ETFs -- The Next Bubble?

Over the last decade, we've seen bubbles in technology/Internet stocks and real estate. Can ETFs by next?
By TheStreet Guest Contributor ,

The following guest commentary was written by the staff of the YieldPig investing blog.

What do Don Ho, the late Hawaiian heartthrob, and Yale economist Robert Shiller have in common? More than you would initially think. Surprisingly, Ho held a bachelor's degree in sociology from the University of Hawaii. He was best known, though, as a one-hit wonder and had a very long career singing about bubbles. Shiller's work, although somewhat more erudite, is about the same, burning the housing price index half named for him in our collective, real estate-bust memory.

In the

New York Times

last month, Jack Ewing examined Shiller's checklist for recognizing asset price bubbles. Indicators include:

  • Sharp increases in the price of an asset like real estate or dot-com shares.
  • Great public excitement about said increases.
  • An accompanying media frenzy.
  • Stories of people earning a lot of money, causing envy among people who aren't.
  • Growing interest in the asset class among the general public.
  • "New era" theories to justify unprecedented price increases.
  • A decline in lending standards.

Since man first figured out how to put a value on something, investment bubbles have followed. Over the last decade, we've seen bubbles in technology/Internet stocks, real estate and, most likely, commodities. What's next? China, maybe. Clean energy? Not yet. If a guess had to be ventured, exchange- traded funds, while not officially an asset class, could be a front-runner.

Currently, there are about 800 ETFs floating about. According to the Feb. 3 issue of S&P's "The Outlook," 552 new ETFs are in registration. While a few may never get out of the barn, that's more than a 50% increase. In 2009, ETF assets under management rose 45% and ETF trading on U.S. exchanges increased 10%. Discount broker

Charles Schwab

(SCHW) - Get Report

planted the DIY flag on Mt. ETF by announcing commission-free trading of their own brand of ETFs. Low-cost fund peddler

Vanguard

has had an ETF fund machine cranking for the last few years.

The ETF racket loosely resembles the American pop music industry the day after the Beatles appeared on the Ed Sullivan show in 1964: 20,000 garage bands formed overnight and the record companies had signed 5,000 of them by three o'clock that afternoon.

The benefits of ETFs to "Joe Investor" seem honorable enough. They offer sector and market diversification. Internal costs are rock bottom. Then there's the best feature that fits our 15-minute lifestyle: minute-by-minute liquidity. Buy Brazil in the morning, sell it by lunch time, and buy Singapore by the close. (Maybe that's not such a great thing).

Statistics show that market timing, especially by amateurs, is rarely successful. However, "everyman" has the power to keep trying and now it's even cheaper. But does your 73-year-old mother-in-law, who has to call you for a refresher course on how to turn on the computer, really need to have access to an ETF that tracks the Chinese yuan?

Two of Shiller's seven signs fit the ETF invasion. There is a media frenzy. Watch the commercials on any cable financial news network. Look at the top, bottom, left or right of this page. Chances are there's some kind of ETF banner ad. Jim Cramer even pointed to ultra short ETFs as a contributing factor to the market crash of 2008. You know you've arrived when you're a scapegoat.

Secondly, there is a growing interest among the public. Products and media are typically dictated by consumer demand. Everyone's talking about them. Even professional money managers are using them as an asset allocation tool. The top three holdings of a small mutual fund run by a small money manager in our area are ETFs.

ETFs -- the top holdings in an open-ended fund. The trend should be easy to identify. The ETF seems poised to replace the antiquated open-end dinosaur. By the looks of it, it's capable of overthrowing the open-end establishment from within.

The bottom line, of course, is money. Joe Investor wants to make money. He wants to do it himself, do it quickly, and he wants to pay the bare minimum to do so. But the financial services industry is far from a 501(c) 3. In the opinion of S&P Equity Research, "...the lure of increased asset gathering and fee generation from these ETFs will prove too strong to resist." Just like ever increasing real estate values and bubbly wine.

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