ETFs Suck. Here’s How to Make Money On Them Anyway

At this stage in my career, I can pretty much do anything I want.

In fact, last week I rented out a 46,000-seat stadium (Orioles Park at Camden Yards) just so I could record a little video footage. (More on that in just a few minutes.)

So let me be blunt: ETFs suck.

And you should not invest in them.

I tell people all the time that the ETF is a primary weapon in Wall Street’s arsenal. It’s their way of selling you a ticket on the Hindenburg since most investors don’t know what the heck they’re buying into when they buy an ETF.

And the ever-growing ETF market is a minefield of risks as people seek out new ways to beat the market or trade themselves into abject poverty.

Initially, ETFs focused on indexes that provided low-cost liquid asset allocation choices to investors, but we have evolved well past that stage. In today’s market environment, if you have an ingenious idea, odds are someone has already developed an ETF to exploit it.

These ETFs are made even more exploitative by the fact that Vanguard, BlackRock, and other money managers heavily market them to us via Fox News and Facebook. The advertising is great, the sales pitch is excellent, and you will be very comfortable in the herd. For awhile.

Here’s the thing. When ETFs crash (and they will), they’ll create the mother of all profit opportunities…if you play it right.

ETFs Represent Everything That’s Wrong with the Market Right Now

I’m going to call in the big guns here to help me make my point – Howard Marks, legendary investor, writer, and co-chairman of Oaktree Capital Management. In one of his latest “Oaktree Memos,” Marks details, among many other things, the valuation impact of ETF investing.

He notes how the surging popularity of passive investments like ETFs will obviously bring more cash into index-listed stocks like Apple Inc. (Nasdaq: AAPL) and Johnson & Johnson (NYSE: JNJ) than other stocks. This could bode poorly for those other stocks since investors may foolishly pull money out of those and pour it into the indexed companies.

Marks summarized the problem with his letter’s most standout line: “It seems obvious that this can cause the stocks in the indices to appreciate relative to non-index stocks for reasons other than fundamental ones.”

Make no mistake: if stocks are appreciating to high valuations for any reasons other than fundamental ones, it’s a surefire sign of a bad investment.

It’s true that the indexes and sector replication portfolios contain very few bargain stocks right now. But while this may seem frustrating, it also sets the stage for the next sell-off.

Or, as I like to call them, portfolio creation events.

Marks’s memo lays out the case for why passive investors can actually open opportunities for the value-focused loons like us: “Can you picture a world in which nobody’s studying companies or assessing their stocks’ fair value? I’d gladly be the only investor working in that world.”

I sure as hell would too while the herds of people buying stocks without considering the underlying business push valuations to levels quickly becoming unsustainable.

No matter how Wall Street may try to disguise the risk of equity ownership by creating wacky new ETFs, a stock will always represent ownership in that business and eventually reflect the value of the business.

But that’s not even the biggest problem with the absurd ETF world…

This Is How the ETF Herd Opens Up Profit Opportunities for Us

The biggest problem is that ETF owners simply don’t know how to react properly to any market – whether it be bull, bear, sideways, or in circles.

Mr. Marks talks about the high-yield bond ETFs, which are much easier to buy than it is to assemble your own individual bond portfolio. In bad markets, I’ve seen even the popular bond issues of the day go no bid, meaning there was no buyer at any price.

If the ETFs cannot sell bonds, they cannot honor excessive redemptions, and the share price will collapse to zero.

Also consider the First Trust NASDAQ ABA Community Bank ETF (Nasdaq: QABA). This ETF owns hundreds of small community banks, many of which are thinly traded. That means if the fund enters panic-selling mode then the prices of the underlying banks will crater as the fund managers desperately seek buyers to me redemptions requests.

Dozens of ETFs own a lot of small cap stocks that will get crushed if fear enters the herd – and the marketplace.

A bunch of you may be sitting back right now thinking your portfolio is bulletproof since it contains index ETFs with large-cap stocks. Surely these stocks will find buyers even in the worst market, so there is no need to worry.

As someone who has 40 years in the markets under his belt, I can say with some degree of certainty that’s a load of horse pucky.

And Mr. Marks, despite having about a decade on me in the markets and using his words a bit more eloquently, says pretty much the same thing.

He notes, “It’s not clear where index funds and ETFs will find buyers for their over-weighted, highly appreciated holdings if they have to sell in a crunch. In this way, appreciation that was driven by passive buying is likely to eventually turn out to be rotational, not perpetual.”

Someone will eventually buy the shares your ETF holds, but you better consider who those buyers are and the prices they like to pay.

Because those buyers, the last-resort types, are people like Michael Price, Carl Icahn, Seth Klarman, and yours truly.

And guess what, we’re all notorious cheapskates when it comes to buying stocks.

Right now, the median earnings before interest and taxes (EBIT) to enterprise value (EV) for S&P 500 companies is 17.2. None of us are even vaguely interested in those companies until that number falls into the single digits.

The median PE is 21, and again, we all want a single digit number.

The median price-to-book is almost two, and we want less than 1.

If these metrics show anything, it’s that there’s a lot of space between current market valuations and the valuations that cold-blooded buyers like me pounce on.

So if you like ETFs, please keep buying them. It will eventually provide the mother of all buying opportunities when even the biggest stalwart stocks see their prices crater.

If you’re the patient-aggressive type like me who prefers “hidden gem” companies that trade miles outside the indexes, we’ll always have buying opportunities.

That’s where I come in – and that’s what I’ll bring you, no matter what the market does.

And, speaking of profit opportunities…let me tell you a little more about what I was filming at Orioles Park the other day.

Now, I’ve told you about my Five Max Wealth Rules.

But that’s just the beginning.

There’s an INSANE secret I haven’t told you yet – the secret to my UNDEFEATED track record.

And how anyone can do what I did.

  • All 32 of my closed positions are winners. Not some, not most, ALL OF THEM.
  • My average gain is 70%
  • And as of August 8th, 85 of my 87 open positions are up (the vast majority by double and triple-digits).

This gives me a 98% WIN RATE.

And on September 26th (at 8 p.m.) EST., I’m going to show you how.

This video will be like nothing you’ve ever seen before. It includes the Oriole Bird. It includes alligators. And it does not include a single option or complicated trading strategy.

You can register now, right here. This way, you’ll get a link as soon as it goes live.

To the Max,

Tim Melvin

One Response to “ETFs Suck. Here’s How to Make Money On Them Anyway”

  1. Great volume of work Tim, appreciate the insights, but you’re adding more fodder with sports betting comments. Oh those Oriole teams winning 100+ games from 1970-1980 memories the only thing I’d add, maybe Dan Duquette will try Sabermetrics.

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