Sure, the exchange-traded fund market for stocks has exploded by 500% during the ongoing eight-year bull market, but there’s no cause for alarm — yet.
That’s according to Jeffrey Kleintop, chief global investment strategist at Charles Schwab & Co.
In a recent note, Kleintop said that past asset bubbles have inflated by 1,000% over the course of 10 years before bursting. He simply doesn’t think ETFs are embedded enough in the fabric of the market to suffer that same fate, at least at this point.
This assessment flies in the face of a growing chorus of doomsayers warning against the swelling size of the ETF market. Just two months ago, Steven Bregman, the co-founder of Horizon Kinetics, called the shift away from active investing and towards passive strategies like ETFs “the greatest bubble ever.”
After all, the $2.8 trillion ETF market is growing rapidly, providing a low-cost alternative to active management while also offering diversification of holdings. Credit Suisse was forecasting in May that ETFs would see record annual inflows, while Moody’s predicted earlier this year that passive investments would make up 50% of the US stock market by 2024, up from 28.5% in February.
But Kleintop’s argues that ETFs simply haven’t been around long enough — nor risen to an extreme enough degree — to be considered harmful. And that view certainly carries weight, especially when compared to four notable bubbles that have rocked the global landscape over the past three decades. They include:
- The technology, telecommunications and media stocks of the NASDAQ Composite Index (Start date: March 16, 1990)
- Homebuilder stocks in the S&P 500 Homebuilding Index (June 30, 1995)
- Crude oil (June 26, 1998)
- Precious metals (April 27, 2001)
In the chart below, note the red line, which represents net equity ETF assets. It hasn’t yet reached its point of reckoning — a period around the 10-year mark that saw asset values cut roughly in half.
So how did we even get to the point where ETFs are even in the discussion for a market bubble?
First and foremost, the US stock market is in the midst of its second-longest bull market on record. That price appreciation surely makes investing in stocks much more palatable to anyone. And as Kleintop points out in his note, “without the aid of advice, traders often tend to chase returns.” While not the recommended method, it’s worked out pretty well since early 2009.
Another factor driving growth in ETFs has been capital allocation away from mutual funds. Once a red-hot area, much like how ETFs are now, mutual funds have lost their luster. They’ve seen net outflows since mid-2016 as the ETF industry has continued to soar.