ETF Bubble? Nope, Says Schwab’s Kleintop

Since the low in 2009, ETFs that invest in stocks have seen assets rise about 500%

The surge in money going into ETFs has led some market participants to question whether it might be a bubble, according to Schwab’s Jeffrey Kleintop.

“Since the low in 2009, ETFs that invest in stocks have seen assets rise about 500%,” Kleintop writes in his latest commentary. “This strong run is due to stock market appreciation, money moving from mutual funds into ETFs, and net new money coming in.”

Previous asset bubbles — including the technology, telecommunications and media stocks of the Nasdaq composite index; crude oil; precious metals; and homebuilder stocks in the S&P 500 Homebuilding Index — have all inflated 1,000% over 10 years before bursting and cutting prices by more than half in the following two years.

Kleintop says that both the 1,000% gain and the 10-year buildup are important to how embedded the bubble becomes in the markets and economy when it bursts.

“Applying the same classic profile of a bubble to ETFs, it appears that since their financial crisis low point in early March 2009, ETFs have not seen the 1,000% growth seen in destructive bubbles in the past,” he adds.

He notes, though, that the real bubble watch should be on the underlying assets in those ETFs (like tech stocks in 1999, for example) — not the vehicles themselves.

Kleintop finds that investors have been favoring international ETFs. While ETFs (including those based outside the U.S.) that invest in U.S. stocks gathered more assets so far in 2017 than any other individual country or region ($95 billion), most of the inflows were into non-U.S. ETFs ($267 billion).

Kleintop also finds in his analysis that money flows in and out of different country ETFs do not appear to be driven by — or driving — country performance. 

For example, Kleintop points out that strong net flows this year into Spain and India mirror strong performance among stocks in those countries; however, outflows from Mexico and Hong Kong are in contrast with the strong performance in those markets this year. Also, the U.S. and Japan, which are the most favored countries for net inflows, fall near the middle of the range of country performance.

“This suggests the ETF flows are not ‘hot money’ that could quickly reverse if performance stumbles, but instead driven by fundamental reasons or a desire for the greater diversification these markets now provide,” Kleintop writes.

According to Kleintop’s analysis, the flows also show that investors do not seem worried about geopolitical events. He finds that this year has seen solid inflows to markets that are geopolitical hotspots.

“Italian elections in early 2018 do not seem to be holding back inflows, Greece's ongoing debt problems haven't staunched inflows, and the threat posed by North Korea's nuclear ambitions hasn’t kept money from flowing into South Korean funds,” he writes.

He does emphasize that some markets may be vulnerable if geopolitical risk escalates.

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