A Brief History of ETF Bubbles

by on October 23, 2013 | ETFs Mentioned:

The ups and downs on Wall Street have long been a foe of the inexperienced investor, while veterans have come to embrace the wild swings as opportunities to re-position for the next bull run. This decade alone has seen more than a handful of booms and busts all over the investment landscape, setting the scene for some spectacular gains for those with a keen eye and a stomach for risk [see Visual Guide: Major Index Returns by Year from 1970].

In light of U.S. equity markets continuing their ascent into uncharted territory, below we recap the biggest crashes in the ETF universe, highlighting the magnitude and story behind each of the most prominent bubbles:

Tech Bubble: PowerShares QQQ (QQQ, A-)

QQQ

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The adoption of the Internet through the 1990s revolutionized the world of communications and entertainment, also globalizing financial markets along the way. All of the excitement surrounding the new and rapidly growing online world led to sky-high valuations on Wall Street as virtually everyone and their cousin was buying into “hot tech” IPOs. The Nasdaq-100, as represented by QQQ, shed upwards of 80% between the top in March of 2000 and the bottom in October of 2002; this ETF saw its share price drop from $120 to under $20 in less than three years [see Visual History of The S&P 500 Index].

Housing Bubble: State Street SPDR Homebuilders ETF (XHB, A+)

XHB

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Low interest rates and speculative lending practices fueled the housing industry boom, inevitably leading to the subprime mortgage crisis. The Homebuilders ETF, which debuted in early 2006, peaked that same year at $46.52 a share on 4/5; XHB proceeded to decline sharply lower over the coming months as stocks in the industry signaled a downturn prior to  popular broad-based equity indexes topping out in 2007. XHB sank over 80% in a matter of less than three years, trading as low as $8 a share on 3/9/2009 before bottoming out and reversing its course [see also The 5 Most Important Chart Patterns For ETF Traders].

Solar Bubble: Guggenheim Solar ETF (TAN, B+)

TAN

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Encouraging prospects for the alternative energy industry bolstered solar stocks higher in 2007 and into 2008 as presidential candidate, at the time, Barack Obama expressed his commitment to moving forward with the “green energy” revolution. However, Congress failed to renew the investment tax credits in 2008 for the solar industry, which took a bite out of investors’ confidence in the sector given the lack of federal support. The financial meltdown in 2008 further put a damper on solar stocks, as many left the equity market altogether. The solar ETF, TAN, lost over 80% from its peak at $307 a share on 5/19/2008 through the broad-market bottom in early March of 2009; this ETF continued to slide lower until recently finding a bottom above $13 a share in November of 2012.

Gold Bubble: SPDR Gold Trust (GLD, A-)

GLD

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Uncertainty on the domestic economic front following the 2007 financial meltdown led the Federal Reserve to embark on an unprecedented stimulus program, known as quantitative easing or “QE” for short. Historically low interest rates coupled with regular injections of liquidity into the banking system to spark the “free money” craze, as many feared that QE and its subsequent extensions would lead to hyperinflation. Economic growth remained stagnant through 2011, however, clearing away the potential hyperinflation scenario. Furthermore, prospects of improving growth sparked interest in equities, leading to a massive sell-off in GLD as investors re-positioned their portfolios for brighter days; this gold ETF peaked at $185.85 a share on 9/6/2011 and proceeded to lose over 30% over the next two years, recently finding a bottom just below $120 a share [see GLD-Free Gold Bug ETFdb Portfolio]. 

Silver Bubble: iShares Silver Trust (SLV, C+)

SLV

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Silver prices declined to below $9 an ounce in November of 2008 after extreme pessimism had permeated this corner of the industrial metals market. Expansionary monetary policy in the following years bolstered this commodity higher as investors embraced its precious metal qualities as an inflation hedge; SLV gathered more momentum than GLD during its run-up, largely because of the cheaper price and its various industrial applications, further bolstering demand prospects.

This asset class came tumbling down for virtually the same reasons that inspired gold’s decline; no real threat of inflation coupled with improving growth prospects. SLV peaked at $48.35 a share on 4/28/2011 and proceeded to sink upwards of 60% over the following two years until recently finding a bottom just below $20 a share. During this run-up, JP Morgan Chase & Co. was accused of price manipulation; however, the firm won the lawsuit and it was acquitted of charges to drive down silver prices. 

Corn Bubble: Teucrium Corn Fund (CORN, B)

CORN

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Grain prices staged a furious rally in the summer of 2012 as one of the worst droughts in the last 50 years plagued farmland across the entire nation, hitting the Midwest “Corn Belt” the hardest. Unfavorable growing conditions led to a supply scare, which inevitably drove up prices in an exponential manner in two months time. The drought persisted through the end of the year, although projected crop yields topped prior forecasts and an abundance of supply led to a sharp correction in prices. The Corn ETF peaked at $52.71 a share on 8/21/2012 and it has yet to bottom out; from its peak, this ETF has lost more than 35% through the middle of October of this year [see The Ultimate Guide To Resource-Specific "Third Generation" Commodity ETPs]. 

Emerging Bond Bubble: WisdomTree (ELD, B+)

ELD

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Emerging markets bonds, as represented by ELD, sank 15% in a matter of weeks after the Federal Reserve rattled investors’ confidence on the home front with its first “taper” hint seen at the end of May. The Fed’s hint at scaling back on stimulus reminded investors of the looming interest rate hike; in light of prospects of rising rates at home, investors were quick to pull out of their overseas debt investments, deeming them too “risky” when considering that domestic yields would eventually rise as well [see How To Find The Best Emerging Market Bond ETF].

The steep sell off in overseas debt markets was also referred to as the unwinding of the “carry-trade.” Since the start of QE at home in 2008, investors had been borrowing U.S. dollars for cheap (given record low rates), and investing them in higher-yielding instruments overseas, hence “carrying” their money to where it would earn more. When the Fed reminded investors that it would start to tighten monetary policy, many were quick to liquidate their overseas positions first and convert them back to U.S. dollars before locking in profits in their domestic holdings.

The Bottom Line

Being aware of the most recent bubbles in ETF history most likely won’t help you pinpoint the next major top or bottom on Wall Street. However, keeping historical tendencies in mind can serve as a valuable reference when analyzing current market valuations; this means keeping a close watch on fundamental price drivers in times of euphoria as well as sticking to your exit strategy, whether its cutting losses or locking-in profits at a defined level. 

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Disclosure: No positions at time of writing.