IWM Topping QQQ: A Teachable Day for ETF Investors
July 11, 2024 may serve as a wakeup call for
While July 11, 2024 may not stick in investors’ and financial advisors’ minds, maybe it should.
Something happened on that day last Thursday that hasn’t happened before. The most popular index of small cap stocks, as measured by the Russell 2000 Index ETF (IWM), rose 4% while the Invesco QQQ Trust (QQQ) dropped 2%.
Maybe that trading anomaly means absolutely nothing. Still, it may be yet another sign of how ETFs continue to progress through a slow-moving coup that’s making them essential for investors to understand.
As for advisors, it shows an ever-growing risk of being left behind if they don’t learn more about how ETF flows and the occasional herd mentality they force on market prices works. Because none of the above is a bad thing. That is, unless an investor ignores it and is thus caught off guard when they could profit.
In other words, advisors have every opportunity to be the “smart money” in modern markets. And days like last Thursday can not only make them smarter but help them proactively communicate to clients that they're on top of how markets work today, versus how clients may still think they work.
Most advisors’ clients are busy doing other things than noticing nuances like how markets behave now versus how they may have been taught by friends or family years ago, when ETFs were an emerging asset type. They have clearly emerged, and with every trillion dollars that flows in, the “indexation” effect on every investor’s wealth gets magnified.
Why July 11 Was Different This Year
I may be a markets geek, but not to the extent where I know the history of market behavior on July 11 in past years. But in 2024, it was a strange feeling. Seeing QQQ, the confirmed market leader, fall while IWM, a laggard the past few years, posts a return that equals about nine months of T-bill returns in a single day, was surreal.
But it shows that markets more than ever are correlated. Not to each other necessarily. In other words, stocks don’t often all go up and down together in the same percentage levels, though on major down periods, they are more likely to do so. But what is happening more often is a “birds of a feather” effect. Big Nasdaq 100 stocks fell in unison, while investors bought up small caps as if they were all the same company.
QQQ and IWM: How Rules Have Changed
This has nothing to do with fundamental analysis, and everything to do with indexation. That is, when big-pocket investors decide to trade a rally in small cap stocks, they can dissect 2,000 businesses. But they don’t. Instead, they buy IWM or another small cap ETF in a single trade. That promotes the tendency for small caps to flock together. Because they are all part of the same index, and ETFs have so much capital flowing into them, some like IWM and QQQ become “one-stop shops” for entities looking to move quickly.
There is a bit less synchronicity in QQQ, since it is so top-heavy, with seven stocks occupying 43% of the index and thus, that ETF. And with those mega-cap leaders each being looked at so closely as individual stocks, many trading days can be a mixed bag, so to speak.
Through the end of last month, IWM had trailed QQQ by about 15% over the preceding six months. That’s not the highest gap on record, but it is toward the top of the list historically. So, a one-day mirror image of that longer term performance trend is a very Wall Street thing to see for a day. But the fact that “7-11” saw a record disparity between the two reminds us that markets more than ever can move suddenly, and sharply.
And it doesn’t take much to make it so. Indexation, the increased presence of algorithmic trading and other aspects of contemporary stock market realities all add up to a new environment. Advisors who are proactive in studying this as part of their fiduciary role in presenting timely knowledge to clients will put clients in a position to capitalize going forward, rather than being left wondering what changed, or what went wrong.