Stay away from S&P500 ETFs? – Monday Morning Millionaire

This question was posed by L. McI….. DDS

Question:

The author of a recent Forbes article expresses concern over the fact that record amounts of money have flowed into SPY, IVV, VOO and other S&P 500 ETFs as markets have soared during the last three years.

I am not about to sell any of my US index ETFs. I feel that the MMM portfolio rebalancing strategy outlined in Milan’s book mitigates much of the risk mentioned in the article.

The article then outlines the 4 reasons to stay away from these ETFs:

1. Overexposure to FAANG and other insanely valued stocks (FAANG being Facebook, Amazon, Apple, Netflix and Google), stating that P/E ratios are too high, and Tech makes up a quarter of the index.

2. Diversification Myth – the argument is that ETF investors are driving up the value of these 500 stocks with no regard to company fundamentals.

3. Growth vs. Value Gap – buying the S&P gives you overexposure to overpriced stocks, and the article warns of an upcoming sell off in the markets. The article states that indexing is very dangerous when the performance differential gap between value and growth stocks is extreme. Apparently the “smart money” is now dumping the index.

4. Unknown Territory – A warning that due to ETFs being a “relatively new” investment vehicle, their liquidity is yet to be tested in a “major bear market”.

What are the experts’ opinions on this?

Monday Morning Millionaire Program Answer:

SPY, IVV, VOO and other S&P 500 ETFs closely parallel the market which has been hitting new highs over the last few years. By rebalancing their portfolios, Monday Morning members have been taking profits. SPY, IVV, VOO and other S&P 500 ETFs will drop in value when the market inevitably declines. By rebalancing their portfolios, Monday Morning members will be scooping up bargains.

1. Concerning overexposure to tech stocks of which FAANG stocks are a part, while they do make up about 25% of the S&P 500 like they did before the crash of 2000, they are much more reasonably priced today according to the Bespoke Investment Group. The tech stock forward price-to-earnings ratio is at about 19, compared to 60 in before the 2000 crash. Their valuations are more justified by the fundamentals.

The FAANG stocks themselves really are insanely valued but they make up only 5% of the S&P 500. If they lose 100% of their value, the S&P 500 will drop only 5%. Moreover, any drop in the FAANG stocks value would be offset by Microsoft Corporation, Berkshire Hathaway, JP Morgan Chase, Exxon Mobil, Johnson and Johnson, Bank of America, Intel Corp. and many other more reasonably valued giants.

2. Concerning the diversification myth, most great fortunes in history were made by concentration and not by diversification. Think of the Medicis and the Rothschilds in banking, the Rockefellers in oil, Henry Ford in automobiles, Thomas Edison in electricity, and more recently, Bill Gates in software, Andy Grove and Gordon Moore in computer chips and more. Few achieve what they did. Since the beginning of time, failures exceed successes by an enormous margin.

Monday Morning members build their wealth by taking the safe route of diversified concentration or the concentrated diversification approach by investing in the entire US market by holding SPY or IVV or VOO or any other S&P 500 ETF. That means they have a share in the largest 500 blue chip companies on the planet most of which operate internationally. Five hundred! Internationally! Need more diversification?

3. Concerning “smart money” dumping the index, see our May 14, 2018 blog. To whom are they selling? They are selling to equally “smart money” at Goldman Sachs, BMO Capital Markets, Morgan Stanley, Bank of America, Credit Suisse and others who, collectively on average see the S&P500 at 2,861, or up 5% by the end of 2018!

4. Concerning ETF liquidity in a major bear market, securities listed at key stock exchanges can be sold in a split-second be they rising, sideways or dropping. That has always been true. Oliver Garret, the author of the Forbes article, could be wrong.