This ETF Double Counting Adds Up to Insanity

What is going on here? The market is going bananas on Tuesday, as the Dow Jones industrial average posted a 250 point negative reversal in the space of an hour, with 200 of those points disappearing between 10:20 a.m. and 10:30. I am writing this column in real-time, so I am sure those figures will have changed by the time it posts, but the action is more important than the absolute levels of the indexes.

This is how markets work. But for goodness' sake, it is heartening to see them work. I have mentioned works such as Adam Smith's "Wealth of Nations," Charles Mackay's "Extraordinary Delusions and the Popular Madness of Crowds," Burton Malkiel's "Random Walk Down Wall Street" and the scholarly writings of Hyman Minsky in my Real Money column and have never gotten a single comment on those references. That said, if I have the gall in a Real Money column to suggest that either a) Elon Musk is not infallible or b) Tesla (TSLA) is not going to go bankrupt tomorrow, my inbox lights up like a great round on a pinball machine.

That's the problem. Investing has been replaced by poll-taking, and these "narratives" have replaced good old-fashioned analysis. The problem is there is no -- to use a very fashionable word -- sustainability in that solution. Narratives can and do change. Run a 20-year chart of Amazon (AMZN) vs. Blackberry/RIM (BB) to understand that.

The same people who were telling you to buy stocks last week when the forward price-to-earnings on the S&P 500 crossed 20-times (on my estimate of 2020 earnings per share of $160/share for EPS for the index, which is more conservative than the Street's consensus of $176/share) are the same who were saying that BlackBerry was invincible when the stock was trading north of $100 a share in early 2008; BB is quoted at $5.69 today.

You have to invest with your eyes wide open, and open to other markets. The move in the yield of the 10-year U.S Treasury Note to 1.32%, which will represent an all-time low closing value if it holds of the rest of the day, is a sign that investors are fearful, driven mainly by the outbreak of COVID-19, the disease caused by the newly discovered coronavirus spreading globally.

The issue is that so many investors cannot re-allocate assets in this market. Stock-based exchange-traded funds have to be fully invested in stocks. It is the only reason they exist.

If the SPDR S&P 500 ETF trust (SPY) were a stock, it would be ranked 11th in the U.S. market behind Walmart (WMT) and ahead of Procter & Gamble (PG) . Adding the value of the Top 4 broad market ETFs (SPY; iShares S&P 500 Index (IVV) ; Vanguard IX/Vanguard Total Stock Fund (VTI) ; Vanguard IX/S&P 500 ETF SHS New (VOO) ) gets you to about $830 billion, which would rank No. 5 overall, between Alphabet (GOOGL) and Facebook FB . But those ETFs are nothing but stock-like instruments entirely composed of stocks. Since they need to match the performance of the indexes, they are composed mainly of the largest stocks -- Apple (AAPL) , (AMZN) , Microsoft (MSFT) , and so on.

It's double counting, it is insanity, and it will be just as costly on the way down as it has been lucrative on the way up. That some of the largest "stocks" are just stocks created to own stocks, has to strike someone as a tautological paradox.

It is too easy to buy stocks now. Zero-commission trading is the stock market's equivalent of no-interest/no-income mortgage loans in the mid 2000s. The actual volatility of the market has been far too low for far too long. (Forget implied volatilities as measured by the indexes like the Volatility Index VIX.X ; trust me when I say no one understands how they are calculated.)

SPY's standard deviation has averaged 11.9% over the past year, 13.3% over the past five years and 14.7% over the past 10 years. Why does volatility keep falling? Also, none of those time periods comprehend the Great Financial Crisis. If we take that into account the lifetime standard deviation (it was launched on Jan. 22 1993) for the SPY is 18.1%. Is the global economy that much less risky now than it was then? No.

The outbreak of COVID-19 has shaken this market out of its complacency, but don't forget we were registering new all-time highs on all three major indexes as recently as last week.

Equities are as fundamentally overvalued here as they have been in a generation. In no way, shape or form does the S&P 500 at 3200 represent the realities of the current global economic situation.

I see support for the S&P 500 in the near-term at 2880 (18-times my 2020 S&P EPS forecast of $160) and would be looking to initiate new positions at about 2500. That would represent about a 25% pullback from last week's levels. This market needs it.

(AAPL, AMZN, GOOGL, FB and MSFT are holdings in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells them? Learn more now.)

At the time of publication, Collins had no position in the securities mentioned.