Popular ETFs Are Potential “Financial Weapons of Mass Destruction”

According to Money Morning Capital Wave Strategist Shah Gilani, there is a major financial event on the horizon that could impact your wealth in a massive way. And like a giant asteroid hurtling toward Earth, we can actually see it coming.


He calls it the “ETF Apocalypse.”

ETFs, short for exchange-traded funds, have been a boon for investors in recent years. They package industry groups, market sectors, or even the entire stock market into units that are easy to buy and sell. You buy them in the exact same way you buy common stocks.

And they’re huge, too.

Right now, the value of ETFs in the United States is about $3.4 trillion. It’s no wonder, because ETFs, unlike mutual funds, can be bought or sold all day long. They offer trading efficiency and favorable tax treatment, too.

The problem with most ETFs is that they try to replicate the performance of some index, such as the S&P 500 or the S&P Banks Select Industry Index. And most indexes are capitalization-weighted, meaning the more valuable a company is in the stock market, the more heavily weighted it is in the index.

When a stock is added or removed from an index, both mutual fund and ETF managers must make the same adjustments. That is why we saw the price of Twitter Inc. (Nasdaq: TWTR), for example, jump up the day it was added to the S&P 500. All those managers had to scramble to buy it, ramping up demand and pushing up price with it.

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The real problem is that the higher the market goes, the more valuable the biggest stocks become. They command even greater percentages of representation in ETFs in an ongoing spiral.

Here are some statistics from Gilani’s recent report:

Microsoft Corp. (Nasdaq: MSFT) alone represents 3.2% of the S&P 500. Apple Inc. (Nasdaq: AAPL) is 4% of the S&P 500. Alphabet Inc. (Nasdaq: GOOGL) is 3.1%.

Apple’s also in the Dow Jones, where its weighting in that index is 5.19%, and Microsoft’s weighting in the Dow is 2.68%. The Boeing Co. (NYSE: BA) is the Dow’s weightiest, at 9.79%, versus its 0.84% in the S&P 500.

When an index like the S&P 500 soars higher, the valuations of the biggest stocks continue to gain percentage-wise on the smaller and non-indexed stocks. This really distorts the market, as index performance masks what may be happening in the lower tiers of the market.

What would happen if ETF holders decided to sell a good deal of their holdings? It could happen when the current nine-year-old bull market finally peters out.

Just as the ETFs had to buy disproportionately more of the biggest stocks, so, too, would they have to sell disproportionately more when prices start to fall.

Envision a snowball rolling down hill and gathering more and more snow as it does.

The fallout would impact every single investor…

3 Possible Results of the ETF Apocalypse

First, it would probably start with a general market sell-off. The snowball starts slowly, with a small size, but it gathers more snow, or selling, in this case.

As ETF shareholders sell their index products, the heavily weighted big-cap names are sold in larger numbers. Just as they had more influence on the indexes they’re in on the way up, so, too, will they have the opposite, negative influence on the way down.

The snowball is now bigger and faster, and its larger size enables it to gather more snow at a faster pace.

Now, as the market is in decline, short sellers get in on the action. They add to the selling pressure, and the snowball grows yet again.

As shareholders sell their ETFs, those sell orders are followed by “authorized participants” – the trading desks that fund sponsors hire to create “units” of ETFs (a creation unit is 50,000 shares) – who unwind them as sellers reduce the need to hold underlying shares in trust.

It’s a devastating negative feedback loop…

No matter if you are a high-net-worth investor, a casual portfolio readjuster, or just a working stiff with a 401-K, chances are you have some of your money tied directly to the stock market. And you probably have exposure to ETFs that hold some of those behemoth stocks that can drag down the entire market.

The question is – other dumping your entire portfolio – whether there is something you can do about it.

It’s going to be spectacularly ugly and mighty tough for regular investors to get through it with their wealth intact.

So let’s get real: It doesn’t matter whether you’re a high-net-worth player or a middle-class retiree or saver, as long as your money is tied up in stocks, ETFs, or funds, you will always be at the mercy of Wall Street – and subject to outrageous risks like the ones we’ve just described.

Stocks… ETFs… they’re like D-list celebrities. One minute they’re on fire, the next, they’re burning out like a Fourth of July sparkler.

So what Shah has to show you could give you a shot at a much easier way to make money on the markets – week in, week out – far from the grasp of the Wall Street crooks who got us into this mess.

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