry says. "Like most bubbles, the longer it goes on, the worse the crash will be."

To make things worse, many of the stocks included in various index funds are relatively lightly traded. Many of the stocks in the Russell 2000 trade at less than $5 million in value per day."

That sounds like a lot," Burry says, but trillions of dollars in assets globally are indexed to these stocks," Burry says. "The theater keeps getting more crowded, but the exit door is the same as it always was."

All this as ETF hit records...beware....

ETF assets increase to record $4 trillion: RPT https://finance.yahoo.com/video/etf-assets-increase-record-4-204219419.html?soc_src=strm&soc_trk=tw

via @YahooFinance

Thanks for reading and keep it profitable,

ProTrader Mike

Featured Posts
Recent Posts
Archive
Search By Tags
Follow Us
  • Facebook Basic Square
  • Twitter Basic Square

Stay Connected

© 2012-2021 MOJO Day Trading, LLC.   All Rights Reserved. 

The information contained on this website is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You must review and agree to our Disclaimers and Terms and Conditions before using this site. Mojo Day Trading nor ProTrader Mike is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. 

Mojo Day Trading and ProTrader Mike cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Individual results may vary, and testimonials are not claimed to represent typical results. All testimonials are by real people, and may not reflect the typical purchaser’s experience, and are not intended to represent or guarantee that anyone will achieve the same or similar results. 

Mojo Day Trading and ProTrader Mike in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Mojo Day Trading and ProTrader Mike accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

CFTC RULE 4.41 - HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY, SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.