I’ve made a career in spotting trillion-dollar themes in the market, first as an equity analyst and more recently as a pre-IPO investor.
Any analyst can create a cash flow model — it’s as simple as working through a company’s financial statements to scrutinize the true cash-generating power of the investment. Every broker, research firm and fund manager has a team of analysts with their noses buried in 10-Ks and other documents.
But being ahead of the herd requires finding those market forces that will influence the direction of whole sectors, or even the entire market.
It’s finding themes with the force of trillions behind them that create triple-digit return strategies.
I’ve used what is likely the most pervasive theme driving today’s markets to find stocks with huge support. I then looked for upside price catalysts on these stocks to identify three names that could be the biggest outperformers of the year.
Are ETFs Taking Over The Market?
Hedge Fund investors and Mutual Fund clients are dropping expensive portfolio managers in favor of passively-managed exchange-traded funds (or ETFs).
Global ETF inflows reached a record of $375 billion in 2016, an increase of 7.8% over the previous year. U.S.-listed ETF assets now total a staggering $2.56 trillion.
FactSet data shows that 2017 ETF inflows have already topped $203 billion through May, putting this year on track to pass $3 trillion in ETF assets.
ETFs now account for 30% of the trading volume in stocks, double their trading volume a decade ago.
Investment consultant NEPC surveyed 74 endowment and foundation clients recently and found 40% had increased allocation to passive investment funds. More than a quarter of the respondents said they planned on further increasing their exposure over the next 12 months.
The stampede to ETFs is a pervasive theme, shifting money in every sector and asset class. Besides lowering trading costs, a good thing, it’s also creating a huge market imbalance.
That could be a bad thing, unless you know how to use it to your advantage.
The ETF Trend Could Be A Stock Picker’s Dream
There are two potential effects of the shift to ETF investing by institutional and retail investors.
As passively managed funds, there is less market discovery in stock prices. If a portfolio manager is simply recreating in an index, there is very little or no analysis of the investment value of stocks in the index. When this is done on a massive scale and with trillions of dollars, prices and valuations can become distorted.
This creates an opportunity for investors that are ready to spend the time to find individual stocks.
Since these funds passively invest in an index, a group of stocks that is only rarely changed, the buying in those stocks is relatively stable. This creates a level of demand for stocks in the most widely-held indexes with a stable group of funds continuously buying more shares as money flows into the ETFs.
That means stocks with a high percentage of shares outstanding held in ETFs should see a level of support on the demand from fund buying. An individual company may be listed in several different indexes, including groupings by sector, markets, geographic exposure and income.
Combine this market price support with a search for companies with upside catalysts and you’ve got a strategy with limited downside and the potential for strong returns.