Exchange traded fun

Barry Ritholtz points to an article about the massive amount of insider selling that has taken place in December. Guambat has grown weary of trying to find any correlation between news such as that and market direction, but did raise an eyebrow over the following bit:

It's critical to remember, Alan points out, that for an exchange-traded fund to issue shares it must first buy the underlying assets, primarily stocks. That demand all by itself, he reckons, was enough to keep the market rally of the past few months alive and well.

Not the least interesting thing about ETFs and their powerful impact on market prices is that they don't trade on the basis of individual corporate prospects. Alan posits that more than half the price of many stocks is now dependent on "index or sector sponsorship, the obvious result of a market that has been increasingly sectored to death and indexed beyond any efficiency" imagined by academics. For ETFs, in other words, valuations don't matter.

Which is the dangerous message he gets from the fact that the top 10 constituents of the most popular ETF, the Nasdaq 100 Trust (QQQQ), which trades a formidable $4.7 billion a day, sport a P/E north of 33 and are selling at over six times sales.

Unless we're willing to say history and, for that matter, logic are bunk, it's plain as the nose on your face that valuations do matter.