I’ll tell you what fascinates me about stocks.
Before that, Barry Diller’s memoir is out. I’ve long thought him an interesting guy. It’s no doubt worth reading. He says he spends months on his 300-foot schooner, Eos. We saw his big boat (see photo) sailing (well, we were sailing too but on a tiny 70-foot catamaran) last month off St Vincent.
One more book idea: In My Time of Dying, by Sebastian Yunger, author of The Perfect Storm. Read it. We listened via Audible from Steamboat to Denver.
Back to stocks. I find it both illuminating and curious that people like JP Morgan CEO Jamie Dimon and Morgan Stanley chief investment officer Lisa Shalett warn investors of complacency and high multiples in equities.
Both firms are top-seven managers of equity assets, and they use asset-allocation models that don’t depend on valuation, multiples. They put percentages of resources into asset classes using models.
(Kudos to Barbara Kollmeyer again for her Marketwatch columns keeping me apprised of what these folks say.)
I have great respect for Mr. Dimon. I don’t know much about Ms. Shalett but I’m sure she’s competent. Yet it’s misleading to describe the market differently from how you invest.
Why are Mr. Dimon and Ms. Shalett telling people multiples are too high and there’s complacency when their OWN strategies ignore multiples, fundamentals?
They should add, “We run models that depend on market cap, liquidity, volatility and other quantitative factors, and fundamentals are a screen only for quality.”
I find it similarly fascinating that sellside firms cut their targets for the market in April when stocks had already tanked. Then stocks roared off, rising roughly 20% from lows. The same firms reversed course and revised their price targets.
Tell me the difference between that and a consequence? Happens with individual names too. Analysts have price targets. Stocks dive. Analysts cut price targets. Stocks soar.
Take TSLA. It was assigned to the scrapheap. Elon Musk had wrecked his brand. TSLA is up 51% the past month since everyone slashed it.
If the sellside is reactionary it’s because the sellside isn’t causal. It’s a follower.
The fact is the stock market is a big boatful of ETFs. I explained in last week’s blog why it bounces back.
TSLA is in 527 ETFs. Most are market-cap focused. It’s in the Consumer Discretionary sector but just 12 sector ETFs. It’s in twice as many Tech ETFs. It’s in 38 leveraged ETFs, more than the two sectors combined.
TSLA is one of 11 stocks with $1 trillion or more of market cap. There are 123 stocks with $100 billion or more of market cap – and they’re 65% of the market.
That’s what drives TSLA (so to speak) and underpins the 1,497 US equity ETFs comprising the 3,822 ETFs trading in the US stock market.
If the supply of ETFs relentlessly rises, ETFs can ratchet stocks up to meet them. We haven’t had a month with net redemptions of ETF shares since Apr 2022. And that was just a negative five billion dollars. One month of redemptions – in a bear market!
The number of companies in the market declines (Mr. Dimon has decried it). The number of ETFs only rises. All the equity ETFs depend on the same underlying set of stocks. Especially BIG stocks.
Since Jan 2020, ETF shares have expanded by over $4.1 trillion, or $65 billion every month (data from the Investment Company Institute).
So if there are more ETF shares every day, and more money flowing to ETFs, the “arbitrage mechanism” through which traders align ETFs with baskets of stocks will pull the prices of stocks up to the prices of ETFs.
You with me? ETFs are THE engine.
If the supply of ETF shares only increases, why do stock-prices decline at all?
Two reasons. Options predicated on stocks and ETFs are out in front with implied prices for implied rights to buy or sell. If faith in prices wavers, the options market collapses, and the implied demand in options exits stocks.
Kaboom! That’s what happened in early April. But if flows continue, options revalue and the arbitrage mechanism snaps prices back in line.
The other reason is excess supply. While more money chasing the same goods inflates prices – and that’s what ETFs have done to stock-multiples – a surfeit of ETF shares in a demand swale will sap prices. Too much supply, not enough demand.
Happy message, Quast. You sit around contemplating this stuff? Maybe you should get out more.
Fair point.
To manage risk, you must FIRST understand it. That applies to your stock, public companies. You need a strategy for a market dominated by ETFs, in addition to your storytelling plan. It’s understanding Demand and Supply, controlling the controllable factors – like volatility.
Same thing for you, investors. If your only strategy is studying financial results, the market will flog you with a stick.
And guess what? Today VIX options expire. If you need help, public companies, we’ve got it. Same for you, investors. Come sit in on our live Discussion Thursday.
