(24-06-2021, 11:32 PM)Wildreamz Wrote: [ -> ]That said, I don't think it's a good strategy for indexers to time entry and exit, in general; better to dollar-cost-average over time to remove emotions as a factor.
I broadly agree with that but as with every investment strategy: only within limits. The S&P 500 is massive and diversified but there must be a point where it trades so more much than it is worth that it can reasonably be seen to be a bad investment. And I think that point has been crossed.
With pre-pandemic earnings and today's price the S&P trades at a 30 P/E ratio. That's as high as fast growers like Google (34) and Facebook (29). It is insanity. Costco, by all measures a stalwart, trades at 37 P/E. Walmart at 32. Johnson & Johnson at 29. The only major stocks I find trading at reasonable P/Es are banks and insurance, both interest rate sensitive businesses.
When all is said and done ETFs are a derivative. They are structured by their creation/redemption mechanism through the primary and secondary ETF markets to keep costs low by minimizing trades of component stocks on the stock market, which they are extremely successful at. The effect of this is that shares held by ETFs are "closely held". They are bought and held with trades only necessary to feed the increase or decrease in their AUM (and ETF AUM has gone up year after year steadily).
The magic number for the S&P 500 is presently 6.5%. This is the value of S&P AUM to the sum of its constituent market caps. Because it is a market cap weighed index, this means that 6.5% of every component stock is held under the S&P ETF. This is not a very big number in terms of reducing the float or trading volume (even low volume stocks like Wells Fargo has a daily turnover of 0.5%). But ETFs are growing at something like 23% a year. If this continues in 3 years it'll be 13% of shares held off the market, in another 3 it'll be 26% and in another 3 52%.
Burry thinks that it's a bubble not just because of the liquidity issue of trying to redeem the S&P ETF shares, but also because of the increased covariance of indexed stocks, or in his words the removal of individual price discovery. The first is not a short term issue and the second will not directly be an issue either. Indexes' 'close holding' behavior means they effectively act like a very passive investor trading a very small portion of his shares, thus they do not affect market prices much. I do not know exactly how much, but it is a very small percentage of the already small 6.5% of stocks held under the S&P ETF.
Instead the growth of indexes affects stock prices indirectly by tying up float. This is not a very big deal in sleepy stocks like Wells Fargo, but 6.5% of Tesla is probably a different story. Reducing float increases volatility, probably compounding it with existing volatility.
An
empirical study done on the price effects of indexes show somewhat counterintuitively that indexes affect only larger cap stocks and have almost no effect on its smaller constituents. Probably an index entering to buy 6.5% of a $500 billion dollar company has more effect than 6.5% of a $5 billion dollar company. The paper suggests that it is because "noise traders" jump onto trading in big cap companies but do not for small caps. Another explanation is that it was conducted in the recent past, when the explosion in ETFs has coincided with the explosion of red hot companies whose hundred billion dollar market caps comes from high valuations and not high earnings.
If the stock market is going to crash it is best that it do in the next 5 years. Because if the Fed continues to pump in money to the system, sustain or even inflate asset prices further and really push things to a razor edged precipice, after that there is a substantial chance that the ETF bubble is going to burst at the same time as the stock bubble. That would I think be in terms of both the size and amount of Fed-fueled liquidity by far the biggest bubble to ever burst. The thing about the Jupiter sized amounts of liquidity the Fed has been pumping into the system since the GFC is that it cannot take it back without crushing the US economy like a paper bag.