Irrational exuberance

A very interesting fact is shown in the chart below. When markets get ahead of themselves, often you see signs that would indicate common sense has taken the back seat. There are currently more ETFs listed in the U.S. than actual stocks, which is the typical underlying of those ETFs. Think about that for a second: there are more baskets of financial assets, than financial assets. It’s like having more hammers than nails. We also know that the total gross notional exposure in OTC derivatives is approximately $850Tn. The total amount of listed equities and bonds is roughly $275Tn. Of course the currency market is huge, but we’re talking about more than 3X the underlying. Technology has lowered so much the cost of building those second derivative financial assets, that they are popping up like mushrooms. One of the main implications of this oversupply, is that fees associated with these ETFs need to go down, because they compete among them. And to differentiate themselves, a significant amount of newly created ETFs use leverage, because they need to compete in returns as well. That’s one additional indicator (other than valuations, leverage, concentration, debt, etc) that tells us we’ve entered the irrational part of the bull market.

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