The Effects of ETF Cash Flows on Equity Values

My response by email to Mr. Zweig yesterday –
I have been convinced that the ETF funds exercise a significant influence on equity valuations and your recent column on low volatility stocks gave me an opportunity to prove it – to my satisfaction anyway.
The first graph is the dollar volume for the large ETF, iShares MSCI USA Minimum Volatility (USMV) showing a clear run-up that you described. (Yahoo Finance: Monthly, $ millions.)


The chart below shows the relative strength of 50  of the larger stock holdings in the USMV. The index is the relative performance of these stocks compared to the average of our universe of close to 500 equities. It shows a gain of 25% from the low in the summer of 2014.


Finally, this is the average Valuation Return/Risk (VR) of these stocks, again relative to our universe. From a high of +5%  in early 2014, the average Risk is now -15%. (VR is the projected price change between the current price and the price at which it would equal its inherent value)

My theory is that purchasing ETFs does not involve valuation analysis as individual stock selection would and it appeals to Momentum buyers.  As such it becomes a source of inefficiency in equity pricing.
(c) 2016 Robert L. Colby

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