I solved a problem.
In the book “The Humans,” by Matt Haig, a mathematician is trying to prove the Riemann Hypothesis suggesting deep foundational meaning in prime numbers.
No, I didn’t solve that one. A different one.
Before I get to that: Oil jumped Monday the most ever in history, 30% in a day. And gave it all back. Markets have been roiled into epic volatility, levels we’ve never seen without a correction.
What the hell is going on?
Quantitative traders are hedging with derivatives to a neutral exposure and profiting on tumultuous volatility in stocks and commodities. It’s in a way related to the equation I discovered.
Be careful about ascribing things like “easing war fears” to market behavior. It’s incorrect. The market is in an epic battle with its own structure.
Which brings me to the problem: I found mathematical proof that single stocks and public companies are harmed by ETFs.
It doesn’t mean I’m opposed to them. We help public companies attract and keep ETF flows – because they’re massive. There are 2,500 ETFs tied to US equities, 4,600 ETFs trading in the US market. Over $14 trillion in ETF assets, up over $3 trillion in the last year alone.
The wholesale ETF market is averaging over $1 trillion per month, dwarfing every other form of fund-flows. That’s the “arbitrage mechanism,” where ETFs are created and redeemed off-market in large blocks between, say, Blackrock and its authorized participant like JP Morgan.
ETFs like IVV from Blackrock tracking the S&P 500 are popular because of performance and cost. IVV costs 0.03%. Growth Fund of America from Capital Group costs 0.59% by comparison. Eight of the top ten holdings are the same. Why pay 20 times more for the same stocks?
And that’s the problem for active managers. I’ve explained all these things before.
Now to the mathematical proof. Add up the prices of the 500-ish stocks in the S&P 500. Divide by 500. That’ll give you a current average price of about $228. Track that measure over the last year. It’s up about 9%.
But SPY tracking those same stocks is up about 20%. Literally 100% higher. And it costs three basis points like IVV.
Clearly, investors are better off owning SPY than the underlying stocks.
You might think market-cap weighting is why there’s a 100% spread between SPY and the stocks it tracks. Passive investment prioritizes money to large caps, and 90% of ETF assets are in large caps.
Nope, not the answer. ETFs are “elastic.” They continuously vary share-supplies through the creation/redemption process, with more shares created than redeemed at a pace of over $100 billion per month.
It’s the same thing the Federal Reserve does with the dollar. By relentlessly increasing the supply of dollars so prices rise at least 2% per year, there’s ostensible predictability and low volatility in consumer prices.
This is not a monetary treatise. But the lesson is the same. Inflation is theft. It’s taking two pennies from every dollar you make. A commission. A management fee. Except it can be a lot more than 2% and it never goes down.
ETFs do it through volatility. The average spread between daily high and low prices in an ETF like IVV, VOO, SPY, is about 1%. Over the trailing year from Mar 10, 2025, to Mar 9, 2026, volatility in SPY totaled 291%. That’s adding up the daily figures.
I did the same math in the basket of 500 underlying stocks. Volatility averaged 2.6% daily over the last year and totaled 645%.
And I sat back and said, “Wow. There it is.”
The spread is about 120%, a bit larger than the difference in returns the past year between SPY and the underlying basket.
But close enough.
This is how ETFs cost almost nothing. Payment comes from the underlying STOCKS in the form of volatility. ETF market-makers are paid by that spread to keep ETFs tracking stocks.
If you own stocks, then, you have a much higher probability – call it 2.2 times greater – of getting “adverse selection” when buying or selling. Your returns disproportionately flow to Citadel, Susquehanna, Jane Street, other big brokers sitting in the middle.
And that harms your shareholder returns, public companies. The market favors ETFs. In fact, why would anyone own stocks if ETFs cost less and perform better?
But targeting stock-pickers isn’t your answer. They’re net sellers. And they’re at a disadvantage. You have to get bigger, and purposely work to dampen volatility – so you’re attractive to ETFs. Perversely, how public companies report financial results does the opposite. Most are out of step with the money. Ask us, we’ll fix that for you.
At some point, the math of volatility will become the Achilles heel of the market. Nobody will buy stocks – and ETFs depend on them for prices.
Investors, to navigate this market you need to understand Demand, Supply and volatility. See EDGE to learn how.
