There's No Such Thing as an ETF Bubble

Some have said that ETF bubbles helped lead to the stock-market decline. As ETFs track indexes, that can't be true.
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BOSTON (TheStreet) -- TheStreet.com recently published a guest article by an anonymous blogger from a site called YieldPig asking the rhetorical question of whether exchange traded funds are "the next bubble."

Bubbles are all-encompassing events that leave much damage in their wake. The tech-wreck bubble 10 years ago was a major catalyst in driving the stock market down 50% and causing ripple effects. The contributing factors that caused housing to implode in the past couple of years, again, were catalysts for the stock market falling by half. We're still trying to sort out the consequences yet to come.

About a year and half ago, I was on

The Closing Bell

on CNBC and was asked whether solar stocks were a bubble. That was when crude oil was close to its high, and solar stocks were popular and doing well. Solar stocks weren't considered a bubble. Not everything that goes up in price, only to plummet, is a bubble. The

Market Vectors Solar Energy ETF

(KWT)

had a market value of less than $100 billion. During the tech wreck, we had dozens of stocks with no earnings with market caps greater than $100 billion -- does anyone remember Commerce One or Ariba? The difference is that one was an industry, solar, and the others are companies. Maybe solar was a mania but most definitely not a bubble.

The guest author from the ETF-bubble story shares a list from Robert Shiller of seven things to look for in a bubble. According to the author, ETFs meet two of Shiller's criteria: a lot of media attention and interest among the investing public. The author seems not to understand what ETFs are: They provide access to all sorts of market segments, including broad stock-market indexes, gimmicky themes and exotic currencies.

You may believe that housing became a bubble in the past couple of years, along with bank stocks, REITs and maybe even the stock market itself. If so, were the bubbles caused by the funds tracking those market segments? Did the existence of the

Financial Select Sector SPDR

(XLF) - Get Report

, the

iShares DJ US Real Estate Index Fund

(IYR) - Get Report

or the

S&P 500 SPDR

(SPY) - Get Report

cause the bubble or was it some combination of low interest rates, inappropriate lending standards and the misuse of leverage?

Those three ETFs clearly went along for the ride as the bubble inflated and then popped in the aftermath. But the notion that the bubble could be caused by funds tracking the source of the bubble is shortsighted. It is a good bet that there are ETFs that will track whatever the next true bubble is.

The guest author, in trying to support his case that ETFs could be a bubble, notes that his 73-year-old mother-in-law doesn't need an ETF that "tracks the Chinese yuan." This line of thinking comes up frequently and is thoroughly ludicrous. Following his logic, anything that isn't suitable for his mother-in-law shouldn't exist. Investors, pros and individuals alike, have been blowing up their portfolios for years, long before ETFs began to proliferate. If every ETF closed tomorrow, people could still get into plenty of trouble buying out-of-the-money options to speculate on an earnings release or by loading up on a stock like

Dendreon

(DNDN)

right before Food and Drug Administration news is due to hit. Greed and betting far too much on a specific outcome weren't invented in 1993 when the first U.S. ETF was listed.

There are plenty of ETFs that provide a means for aggressive speculation, and they have an audience, to be sure.

Direxion Funds

, the provider known for offering long and short funds that offer 300% of the daily exposure for the indexes they track, has almost $6 billion in assets under management. There's no doubt that some folks won't understand the dynamics of those products. This would be no different than with options or lottery-ticket stocks.

Investment products aren't greed-causing or speculative in and of themselves. They may create the means with which to express those behaviors. But remember that options can be used in defensive hedging strategies, and bonds, considered the safest of securities, can be used in speculative trading. The opinion expressed from the YieldPig blog is better pointed at human behavior, not an investment product.

At the time of publication, Roger Nusbaum had no positions in the securities mentioned.

Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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