Nine years into the global market’s bull run, exchange-traded funds (ETFs) appear to be pushing US tech stocks into unrealistic valuations in ways that may end badly for many, a new whitepaper from Montgomery Investment Management said.
According to Montgomery Investment Management chief investment officer, Roger Montgomery, In the wake of the global financial crisis (GFC), index ETFs were meant to offer risk-averse investors a safe and easy way to gain diversification.
However, in late 2018, markets are at a fork in the road where investors may want to reconsider their strategies, he said.
“The trillions of dollars flowing into ETFs peaked in March and we’re starting to see tech stocks return to earth,” Montgomery said. “The FAANG stocks, which include the likes of Amazon, Facebook and Google, lost a combined US$172.7 billion in value on 10 October alone.”
In the whitepaper, Montgomery said it was his “very personal view” that the ETF bubble is the transmission mechanism for a technology share bubble.
“As tech shares have rocketed higher, ETF operators have been forced to buy more amid a self-reinforcing circle of enthusiasm that is no different to bond ETF managers buying more debt of the countries accumulating it,” he said.
Montgomery said that the trillions of dollars flowing into ETFs, which peaked at USD$34 billion for the week ending 16 March 2018, distorted all asset prices and those who have invested in US Index ETFs, believing they are diversified, are no more protected than the municipal funds that invested in mortgage-backed CDOs and believed geographic diversification would protect them from default.
He said that as the “indiscriminate index investing fad” unwinds, volatility will increase, and many investors will realise substantial losses. However, he said that active, value-oriented investors with insight will be able to take advantage of a relatively rare overreaction that will set them up for another decade.
“It will become a reminder to investors, especially index investors, of the principle that excess profitability is always met by an opposing force. The ideal window to switch from passive index funds to value-oriented active fund managers may not be open for long,” he said.