We’ve all heard the indelicate expression “Money talks, B.S. walks.” Well, as it turns out, when money struts into the stock market, it does not merely talk.
It grabs a megaphone and barks out commands… and that’s no B.S.
When money is pouring into a sector-focused exchange-traded fund like Invesco Solar ETF (NYSEARCA:TAN), it “tells” that ETF to buy more of the stocks it already owns.
Therefore, robust inflows boost the prices of the stocks an ETF owns, which in turn causes the ETF share price to move higher. The rising ETF price attracts even more money, which causes the ETF to buy additional stocks, etc.
A self-fulfilling virtuous cycle develops, in which ETF buying begets more ETF buying. As the process proceeds, the narrative surrounding the ETF’s area of focus grows increasingly bullish — proving the adage “Markets make opinions.”
The ETF’s high-flying price makes the opinion that the stocks in that sector not only deserve their rich valuations, but also deserve even higher valuations.
In other words, tail wags dog. A rising ETF price fosters rationales for buying it, rather than the other way around.
“Aspirational pricing” is a kind way of explaining — and rationalizing — the giddy valuations that result from this virtuous cycle.
But at some point, the robust inflows reverse. Seemingly out of nowhere, exuberant buyers become anxious sellers… and the delightful inflows that had been inflating share prices become outflows that deflate share prices.
As the outflows gain momentum, the virtuous cycle becomes a vicious one that drives share prices lower. Selling begets more selling, and a bearish narrative develops.
Once this phase begins, it usually runs for a while before playing itself out.
To observe how money has been “talking” to it, let’s take a closer look at TAN…
When Booms Lead to Busts
Recently, this solar-focused ETF achieved an eye-popping valuation of 180 times earnings. Robust fund inflows deserve most of the credit for this achievement.
During the two months preceding the stock’s peak on January 26, a whopping $1.37 billion flowed into TAN. For perspective, that massive sum boosted the fund’s size by 75%… and caused its share price to rocket toward the heavens.
Since that peak, however, more than $400 million has fled the ETF, causing TAN’s price to tumble 35%.
A similar boom-bust event unfolded at the Invesco WilderHill Clean Energy ETF (NYSEARCA:PBW). During the two months preceding the stock’s recent peak on February 10, $1 billion flowed into this ETF — causing its market value to surge by 50%.
Since that peak, however, more than $200 million has fled PBW, causing its price to tumble 40%.
Clearly, when money talks to ETFs, they listen… and obey.
Richly valued stocks like the ones that populate the portfolios of TAN and PBW are usually riskier than most. But they’re especially risky when investor funds are fleeing from them, which is exactly what’s happening at the moment.
Prudence would dictate steering clear of ETFs like these.
Even so, you need not climb into a bunker and hide from the entire stock market…
Stick to Quality and Growth
Simply avoid frothy stocks and sectors, while continuing to invest in high-quality, high-growth prospects, one by one. Focus your capital on the hardy stocks that can weather financial storms and deliver exceptional returns over time.
Admittedly, finding compelling opportunities in a richly priced stock market can be as challenging as shopping for bargains in an Hermès or Louis Vuitton boutique.
But even in high-end shops like these, a “Sale” rack is usually hiding somewhere in the back, maybe tucked behind a display of $2,000 scarves.
Timing is certainly important, but it’s not everything. In fact, I have identified some of my most successful investment opportunities close to major market highs.
Obviously, a serious market downtrend would weigh on most of the stocks in my Fry’s Investment Report portfolio. But over time, I expect them to deliver worthwhile gains, even if the overall market is going nowhere.
The travel and hospitality sector, for example, is one likely outperformer over the coming months. Our main play there is already up by more than 20% just shortly after I recommended it.
And I’m always looking for more undervalued stocks in the travel sector and elsewhere to add to the Investment Report portfolio.
P.S. Hundreds of thousands of folks saw my “Technochasm” viral video from earlier this year.
Well, the whole world has changed since then… and I’m back to talk about the Technochasm, the biggest megatrend in investing, in ways I couldn’t before… and discuss opportunities for even bigger market gains… the kind to keep you from falling behind. And I’m bringing along investing legend Louis Navellier to join me on camera for the first time ever.
On the date of publication, Eric Fry did not own either directly or indirectly any positions in the securities mentioned in this article.
Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends… before they take off. In fact, Eric has recommended 41 different 1,000%+ stock market winners in his career. Plus, he beat 650 of the world’s most famous investors (including Bill Ackman and David Einhorn) in a contest. And today he’s revealing his next potential 1,000% winner for free, right here.