I would like to talk about three events that have been in progress for couple years.
1. The dark cloud on the immediate horizon is the Exchange-trade funds, which have grown exponentially in size in the past five years, but never been crucially examined by panicked selling. If the market turns around and the ETF investors decide to abandon their shares out of fear, ETFs would be forced to dump stocks and such behaviors could begin a vicious circle and drag the stock prices into a deeper valley. And I believe the algorithmic or AI trading could deteriorate such situation.
2. The S&P 500 has reached 19 times of P/E ratio, higher than the historical average of about 15. Readers might read my article on P/E ratio first— “談本益比觀念的對與錯 ” I think the 19 times of P/E ratio is not the problem itself. It simply reflects the reality of extremely low interest rates for almost a decade. The artificial manipulation of interest rates can mislead the prices of time of the markets, distort the anticipates of incomes, and increase the information costs. Therefore, the interest rates are the causes and the high P/E ratio is nothing but the unavoidable effect. “Action and reaction,” as they said. You shall not explain facts by facts.
3. The low interest rates also have encouraged a lot of corporate-share-buyback plans by borrowing, which has been one of the factors boosted the stock prices in the past five years. And I wouldn’t say it is a healthy phenomenon, despite Warren Buffett’s preference.
All these factors imply that the intrinsic economic progress might be left behind the raising prices of the capital markets. The diversion of these two, the reality and the artificial finance system, is the major cause of most financial crises.
As I said in the last article, “榮景或低成長的十字路口 (We are at the crossroads of prosperity or low progress) ,” the monetary policy of Fed and the uncertain success of the economic reforms by President Donald Trump are two key factors in my prediction of the US economy and the performance of its stock markets. Once either one went wrong, the bear could show up all of a sudden.
1. There can be high settlement or bankruptcy risks for small or over-diversified ETFs in the bear markets. Although the investors can get back their shares of the real assets, it could be worthless after all. And such fear could induce investors and the ETF managers, who by doing so is breaking the contracts, to dump their holdings for money.
2. There can be even higher risks for leverage, inverse, or complex-designed derivative ETFs in a down turn. And I guess the bankruptcy administrators assigned by the courts would probably choose to sell the stocks or bonds and to cancel or abolish the complex derivative financial contracts for cash as soon as possible, which could cause the vicious circle as I mentioned in the article.
At present the ETFs go too far from the original purpose. For me, many of them are more like derivative goods rather than pure investing vehicles. It’s kind of new fashion for people of means. But we have no idea what would really happen when the tide is out. We can wait and see.