May 8, 2017
What We’re Reading This Week
Last week American Airlines announced plans to increase pay to their flight attendants and pilots. There were many people that did not like that, but none of them were pilots or flight attendants. An analyst at JP Morgan, Jamie Baker, wrote that he was “troubled” by the airline’s “wealth transfer of nearly $1 billion” to labor groups. The bank concurrently cut its opinion on the airline from neutral to overweight. Granted, I am not a stock analyst, so maybe someone can email me, but have analysts always used “overweight?” It is hard not to take that personally.
Investors also punished the stock and the price slid around 5.8% that afternoon. As of writing, American Airlines is down six percent for the year. Other airlines’ stock dropped too, possibly lending credence to the idea that index based funds somehow hurt the market and investors. One side of that argument, the side represented by stock analysts I assume or people that live in bunkers, is that ETFs hurt the market by allowing companies to squeeze customers and employees because less people own the stock individually. Normally, when you sell a stock, the company is sad. When the vast majority of shareholders are large institutions that is less of a problem. If you run some type of indexed investment and the index you track has 12% exposure to the airline industry, the individual companies are somewhat irrelevant to you. When American Airlines decides to raise pay and you tell your boss, “We should sell!” I have to imagine their response would be, “Why isn’t a computer doing your job?”…or something like that. Anyway, you would still own a bunch of airline stock. This idea is predicated on the notion that all companies are evil and they will gouge customers and employees without the subtle, caring hand of Wall Street.
You could – maybe – take up the other side of that argument though. That when individual investors sell off exposure to a company they hurt the rest of the industry because they only own companies through index based investments. If say, I read the American Airlines headline and sold my transportation ETF, IYT, I effectively sold off a bunch of airline stock. Of course, IYT did fine the day of the announcement so that does not really work either.
So how do you explain American Airline’s decision to raise pay and investors’ decision to sell off holdings in other airlines? It is really simple – sometimes companies do things that are good for the company and its employees. When one company does something, investors get scared that other companies will see it and think it looks fun. Then those other companies will want to do everything the other company did.
Right now, there is a lot of talk about the passive investment revolution. Millions (Billions?) of dollars are changing hands from active mutual fund managers to passive, indexed investments. Some people might interpret that as a significant shift in investor behavior, but that is probably a mistake. It seems unlikely to me that millions of investors are just now getting around to reading Harry Markowitz’s work on modern portfolio theory and its eventual impact on the capital asset pricing model. Do not get me wrong, it is all very fascinating but I feel like ETFs are just a more efficient way of doing what people have always done.
At some point in history, if you wanted to buy a stock, you would travel to New York and meet near a Buttonwood Tree. An auctioneer would then mediate the sale between you and other buyers and the highest bidder got the stock. There was a lot of other “back office” stuff going on but that was the gist of it. Shortly after that, we began to trade stocks on the internet and the process became a lot more efficient. Similarly, where you might have once bought stock in American Airlines, you can now buy an ETF that gives you more exposure while reducing your risk.
Likewise, if you have a penchant for day trading, instead of using individual securities you can now use ETFs. Yesterday, the SEC approved the sale of quadruple leveraged EFTs. In short, a quadruple leveraged ETF will return roughly four times the respective index. I really want these to be sold by old-timely carnival barkers, “If you like the S&P, you’ll LOVE this ETF!”
Alternatively, you will also experience four times the loss of the S&P, but investors are mostly intelligent, thoughtful people making smart decisions with their money. This additional volatility is achieved through debt inside of the investment. Historically, you would need to apply and be approved for margin in your brokerage account. You would also need to be approved to short sell a security. The difference is that almost anyone can buy a quadruple leveraged ETF. In effect, it is an extremely more efficient way to lose your money.
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