Stocks step into bubble territory when mom-and-pop investors start buying shares, according to one Wall Street adage about contrary indicators of the market’s direction.
With passive investing strategies becoming more popular than active fund management, exchange-traded funds are seeing record inflows of cash from people seeking to join in on the rally since Republican Donald Trump won the election. And that’s a worrying sign, according to the Financial Times.
Dan Mannix, chief executive of U.K. asset manager RWC Partners Ltd., told the newspaper that he feared unsophisticated investors were being “sucked into the market” because ETFs were cheap. There were dangers if ETF flows reversed, he said.
Investors pumped a record-breaking $131 billion into index-tracking funds during the first two months of 2017, according to data from consulting firm ETFGI Llp., while the total for 2016 was $390 billion. The S&P 500 stock index has risen about 11 percent since the Nov. 8 election to record highs.
Trump’s pledge to cut taxes and regulation while spending $1 trillion on roads, bridges and airports has made investors strongly optimistic about the future of company profits. A major risk is that Trump’s ambitious plans to overhaul the federal government will get become mired in legislative wrangling, and that could damp investor sentiment.
“Much of the capital in ETFs is short term, so we could see rapid outflows followed by a vicious circle where falls in asset prices lead to more selling pressure from ETFs,” Mannix told the FT.
U.S. stocks are expensive, trading at a historically high valuation multiple of about 18 times future earnings.
“The tide will also turn for ETFs, as returns from trackers following broad equity indices are likely to be lower in the future than those achieved historically,” Euan Munro, chief executive of Aviva Investors, who warned that there were worrying similarities between the current fashion for ETFs and the damaging bubbles that developed in technology stocks in 1999 and the financial sector in 2006, the FT reported.
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