ETFs Prophesized by Nostradamus To End The World!

That was kind of thought I had yesterday as I read articles from three different and well regarded bloggers. Trader Mark believes they are the tail wagging the dog (in some instances), Phil's Stock World feels that when it comes to going long "we usually know how to pick a good stock for ourselves, thank you very much, that will outperform a whole index" and Barry Ritholtz re-ran a funny post about the next big thing in ETFs being single stock ETFs which will capture 99% of the common but without the dividend.

It makes me wonder who could it have been who came up with this idea...who could it possibly have been....oh, I don't know, Satan?

One big macro point to make is that for better or worse financial services and markets is an industry that evolves. Love 'em or hate 'em ETFs are part of how things are evolving currently. Trader Mark points out that hedge funds used to buy baskets of a few individual stocks to create exposure but now use ETFs which he says means that these dollars are moving the entire index.

The flip side to that might be that the same dollars would potentially be accused of manipulating far fewer stocks without the ETFs.

Phil covered a lot of ground so I will do my best to capture the correct context but he says one thing that, if I am understanding him, is flat out wrong. He notes that the US Oil Fund (USO) is a "poor tracker." Joe Terranova said essentially the same thing on Fast Money one morning (in my time zone) last week. Both say, or imply, that USO does a poor job tracking spot oil and so people should avoid the fund (actually Phil said he sells it short). USO might do a poor job tracking the spot price but, um, well, it is not supposed to track the spot price. USO tracks the front month futures contract. If the market is in contango then it will be a "bad" hold. I have said quite a few times that in addition to being right about the crude oil market you also have to be correct about the roll yield in order to have success with USO--or simply short that fund which has generally worked.

To be clear I have no use for USO as tracking the front month in an ETP has proven out to be worthless IMO but it is functioning the way it is supposed to function--tracking the front month and the consequence (or benefit) of rolling to the next month's contract.

The joke about single stock ETFs makes a point about the proliferation of funds but of course the market place sorts this out with flows into useful (intentionally vague word) funds and little to no flows into funds that for whatever reason lack utility.

The argument about picking stocks and not using ETFs is not much of an argument as an indictment for the wrapper. The idea of doing the work to research the stocks and then buying the best one ignores a lot of variables like just being wrong which happens to everyone or choosing the right stock at the wrong time or choosing the wrong stock but at the right time.

Plenty of people are successful bottoms up stock pickers but ETFs offer access for people who want most of the narrowness of stocks but who do not want single stock risk. While I do not think the Global X Lithium ETF (LIT) will ever look much different than SQM it will be more comfortable for some folks who do the work and conclude yes on lithium to buy the fund over the stock. As another example, in talking about individual stocks people say there is a limit to how many individual stocks an investor can own and maintain proper diligence on. If your number for individual stocks is five are you going to put your entire nest egg into five stocks or will you use other investment products, like maybe ETFs, to round out a diversified portfolio? On a related note ETFs require plenty of work for reasons I have mentioned in other posts but for brevity sake, won't go into here.

I am a huge believer in using whatever you think is the best product for each exposure sought for the portfolio. To repeat myself, it is illogical that any single wrapper can be the best way into every single part of the market for every investor.

As an example, a long time ago we owned BP. We sold it in Q1 2007 and swapped it for WisdomTree International Energy (DKA). Later we sold Sinopec (SNP) and increased our exposure to DKA, which we still own. Going into the bear market it made sense to me, as part of our defensive strategy, to reduce single stock risk and volatility in the sector and by extension, the portfolio. More recently we bought Suncor (SU) to increase the energy exposure and the overall long exposure of the portfolio as adding volatility back in made sense as time moved on from the March 2009 low. Very recently we sold some of the DKA and and bought the Market Vectors Coal ETF (KOL) as increasing the volatility but with the same amount long made sense to me when we did this trade. I have a list now of three or four oil stocks that could replace DKA which I will probably implement in the next couple of months or so. The remaining weight in DKA is such that it would take two or three stocks to replace it out of the four I have isolated as possible candidates.

Don't focus on whether I turn out to be right or wrong with the timing of anything as opposed to the process of ETFs being the better choice for some parts of the stock market cycle versus stocks being better at other times or a combo of the two. At times it makes more sense to take on more volatility and take more single stock risk, relatively speaking, and having multiple products in the context described about makes this easier which is where I think the utility really is.