WASHINGTON. In our previous article, we discussed our own and a prominent investor’s matching thoughts on how large, popular index funds and index ETFs can take a bite out of investor portfolios when things go bad. Most index funds and index ETFs are weighted in favor of large cap stock holdings. But when just a few of these large caps turn in a lousy performance, they can kill the whole index. Subsequently, in doing so, they can also damage many other perfectly good-performing stocks in the process.
Let’s check out one real world example we recently invested – and disinvested – in.
Investors playing Russian Roulette with index funds and index ETFs?
Example: We experimentally invested in two new index ETFs that were built in advance to represent the new S&P Communications Services industry sector. This sector was created by joining the dying Telecommunications sector – there are almost no pure-play telephone companies left – with the broad category that includes newer companies or conglomerates that facilitate or host “communications.”
S&P pulled broad number of very popular stocks from its existing IT (Facebook, Google) and Consumer Discretionary (Comcast, Disney) indexes and joined them with the remains of the old telcos (like AT&T), and voilà! They created what seemed to be a very promising, up-to-date, and robust new industry sector that took into account how the communications sector had evolved.
No sooner had we tried out these indexes via ETFs like Vanguard’s VOX (trading symbol: VOX) than these new indexes tanked. They’ve been tanking ever since. This horrendous performance is largely due to VOX’s outsized position in heavily weighted Facebook (FB).
VOX and the Communications Services industry sector aren’t feeling so hot
Due to various miscalculations and social missteps, Facebook shares remain under serious pressure. VOX’s holding of FB shares – 12.58 percent of its total holdings – has been getting slaughtered for months. This position is currently down 18.36 percent year-to-date.
Add to that dismal performance the even-worse performance of old telco / new media company AT&T (T) – 4.6 percent of VOX but down 22.27 percent YTD. Throw in Comcast Class A shares (CSCA) – 4.5 percent of VOX, but off 9.26 percent YTD. Now, nearly 25 percent of this new index is deep under water, compared to its relative robustness earlier this year.
Better performances by Netflix (NFLX) – 4.73 percent of VOX, up 39.01 percent – and 21stCentury Fox Class A – 2.08 percent of VOX, up 42.08 percent (due to takeover activity) aren’t enough to help. VOX still can’t come close to compensating for the catastrophic performance of FB, T and CMCSA.
Put together earlier this year based on the conjectural contents of the new Communications Services Index (which went into effect in late September 2018), VOX hit its peak price of $93.38 per share back in February. But this ETF, managed by respected mutual fund and ETF stalwart Vanguard, has remained on a steady downward trajectory ever since, largely due to the horrendous performance of its highly weighted holdings in Facebook.
We join an ETF dump-athon
We dumped what shares we held a couple of months ago. Too much pain for the investment with zero hope of near-term recovery. Conceptually, the new Communications Services index contains a lot of exciting stocks. Many of its current holdings are doing just fine.
But with the heavy, large capitalization stocks doing so poorly, the entire index – and hence an ETF like VOX – is cliff diving. But the neverending plunge is based primarily on the rotten performance of those heavily weighted big caps. Dumping the ETF shares causes commensurate selling in all its components, including those that continue to do well. Thus, in effect, big loser stocks like Facebook, AT&T and Comcast are destroying all the other stocks in this index (and associated ETFs like VOX).
This is unfair. But, alas, we’re in the wonderful world of investing where “unfair” stuff is part of market risk. Nevertheless, you can see how index funds and related ETFs can massively lift all boats when things are good, but sink the investor Titanic when the tide goes back out again.
Complicated? Boring? Yeah. But even though we’re deep into a few ETFs right now, most of these conglomerate holdings are looking pretty bad.
A variety of villains are slaughtering end-of-year markets
Recall again our previous article. While CNBC interviewee Jeffrey Gundlach may not be exactly right about the current state of ETFs – after all, his firm does compete, in a way, with ETFs – he does call out an issue we’ve long worried about. What if all the lemmings do the same thing and dump a big index ETF wholesale. This would have a far, far worse negative impact on the market than, say, just dumping shares of Facebook.
Yet we think that’s at least part of what’s playing out in today’s market action. Like Friday’s bi-polar mark Monday trading has veered from near flatline to another, horrible 400-point decline at 2 p.m. ET Monday. Massive dumping of stocks, ETFs, bonds, you name it by failing hedge funds isn’t helping here, either.
The vexing thing about all this is that you can never know at all where the market will close on a given day. Thus, you never really know when it’s a good time to buy and sell, since this market will do a 180 either way within an hour of a market low or high.
This is why investors are heading for the exits en masse as 2018 draws to a close. It’s a stampede that’s approaching irrationality. But people no longer care. They just want out. And whenever some overly optimistic big investor or fund scoops up a bunch of shares they view as outstanding bargains, driving those shares nicely up, the sellers use this as an excuse to dump even more shares and, of course ETF shares as well.
Batten down the hatches
This agony will not end until everyone who’s wanted to sell finally sells. According to tradition, the bloodshed should end on the last trading day of 2018. That’s when those final sell orders will close out the investing year before the new one begins.
But if momentum yet remains with this fall’s massive selling tsunami, 2019 could end up beginning just like 2018 ended. Not with a bang, but a whimper.
— Headline image: Vintage, out-of-copyright Yellow Kid cartoon from late 19th-early 20th century.
Cartoon verbiage updated by T. L. Ponick to reflect December 2018 stock market conditions.