ETF Love Affair To Cause The Next Market Crash?

Posted by on February 1, 2017 2:54 pm
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According to some, ETF investing is the driving force behind recent market strength that many professional investors have underestimated. And that might not be that far fetched. Consider the following……

This, not Donald Trump, is the true revolution upending stock-market investing

This sea change, which has developed over the last decade, consists of three big trends:

1. Investors have abandoned individual stocks for funds and exchange-traded funds (ETFs).

2. They have dumped actively managed mutual funds for index funds.

3. They have flocked to target-date funds as vehicle of choice for retirement saving and investing.

How revolutionary is this?

Now, all of the above is great until it backfires. Allow me to explain.

It appears I am not the only one who is aware of the ETF liquidity time bomb. I first published this post in September of 2015. If The Market Crashes, How Will The ETF’s React?

David Stockman tends to agree. Mutual Funds, ETFs at Risk of a Run For a different reason, but his concerns lead to the same conclusion. When the next sell-off hits, and it most certainly will, at some point ETF’s liquidity will vanish. Leading to massive gap downs (or worse) we all saw on August 24th, 2015.

Previously published analysis: September 14th, 2015

August 24th gap down (or mini crash) of 1,000 points on the Dow was incredibly important from another angle. It has exposed a weakness in ETF’s that not many were aware of. Still not aware of. An in depth discussion can be found here…..

Wild Trading Exposed Flaws in ETFs

For our purposes and since we follow the Dow so closely, let’s take a look at DIA (chart above). But keep in mind, the analysis below was evident throughout the  stock market and across most financial instruments the morning of August 24th.

The Dow and DIA typically move together (+/- 20 cents). That morning the Dow bottomed 5 minutes into trading at 15,370, while the DIA bottomed at $150.57. That’s a 2% discrepancy or an arbitrage that can be recovered in a matter of minutes.We saw the same on QQQ/NDX and SPY/SPX, plus numerous other ETF’s.

Here is what I am thinking. Should the market crash over the next few months, something that is possible given today’s overvaluation/speculation environment, enterprising investors/traders might want to look at ETF’s to boost up their gains. On both the short side and subsequent reversals.

Who knows, the next discrepancy could be 2-5%, depending on the size and speed of the primary move. That is to say, put this arbitrage on your “To Watch List” and be ready to act if the market is crashing and/or moving fast.