Zero Hedge
0
All posts from Zero Hedge
Zero Hedge in Zero Hedge,

ETF Trading Volume Eclipses US GDP

In "signs of the coming financial apocalypse" news, ETF trading has now eclipsed US GDP. 

You read that correctly. Here’s Bloomberg

In the past 12 months investors traded $18.2 trillion worth of ETF shares, according to data from the New York Stock Exchange and Bloomberg. That's a 17 percent increase from the 12 months prior and more than triple what it was 10 years ago. For perspective, that means the amount of dollars exchanging hands through ETFs is now more than the U.S. gross domestic product, which stands at $17.4 trillion

To the Zero Hedge faithful, it should be immediately clear why this is so frightening, but for anyone who may be new to the "why BlackRock is a dangerous company" (to quote Carl Icahn) debate, allow us to explain, and because we’ve covered this extensively, we’ll stick to the high points. 

First, the post-crisis proliferation of ETFs has funneled massive amounts of retail money into corners of the market where mom and pop previously never dared to tread. This trend has been exacerbated by ultra accommodative central bank policy, which has had the effect of herding investors into riskier assets in a desperate search for yield. 

This comes as banks have pulled back from their traditional role as middlemen in the secondary market, meaning that while instruments like HY bond ETFs give the impression of daily liquidity, they cannot, by definition, be more liquid than the underlying assets they reference, and if dealers are unwilling to expand their inventories in a sell-off, fund managers facing sizeable redemptions could find that transacting in size is virtually impossible without having a significant negative impact on prices. 

So far, the diversifiable nature of fund flows (i.e. when one fund faces redemptions, other funds are seeing inflows) has allowed fund managers to use portfolio products in place of sellside dealer books. But that won’t work when flows become unidirectional (i.e. when everyone is selling) and if the underlying cash market is inordinately thin when fund managers finally need to sell assets, a fire sale could ensue due to a dearth of willing buyers. 

In essence, the ETF market is a mirage - a shiny veneer that masks a very ugly underlying situation.

If you need proof of how dangerous things have become, you needn’t look further than the fact that some of the world’s largest asset managers - Vanguard among them - have lined up emergency liquidity lines that can be tapped in the event a rate hike, a wave of bankruptcies in HY, or some exogenous shock sends ETF holders to the exits all at once (for the complete guide to ETF phantom liquidity, see here).

Think about that for a minute - what does it say about the market when fund managers plan to borrow money from banks to meet redemptions rather than risk selling the underlying assets? 

Of course the greatest tragedy here is that the continued use of ETFs and other portfolio products to satisfy diversifiable flows and the prospect of cashing investors out with borrowed money rather than the proceeds from asset sales in the event flows suddenly become decisively non-diversifiable only serves to exacerbate the situation - that is, the more you avoid the underlying market, the more illiquid it becomes. 

Here’s Bloomberg with some numbers which help to illustrate the narrative outlined above: 

But perhaps even more astonishing than the raw amount of trading is that U.S. ETFs only have $2.1 trillion in assets. In other words, the turnover in ETFs is about 870 percent a year. This is more than four times the turnover for U.S. stocks, which comes in at about 200 percent.

 

The increase in volume over the years can be attributed to both repeat customers as well as new participants who like anonymously darting in and out of everything from small-cap stocks to high-yield bonds to oil futures in an instrument that trades like a stock. Like a snowball rolling downhill, as an ETF sees volume increase it tends to attracts more, and bigger, investors, which in turn increase the volume.

 

All this manic trading is led by the insanely active SPDR S&P 500 ETF (SPY), which makes up a third of the total, or $6 trillion. That breaks down to about $24 billion a day, which is four times more than any other security on the planet and more than the next nine most traded equities combined. With $177 billion in assets, SPY’s yearly turnover equates to a mind-boggling 3,400 percent.

 

Beyond SPY, ETFs account for three of the top four most active equities, with the iShares Russell 2000 ETF (IWM) and the Powershares QQQ Trust (QQQ) trading over $3 billion a day each. Beyond equities, another big-time contributor to the trading volume is the iShares 20+ Year Treasury Bond ETF (TLT), which trades $1.1 billion a day, or more than what Citigroup stock trades. TLT’s massive volume shows just how thirstyinvestors are to trade bonds like stocks. (Individual bonds traditionally trade over the counter, and investors' use of ETFs to dip in and out of less liquid fixed-income assets has prompted quite a bit of controversy in recent years.)

The takeaway here, in the simplest possible terms, is this: underlying asset markets are disappearing while the vehicles that reference them are rapidly proliferating.

Obviously, this is an untenable situation and the worst part of the entire charade is that it's being perpetuated under the guise of safety, liquidity, and transparency by the companies investors trust most.