Thoughts on etf dangers in a bear market
I appreciated reading your column on etf danger in a bear market. Its a topic my trader friends and I have discussed. I would respectfully suggest your column focuses on the wrong aspect of this issue. You seem to focus on selection criteria for index stocks as a non-issue, but I don’t think most view that as the source of the problem in the first place.
The source of the problem as we see it, is the crowding of money into specific indexes/stocks. If a higher concentration of total market cap is represented by a smaller number of stocks, then the unwinding of that trade may be more violent than in the past. The data on active vs passive is interesting but doesn’t necessarily compare the same outcomes. if the active managers in 2001, ’02, ’08 were in a different set of stocks than the index itself, then a comparison to the next crash in which a much higher percentage investors are in all the same index/stocks may not be valid.
Assuming the article you linked to is accurate, one company’s ETF’s represent 6.9% of the total S&P market cap. Thats nuts. Then add up all the other S&P index and sector funds. The SPY alone is over 1% of the total index market cap.
So what happens when that trade gets “unwound” in the next market crash? To answer that question I think you need to look at concentration of stock assets between periods of time, rather than selection criteria of the S&P index. We know the number of public companies has decreased substantially since the last crash and index ETF investment has skyrocketed.
So its likely that the concentration of investments in the S&P 500 stocks has increased compared with prior pre-crash periods. If true, that would likely result in a more violent downmove as investors withdraw from index funds. if this isn’t true, then you’re right, we probably don’t have to worry about so many people during into index etf’s.
This comment references http://www.pragcap.com/are-etfs-and-index-funds-more-dangerous-in-a-bear-market/
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