At the end of last month, quarter-end window dressing wasn’t the only driving factor for stocks. The 90-day realignment of smart Beta and equally weighted ETFs also provided a significant boost. However, on the heels of the ETFs rebalancing act, fears arose that an ETF meltdown is on the horizon, and that it could, in turn, hinder the overall stock market. Let’s dig into what’s really happening…
The truth of the matter is the Robo Advisor revolution is designed to "churn" ETFs, enabling trading desks, ETF specialists and NYSE specialists to make money via premiums and discounts charged to net asset value. And therein lies the problem.
If there is a stock market correction, the "discounts to net asset value" of ETFs will plunge. As a result, ETF investors could be badly burned, due largely to the fact that ETFs do not trade at net asset value and would likely trade at a deep discount during a selloff.
Individual stocks and the underlying stock market, on the other hand, would not correct anywhere near what the ETFs plunged. Individual stocks cannot trade at a discount to their underlying stock prices.
Now, if you’ve been reading this blog for a while, then you’re probably familiar with the term "tail of the dog." Essentially, when you invest in a Robo Advisor or ETF model portfolio, you are the "tail of the dog."
Personally, I think the view—as well as performance—is far superior when you’re the "nose of the dog." In other words, when you’re front running the Robo Advisors and ETFs by investing in fundamentally superior stocks.
In my opinion, ETFs are often inefficiently priced at extreme discounts and premiums during fast market conditions, which is why some on Wall Street fear an ETF-induced correction. However, any correction would be fast and furious, and fundamentally superior stocks would bounce back like fresh tennis balls.
We saw this happen in September when technology stocks sold off hard on a Monday, and then erased these losses following a better-than-expected earnings report from Micron Technology (MU).
So my best advice: don’t stress about an ETF-induced pullback. Stay invested in individual stocks with superior fundamentals, and any market pullback will be short-lived.
This is exactly what we’ve been doing in my Emerging Growth service. We are the "nose of the dog." In fact, some of our 11% gain over the past four weeks is due to smart Beta and equally weighted ETFs buying our Emerging Growth stocks at the end of the quarter. As a result, our Buy List is outperforming many highly rated ETF portfolios simply because we are able to smartly buy strong stocks at great prices and not just every 90 days like ETFs must do.
Of course, if you aren’t ready to join Emerging Growth right now, you can continue running your favorite stocks through my Portfolio Grader tool, and stay tuned into this blog where I’ll continue revealing my daily market insights.