ETF Edge - Investing in the S&P 500 without the Mag 7 10/25/24

Episode Date: October 25, 2024

Worried about portfolio overconcentration in tech? What about the other 493 stocks in the S&P 500? Now, there’s a new ETF for that, too.            Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge Podcast is sponsored by Invesco QQQ, proud provider of access to innovation for the last 25 years. Investco Distributors, Inc. Welcome to ETF, The Podcast. If you are looking to learn the latest insights on all things, exchange, traded funds, you're in the right place. Every week we're bringing you interviews, market analysis, and breaking down what it all means for investors. I am your host, Bob Pisani. The Magnificent 7 ETF is one of the big winners this year. It draws $800 million in assets.

but is it time to look elsewhere, specifically, S&P 500 without the Magnificent 7? Now there's an ETAF for that too. Here is my conversation with Sylvia Jablonsky, CEO of Defiance EPFs. Todd Sone is the ETP, a technical strategist, at Straticus Securities. Sylvia, you launched the ETA, tracks the S&P 500 minus the Magnificent 7. Now, why do we need an ETF that cuts out the magnificent 7? Well, I think the Magnificent Seven have been on an absolute tear. They've rallied for, you know, many, many, many years, particularly the last year or two.

But now we're starting to see valuations getting a little bit loftier. We're starting to see easing monetary policy, which favors broadening markets. And actually, we have a lot of advisors that are realizing that they have such an over-concentration of exposure to these names, whether it's directly through the single stocks, whether it's through the S&P 500 holding 33-33 percent exposure to this, or the various thematic ETFs and things that they have. And so they're really neglecting these 493 stocks, some of which are doing well and are more than outperforming the MAG7 and the SMP 500. And so I think it's just time to add that diversification

and consider it a hedge. You know, we always talk about diversification. This goes back to my old mentor over at Vanguard, Jack Bogle. But I hate to ask the obvious question. What do investors gain by having a more diversified exposure. Yeah, well, I think if you only have exposure to the Mag 7, or if you have so much exposure to the Mag 7, whether it's, again, through your ETF, see the single stock names in S&P 500, when they rise, you do great, but when they fall, boy, do you suffer and do you feel the losses

in your portfolio, broadening out the exposure to the other 493 names, which, you know, arguably we haven't talked about that much because the Mag 7 have been, you know, kind of like the hot kid on the block, and now they're starting to perform. And I think that there's some tailwinds in coming years. What does this ETF look like? What does the S&P look like without the Magnificent Seven? What's in this? What's in this?

What's the biggest holdings? What are you holding? Yeah, I mean, you can look at Eli Lilly, Broadcom, J.P. Morgan, Berkshire, Hathaway. But there's some other names in there. Like Palantir is one of the big AI stocks that is in there. It's not a Mag 7, and it's doing absolutely great, you know, over 160% year to date. Well, we're looking here. This is the current largest holdings here, which makes sense.

It's market cap weighted, right? Market cap weighted, right? So obviously, after the magnificent. This is seven. Here's what you're looking at. Broadcom, Lilly, J.P. Morgan, Berkshire. But what I want to point out, let's put up the next full stream, is the return has been great here, too, as well.

So look here, we're looking at this. Todd, I want to just turn to you now. Each of these popular indices, they've had this heavy skew towards three names. So the S&P, NASDAQ, and essentially the Dow, although Nvidia is not in the now. But Apple, Microsoft, and Nvidia have had this heavy influence. They're at the highest levels of concentration in the S&P in, I don't know, what, 30 years. You always like to say to me, momentum, don't fight the momentum,

but investors should be very aware of their ownership concentration. Let's just put up what we've got here for the top three stocks in the S&P 500. Put the prior one up there. I want to show that 20%. Top three stocks in the S&P 500. You could slice and dice this a million different ways, but, you know, three stocks here, you know, look at that concentration there, 20.6%. We have unprecedented levels of concentration skews within, not only the S&P 500, Russell 1,000

growth, these three stocks and then add in the rest of the Magnumson 7 are over, I think, 60% of that fund. So if you have a portfolio that has an S&P 500 fund, large-cap growth, and maybe you have a tech sector fund in there, too, you have major. exposure to these small core of names. It's been great this cycle, but to Sylvia's point the rest of the index has been ignored and at some point the music stops. And so I think there's this really interesting dichotomy going on the ETF industry. There's Silvia's product which is saying let's focus on the rest of the index, the bench, right?

And then you have other issuers that are really saying you know what, just go big or go home. And I think that part of the equation is getting a little bit off-size especially when we look at flows to tech ETFs and whatnot. And so that just leaves me a little bit hesitant to want to continue to skew that way. I like the idea of looking at financials, industrial, real estate for 2025 to at least broaden out and diversify your exposure. Well, there is certainly evidence that diversifying pays some dividends for investors. Let's put up the returns here for the Magnificent 7 that had excellent gains. We put that up except for Tesla, but look at Sylvia's here. The largest holdings in this XMA 7 ETI, Broadcom, Lilly,

There's the bank that's in seven. Let's go with what we've got here in this current ETF. Broadcom, Lily, J.P. Morgan. Look at the, there's the largest holdings, but look at the percentage returns for the year here. Let's put on the next one. We had a percentage returns, but there we go. Thank you.

That's it. Look at these numbers. 57% return for Broadcom. 53 for Lilly. These have all outperformed the S&P 500 Exxon's kind of in line. line. This has not been a terrible year for, you know, the stuff outside of the Magnificent 7 that are the largest holdings. Is there a way to backtest any of this, or is there hard to figure out how to do this? Yeah, I mean, you can back test it, but it looks the way you

would assume, right? When the Mag 7 are rallying, then the S&P 500, market cap will outperform the rest of the 493 names, right, because you're getting that momentum from the top seven names. But I think the point is just this, that these names have run up and Todd made a great point. If you're over allocated to this, you already have it, right? We're not saying get rid of it. We're just saying to diversify out because if you have any kind of setback in AI, earnings targets are incredibly high. If the Mag 7 doesn't meet or beat to the expectation of the retail investor, you've got to pull back in these names.

Well, we saw this with the Nvidia. Pull back 30%. Right. Absolutely. And I think with the other names, the bar for earnings beats right now is a whole lot lower. So the upside surprise potential is higher. They might get some positive momentum there. Valuations are lower.

There's a good story here. Todd and I, we cover this business microscopically. And it's amazing this idea didn't come up earlier. I guess the Magnificent 7, well, it's been around a number of years. The Mag 7's been four or five years already. And the Max 7 ETF was a year and a half ago. I think it was early 2023. So I guess it takes time to sort of seep into the consciousness.

But it's such an obvious idea. And what I like about it is it's so simple. I don't have to explain zero data expiration options or derivative ETFs or complicated buffered ETFs. Right. People, I can explain it to my mother. Exactly. And when clients speak to us about it, they say things like, I have so much exposure to the

MAG 7, I don't know what to do. How do I diversify it? And we got to thinking, just subtract 7. It's that easy, right? And there are a lot of products that help you, you know, hedge your portfolio or non-correlated and things like this. But if you want broad-based equity exposure, you have a ton of Mag 7, why not just put this out there and let the market cap run up on the other 493 names?

But diversity, but concentration is not going away. You saw BlackRock announced they're doing a 20, top 20, not doing Mag 7, top 20. So they're trying to capture pieces of this. You know, an interesting idea. BlackRock has that. Invesco has MegaQQQQQ that's going to come out soon. And whenever you start to see a theme of, oh, yeah, let's just keep going more and more concentrated. It usually means go the other way.

And that's where the X-Mag 7 product, I think, would come in. Same thing happened with covered call funds two years ago. Everyone launches a covered call fund in the market rips. And then innovation and disruption four years ago. Everyone needed innovation disruption product because of the success of our credit to them. And then all those stocks blew up. So there's this recurring theme now of go big and stay to these heavy weights in the index. And so when I just see these breadcrumbs, I start to get worried about that segment of the market.

So you, I mean, it's certainly true that they follow. The ETF business is a trend follower, essentially. It tries to think of what the public is doing, and this is a pretty obvious product at this point. So some companies are still going towards concentrated bets, expanded Mag 7. They're doing that. BlackRock is doing that. They just launch theirs. I think that's an interesting product.

And you're going the other way. There is the NAS, triple Q's right? They're doing one too. So mega QQ, which is basically going to slice off 90% of the NASDAQ100. Yeah. Yeah. So does the concentration risk worry you? You've said it before, but, you know, I have to say, can I be a little agnostic or maybe dumb?

Is it fair to say? I'm not that worried because we have a paradigm here, AI, that may be once in a generation. It happened in the 1990s with the Internet. That was a once-in-a-generation paradigm. And we had some very high concentration at that time. Is it fair to say or is it stupid to say I'm not that concerned about the concentration? I think, well, so the companies themselves, from what I know, are still strong, right? So their neticum, their cash balances, whatnot.

But if I'm trying to manage risk within a portfolio, that's where I get worried. So as you always say, the market's a voting mechanism, right? And the market is clearly voted for these, superbly. but I just want to be aware of how much ownership I have, especially because they're the same three names, whether it's a blended phone or a growth fund. Right, but you Wall Street guys, you always say you have to be aware. So what does that mean?

What am I supposed to do to be, I'm aware now, okay? I'm the Buddha. I'm enlightened now. I'm not aware. So will I not do this? There's another great point here, though, that AI phenomenon, I completely agree with you, right? You're not that worried because this is a massive trend

and Mag 7 continue to continue to do well. But where is AI going to go next? It's going to impact the earnings and the growth potential of the other 493 stocks. So totally, I agree. You know, don't give up on AI. It's phenomenal, but it's also going to feed down and benefit companies like Eli Lilly and, you know, Broadcom and even the banks, even further, right? When they can figure out, like, their perfect credit risk analysis recipes.

Well, you've been trying to do this. You own ETFs that do some other things. I know, for example, you run the connective technologies, right? ETF. Yes. Yes. What's this, S-I-X-G there? 6G and quantum.

Right. So this focuses on. companies using connective technologies, like 5G networks or 6G networks, cellular equipment, what else, broadband, something like that, related infrastructure. But the ownership here is, and this ETF is, again, heavily concentrated in chips and software. I think we have a screen of this, though. It's Invidia, Broadcom, Oracle, Apple, Cisco, Qualcomm, there we go. See, this is, we're talking about a different ETF. This is the, S-I-X-G E-T-F, and this has done really well this year too.

Yeah, well, this is an AI ETF, right? So we look at AI and slice and dice it in different ways. We think that there's an AI energy story. We think that there's an AI quantum computing super story, and that's the quantum ETF. And 6G is connective technology. So it's basically that lower latency, that ability to process data quickly, that ability to communicate so that AI can actually work, right?

AI is basically processing data in a very, very efficient way so that you can make it useful in ways we've never dreamed of. In order to do that, you need connective technology. And so that's where 6G came from. Now, that makes a lot of sense, right? This has a theme to it. That's very clear. There's a lot of thematic noise,

but this one actually makes more sense because it's going to be sustainable in terms of the build-out of broadband and AI and whatnot, as opposed to some niche corner of the thematic world. Right. So you still have a very heavy tech-oriented theme here. You have some other EATFs out there on tech-oriented themes that are also doing well this year.

Again, I just want to go back to this point. I am, is it, the reason you own the S&P 500 is a form of diversification. If some of it is more concentrated than others, you know, that's just the way the market is voting. And that's why I guess I'm not that concerned about this isn't pets.com, okay?

If we were selling cat food, you know, for $10 and, you know, for free postage, which by the way is what Pets.com did, that's why it went out of business, I'd be a little more concerned. We're not even close to any of this. These companies are enormously profitable.

And the earnings for Nvidia have gone up dramatically, maybe not as much. The multiple has expanded a little more than the earnings for Nvidia. But it's certainly not like eye-popping unbelievable. We're looking at 30-some times forward earnings here. They're much better found fundamental footing than the comparison to the tech bubble.

I guess it's a nifty-50 market. I mean, I wasn't around for that. I don't think many people were, right? But that seems to be the scenario now. Yeah, actually, I was 18 years old in 74. But you're annoying me now because you're starting to remind me how much older I am than you are. So we don't have to know about that. That was 50 years ago.

I retract that comment about me being 18 in 1974. What else do you see happening in the ATF business? You've been around a long time. It's been a remarkable year. we have seen record inflows. We may have a record year. Don't we have a shot at it, Todd? Yeah.

We could do $1 trillion in inflows. Fixed income has already crushed their records. Equity is on pace. I think it's going to depend on the next six, seven weeks of performance if there's a chase. But it's coming from other corners. Crypto, the leverage products that are out there, non-traditional income, stuff like that. It's booming.

And you're seeing all the product come out too, which makes things a little bit harder for us because there's a lot of inventory now to look at but there is a clear It is confusing what are the 3,000 ETFs out there more and more than that and you're going to get conversions galore especially as the mute there's it's a we're at a 24-year low for the number of active equity mutual funds well they're going down slowly going down and the and the well it's not the number that I'm at it's the AUM it's like 19 trillion both the number and the mutual funds are at 19 trillion ETFs are a 10 trillion and it's been going this way for mutual funds this way for for ETFs for years. So the crossing date is when? Sometimes this decade. I think it could be

five to seven years potentially. The wrapper shift is fully. Think how much money the average investor is going to save. Instead of in a hundred basis point mutual fund, you're in a pick a number, 20 basis point on average, you know, ETF. Three if you want an S&P fund, three basis point. I mean, I think of billions of dollars the average investor is going to be saved. It's always amazed me how much money is captured in sleeping mutual funds. How many people seem to be, it's grandma's mutual fund. It's sitting there and they're charging a 2% for an S&P invitation fund, and nobody ever does anything about it because it's grandma's fund that nobody ever looks at it.

So I keep waiting for that. There's that slow conversion. As the grandma wakes up or heaven forbid she passes away and people notice it and things get sold out and bought into other things. Especially as 401K plans start to open up to ETFs as well. I think the next generation is just never going to take the new. The industry doesn't like that though. They don't like that, no. But I think it'll happen.

Fidelity has a huge 401K plan and they do offer that S&P 500 ETF in there. The Fidelity 500, I believe it's called. But you can get them. You just have to look for them. You have to look for them. Amidst this ocean of active, you know, higher. Until they allow crypto. Yeah.

And I think that's coming, too. It's slowly eroding here. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the market's one-o-two portion of the podcast. Todd's own ETF and technical strategies. The Takeda securities continues with us now. And Todd, I'm wondering about with the markets at new highs. how the ETF market is trading.

We see a lot of sort of technically overbought conditions for even the S&P 500, but certainly certain sectors of the S&P 500. I'm wondering how the ETF business, is there signs of, give me a technical analysis perspective on how the ETOF market is doing right now. Well, a few days ago you had about three quarters of the ETF universe, the equity ETIF universe, trading about one to two standardizations above their 200-day movement average. That's just the longer term measure of trend. And when you start to get numbers like that, okay, you can consider the market overbought.

Don't be surprised if you get some sort of pullback. It could be 3%. It could be 13%. We don't know, especially because we have a presidential election on the horizon. I think that can cause the market a little bit of anxiety, right? No matter what the result is, that's irrelevant. But don't be surprised if you can get some sort of a little bit of a pullback from there. Now, the important part is, though, it's all sorts of corners of the ETF market

getting overbought. Its value, its growth, industrials, software to some extent. I think that's the more important thing that the market's still on pretty good footing overall when it comes to trend. And so that leaves me still very much optimistic into the end of the year. So you sent me a note here, say 75% of equity ETFs are one standard deviation above their 200-day moving average. Those of you don't know statistics, that means it's unusual a bit. When you're above one standard deviation. It's an unusual situation. 75% above their 200-day moving average, one standard deviation above. Is that something to be afraid of? What should we take away from that? Here's two comparisons. When you've had a number like this, one example is in January 2013,

market got very overbought, and that was a great year. S&P 500 went up to say 30% that year, and had a strong 2014 as well. The opposite side of that is more, say, off top in a way. That was kind of like January 2018 where a lot of corners of the market peaked and resulted in the latter half of the year, the fourth quarter entering a barren market. Right. So what we're saying here is rising tide is lifting a lot of boats. There's a lot of momentum in the market here. Is this euphoria? Is this a blow off top? That's what people want to know. Where are? I don't get the sense that we are near blow off top levels like we saw three years ago in late 2021 when it was you could find equity ETF flows are on fire anecdotal observations

were through the roof on people buying stocks and crypto and FTs and SPACs, right? So I think sediment can get a little bit hot, but I don't think we're near the point of where it becomes a major red flag for equities. I just look at tech flows and this is where a lot of the momentum is. And even here, it's not everywhere. So there are nice inflows into these broad tech ETFs like XLK, that's the S&P 500 tech sector. And the semiconductor EETF, that's SMH is the symbol there. That has inflows. But we keep talking about general thematic tech ETS, like cybersecurity or stuff like that,

you know, or even AI doesn't have big momentum, big flows necessarily. Tech flows have been all in on either broader semis, like you said. And this is also why it's different than a few years ago. The thematic space really doesn't have that much demand. And yeah, there's some winners here and there in terms of flows. But those borderline products that are out there are really not seeing the major inflows that we've seen. And I also like that you're not seeing any flows to defensive corners. And cyclical ETF flows have been okay.

So if there's a risk out there, it is towards that broad-based tech and semi-area, where everything else has been basically ignored, which I like from the sentiment perspective. Again, this goes to what we were talking about earlier, about should we be concerned about this concentration risk? The market still is not, but as we always like to say, flows follow price. So the flows are still strong because of the price. But I have to say, even when Nvidia was down 30%, there was no wholesale abandonment of the semiconductor ETF. It takes a long time. Look how long Kathy Woods took before people started basically walking away.

Your initial reaction is, oh, it's a dip. You got to buy the dip. You see how it responds. And it really takes, there's a long lead time or lag time, really, frankly, before outflow start in some of these winning ETFs. Yeah. All right. Todd, thanks very much.

We're going to leave it there. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week or head to etfedge.cfecbc.com. How does InvestcoQQQQ rethink possibility? By rethinking access to innovation and the NASDAQ 100. Let's rethink possibility, Investco Distributors, Inc.