2 Reasons Why an ETF-Induced Bubble May Be On the Horizon

The explosion of Exchange Traded Funds (ETFs) now taking place in all major financial markets has officially taken over in the Canadian market as well, as the TSX has now officially celebrated the milestone of having the 500th Exchange Traded Fund listed on the index, representing a doubling of the number of ETFs over a relatively short period of time (five years).

In the U.S. market, ETFs now outnumber the stock market, meaning the trillions of dollars which have flown into the ETF market have searched for a home in a number of underlying stocks without enough underlying shares outstanding, resulting in a situation where some ETFs have begun buying derivatives and other alternative investments to gain exposure to the underlying, effectively creating a situation in which a few key stocks are “over-traded” at any given moment.

Whether this situation creeps into the Canadian market remains to be seen, however one risk which appears to be happening is that due to the market-capitalization weighting of various indices, more and more cash from the ETF sector is now being funneled into a smaller number of stocks, increasing the upward momentum of the traditional FAANG stocks (Facebook, Apple, Amazon, Netflix, Google/Alphabet). With the vast majority of growth in the North American markets stemming from just a few concentrated names, while the median stock traded in North America has not performed as well, it appears increased volatility may be on the rise in years to come, should ETF outflows begin to outpace inflows and investors pull their money out of the market for any reason.

Invest wisely, my friends.