ETFs: From Biggest Winners To Biggest Losers?

Posted by on March 7, 2017 12:42 am
Categories: Uncategorized

Fast adaptation and large money inflow into ETFs is not to be celebrated. On the contrary, it should be a warning sign. Here is why.....

The real winners of the 8-year-old bull market? ETFs and passive investing

Since the S&P 500 bottomed in the wake of the financial crisis, equity investors have been rewarded with a bull market that has tripled stock prices from that 12-year low. But the real winner over the past eight years has been behind the scenes: a fundamental change in the way people invest.

Exchange-traded funds and passive index-based investing have been around for decades—the first ETF launched in 1993, nearly 20 years after the first index mutual fund—but adoption of both has skyrocketed since the crisis, as part of a broader move toward simpler and lower-cost vehicles. The scale of the market’s advance since the March 2009 bottom, which has lifted every sector and nearly every stock, has exacerbated this trend by making the investor who does nothing an investor who does very well.

Fair enough, but we must not forget that the above is likely to hold true in reverse when the market swings the other way. Allow me to illustrate.


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, something that is possible given today's overvaluation/speculation environment, enterprising investors/traders might want to look at ETF's to boost 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.