ETFs Big Buyers Of US Stocks

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By Heather Bell and Sumit Roy

ETFs have been big buyers of stocks this year, but they aren't the biggest ones, according to Goldman Sachs. In a research report published on Friday, Goldman analysts led by David Kostin outlined the most significant sources of equity buying in 2017, and where they see the market headed later this year.

Impressed by the strong inflows into equity ETFs during the first quarter―$98 billion per Goldman―the firm raised its full-year inflows forecast by $100 billion to $300 billion in new assets. ETFs have now bought up so many stocks that they own 6% of the U.S. equity market, according to the investment bank. That is the highest ownership share on record.

In contrast, equity mutual funds were net sellers of stocks to the tune of $31 billion, and Goldman expects that trend to continue with a call for outflows of $50 billion from such funds for the full year. Mutual funds own 24% of the stock market, their lowest share since 2004. The report notes that Goldman expects “modest deceleration” from ETFs during the second half of the year, and that mutual funds will continue to see weakened demand and inflows due to the continued growth of passive management.

Further, Goldman says that by the end of the year, it anticipates foreign investors and corporations to be significant net buyers of stocks. The firm also expects the U.S. market to decline from its current levels, so investors may want to consider foreign equities, with Goldman expecting U.S. investors to purchase a total of $300 billion by the end of the year.

Link Between ETFs & Stock Performance?

If the record growth of ETFs is one of the biggest stories in financial markets, the stock market’s relentless march to new heights is the other. This raises the question of whether the two are connected.

There was some insinuation in last week’s headlines that this is indeed the case, but Goldman analysts never came out and explicitly said ETFs were driving the market higher in the report, just that they represented an increasingly large block of stock ownership.

After all, the growth of ETFs over the past few decades has taken place irrespective of what's happened with the stock market. ETFs have gained assets through up and down markets alike, so why would they suddenly be such a significant driver for stock prices?

The Reasons Why

They're not, according to Todd Rosenbluth, director of ETF and mutual fund research at CFRA, mainly because the money going into U.S. equity ETFs is largely replacing money coming out of active equity mutual funds.

That's just one of the reasons ETFs shouldn't be credited for the market's rise, says Rosenbluth. Additionally, "more than half of the inflows this year are for international equity ETFs, which would not be impacting U.S. stocks," he explained.

Meanwhile, if the inflows into U.S. equity ETFs were notably impacting U.S. stocks, Rosenbluth added that "then there would be a tighter range in performance of sectors, yet we have energy and telecom significantly lagging technology and health care."

Another Viewpoint

Nonetheless, it's still hard to ignore the sheer magnitude of the inflows into ETFs, particularly this year. Through the end of May, flows into ETFs have averaged $2 billion per trading day, almost double last year's rate (though only about a third of that has gone into U.S. equity ETFs).

That may not sound like much compared to the $295 billion worth of securities traded on U.S. equities markets on an average day (according to Bats Global Markets), but stocks are priced on the margin, so a few billion dollars here or there could potentially move the needle.

Ilya Feygin, managing director and senior strategist at WallachBeth Capital, says the evidence suggests ETFs have been a big driver for the market this year. He told CNBC that "the market has often made strong gains in weeks of strong inflows even in the face of bearish macro news, and it has paused when there is not much inflow, or the inflow went to international ETFs instead of U.S."

Another data point that indicates ETFs may be punching above their weight in the market is the fact that they now account for nearly a third of all U.S. equity market trading volume, according to Credit Suisse.

The Middle Ground

Perhaps the truth is somewhere in the middle. ETFs are helping fuel the market's run, but that money would be coming into stocks regardless, whether in the form of individual stocks, mutual funds or hedge funds. ETFs are simply investors' preferred vehicle for getting market exposure today.

That's the explanation that resonates with Eric Balchunas, senior ETF analyst for Bloomberg, who points out that people putting more money into ETFs means there will be more creations and therefore more stocks will be bought.

However, he also points out that investors in stock ETFs are looking for equity exposure and would otherwise just buy stocks directly or invest in actively managed mutual funds.

“Nobody is buying an equity ETF unless they want stocks," Balchunas said, adding that with an ETF, investors get that exposure with a more tax-efficient, flexible and cheaper wrapper.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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