Are ETFs Driving Stocks Higher?

June 29, 2017

Two of the biggest stories in financial markets this year: exchange-traded funds gathering record-setting amounts of assets while the stock market relentlessly marches to new heights. This raises the question, are the two connected?

You might think they are, based on a flurry of headlines from earlier this week that insinuated ETFs were the driving force behind this year's stock market ascent. Those articles cited a Goldman Sachs research report that said ETFs now own 6% of the U.S. stock market, the highest-ever ownership percentage.

But Goldman analysts never came out and explicitly said ETFs were driving the market higher, just that they were an increasingly large buyer of equities.  

Into ETFs, Out Of Mutual Funds

After all, the growth of ETFs over the past few decades has taken place irrespective of what's happened with the stock market. ETFs have gained assets through up and down markets alike, so why would they suddenly be such a significant driver for stock prices?

They're not, according to Todd Rosenbluth, director of ETF and mutual fund research at CFRA, because the money going into U.S. equity ETFs is largely replacing money coming out of active equity mutual funds.

That's one of the reason ETFs shouldn't be credited for the market's rise, says Rosenbluth. Additionally, "more than half of the inflows this year are for international equity ETFs, which would not be impacting U.S. stocks," he explained.

Meanwhile, if the inflows into U.S. equity ETFs were notably impacting U.S. stocks, Rosenbluth added that "then there would be a tighter range in performance of sectors, yet we have energy and telecom significantly lagging technology and health care."

The Relentless Bid Effect

Even if ETFs aren't pushing stocks up, they could still be impacting the market in other ways. Josh Brown, CEO of Ritholtz Wealth Management, published a viral blog piece in 2014 that explained how the big Wall Street wire houses' push toward fee-based money management and away from transactional commission-based management has "greatly affected the behavior of the stock market." 

The result is less churning and more long-term investments in things like passive ETFs. Brown said that the new paradigm means there was "a relentless bid" under the market "as the torrent of assets comes flowing in every day," leading to "shorter and smaller corrections."

That sure sounds like the market of today, with billions pouring into ETFs daily, and the lowest volatility for equities in decades.  

 

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