Top 5 reasons to invest in ETFs: Stocks in Translation

Labeling them as “shock absorbers,” Todd Sohn, ETF strategist at Strategas Asset Management, breaks down the key advantages of ETFs including low cost, global market access, transparency, liquidity, and tax efficiency. He explains how these features make ETFs excellent for long-term investing, especially for newer investors looking to build diversified portfolios.

Sohn goes on to talk about small caps surge, the financial sector, and possible market tells from Beetlejuice and Batman.

He shares his insights with Yahoo Finance’s Jared Blikre and Sydnee Fried on "Stocks in Translation." Listen to the full episode wherever you get your podcasts.

This post was written by Jimi Corpuz

Video Transcript

Welcome to stocks and translation, our essential conversation cutting through the market, mayhem, the noisy numbers and the hyperbole to give you the information you need for your portfolio.

Today, I'm joined as always by Sydney Fried.

And our special guest is Todd, son.

He is the ETF strategist at Strate Asset Management.

Welcome guys.

Today, we're going to take a walk on the passive side with ETF S or exchange traded funds, which is our phrase of the day, what every investor needs to know and understand about the structure of the tech trade and those flows that we've been seeing recently.

This episode brought to you by the number 73.

That's a percent of S and P 500 companies that are beating on earnings this quarter.

We're only a few weeks in what big bank earnings are signaling ahead of big tech on deck from alphabet and Tesla this week.

And Todd, we're gonna let me get your big picture overview here.

How are you seeing the markets?

Because we just went through a very nasty rotation last week.

Yeah.

Well, first, thank you very, very much for having me.

It's great to be here.

Uh I think big picture, it's still a structural bull market right now.

There there are concentration risks depending on the type of fund you may investing in, right, large cap funds.

But last week's rotation also speaks to the growing durability of this market, right?

You're now seeing small caps participate.

And I like the idea that many corners of the equity market have been in bear markets for roughly 2.5 to 3 years.

The non tech corners, financial health care, uh materials, all those areas are just starting to work again after a really challenging environment.

So we think that keeps the big picture structural bull market intact.

Yeah, we're going to talk about all these market moves first.

Want to break down and get into our phrase of the day exchange traded funds or ETF S and this is just so we can kind of broaden the discussion going forward here.

Now, here is the, here's a dictionary definition.

An ETF is a type of investment fund trading on stock exchanges composed of a basket of assets like stocks, bonds, commodities or cryptocurrencies.

It offers diversification, low costs and can be traded throughout the day like individual stocks as opposed to a mutual fund.

Uh So Todd, tell us, I know you trade exclusively.

ETF S correct me if I'm wrong.

What do you like about these vehicles?

So ETF S are great for, I'd say five reasons.

They are low cost, they give you access to virtually any market around the globe and different types of strategies.

Now, uh they are transparent, right?

I can look at the holdings every day.

I know what ingredients are in my investment, they are liquid.

I can trade them throughout the day if I wanted to or if I'm a large investor, I can move large amounts of money to these funds and they're tax efficient, right?

Taxes are basically deferred because of ETF S secret sauce until you decide to make the selling point.

So though the combination of those five points makes them a really great wrapper for investing, especially over the long term.

And those five points sound like great points for someone who is early to investing.

Someone who maybe doesn't want to pick a bunch of stocks or should you kind of lean more heavily on ETF S. If you're, you know, let's say in your, even before your twenties, you're 18, you're 19.

0, absolutely.

You can buy an S and P 500 fund for two or three basis points.

Nothing.

And the basic point is 0.0 1%.

I always get that confused.

I have a follow up question.

So what's, what's the biggest difference between a mutual fund and an ETF because I feel like those get very mixed up in my mind.

The primary difference is that you can buy and sell an ETF all day long, a mutual fund only trades once a day at four o'clock.

Right.

That's when it gets priced, that tells you the value of the fund.

Whereas an ETF I can buy it right now at one o'clock and I can sell it at 330 if I wanted to.

Uh, there's a lot of other little nuances here and there.

But that's basically the, the idea of it, that I can trade it whenever I want.

I want to get back to our Marcus discussion.

We were talking about small caps in that painful rotation.

Um First of all, and when I think small caps, I think, uh IWM, that's ticker uh that's been around the longest, but there are a lot of other ones as well.

What do you think this move in small caps is saying about the market?

This finally, finally, something else is catching up, right?

So if for small caps, the Russell 2000 index, which is an index of all the small cap companies out there.

It's in the fourth longest streak, historically or third longest.

Actually my uh my fault uh without a new all time high, it's been 675 trading days.

That's not necessarily a streak you want, but here we are.

Yeah.

So if I'm thinking about OK, did I miss the move after last week?

Not necessarily, it's the same thing after the say the Bear market of 2000 and the Bear market of 2008, right?

You may have thought you missed the move initially, but there was a lot of room for growth following that.

And so I think A you can still tilt to small caps if you wanted to, if you're missing that exposure.

And B um this just reflects the more participation, more stocks are going up, that is essential for a bull market to continue.

And I think let's get to that concentration argument and because it, and it was well founded, we had the mag seven, really the mag five carrying stocks at the beginning of the year and there wasn't much of a, a let up there, but only within the last two weeks, we've seen a lot of other sectors come alive.

Um And it's not like this only happened in the last two weeks.

Financials have been hitting all time highs, industrials, health care and this is um kind of the way the market generally works where you have things staggered.

You don't necessarily have every single S and P 500 stock hitting record highs at once.

Um So what do you think about the move that we're seeing in some of these other sectors?

What do you like?

So, financials are really interesting to me here.

Um And it's not just the banking stocks, banks have had their issues over the last year or so when we had those bank failures, but I look at some of the big asset managers, right, Blackrock Goldman Sachs, those are all acting much better.

KC is an ETF.

I like to follow.

That is a uh spider capital markets.

ETF.

So it's gonna be all the asset managers in the ETF space managers, mutual funds.

And that is a fund that is a new all time high.

So that tells me the financial space is in good shape, that's helpful for the broader economy in a sense.

Right?

We never like when the economy might be humming along, but financials are starting to deteriorate.

2008, 2008 being the prime example.

And I, I do think health care is interesting and it has been a really challenging time for health, health care if it's not uh GOP one related, but it's been such bad performance and there's been a lot of outflows from health care ETS that I wonder if it's, it's an environment where it's so bad, it might be good if you're interest for what that's worth.

Well, you know, we met at a CMT event that's chartered market technicians uh last week and not a place for me, not the place for me.

Well, you can, you can type away, I'll type I'll type notes.

Um So we, we met at the CMT event and we were talking about biotech and what I I, I've never traded biotech, individual biotech stocks, but I've traded the ETS I happen to like IBB, you can have, you can trade other ones.

But my thinking there is, I don't understand.

I don't even have the ability to understand any biotech company and what they're do doing there trials.

You know, I can't necessarily read, understand the science.

Um, but an ETF S allows me to participate and kind of mix up a few different companies.

What's your thoughts on this?

Exactly.

This is what ETF S are basically made for.

And I'm agreeing with you.

I can't trade biotech.

You should go to the CMT now I'm in.

Yeah, everyone should join, take a look at CMT Association.

We're doing great things on the, on the technical front.

But uh biotech stocks can be lottery tickets, whether they get a drug approval or not that can make or break the stock.

And so an ETF allows you to diversify and the most important thing is to know how is it weighted, right?

So IBB could be uh is cap weighted.

So the biggest stocks of the most weight or something like XB I is equally weighted.

So the biggest stocks and the small stocks are all on the same playing field.

Can we just pause there a second and kind of highlight the difference there because it means different things when you're saying is market uh the difference between market cap weighted and that's when the biggest stocks get the most.

And we know this like from the S and P 500 we got these five or seven stocks.

So market cap weighted means the big guys get the most uh, juice, they get the most weight.

Whereas equal just means everybody gets one share, one vote.

And those are two different strategies for the market.

Right.

Exactly.

And when you equal eight something, you're giving more power in a sense to the smaller folks out there, which there's nothing wrong with that.

It's just a matter of, ok, well, what's, what's working if small caps are struggling, you may not want to equally.

Right.

But I still like it for the diversification purposes.

Let me ask you something because if we're only investing in the ETF S as a beginning in beginner investor, what's the one thing you should know or look at before you invest in an ETF and don't say anything about like a prospectus or anything that only, only a few of us will read the prospectus to understand what's going on, know what is in the ETF, right?

So if we go to the grocery store most of the time, you probably look at the nutrition label, how much sugar is in it, how much carbohydrates, what are the actual ingredients?

It is the same exact thing with an ETF if you are scared of maybe biotech stocks, avoid an ETF that invests only in biotech stocks.

So it's, it's all about looking in the fund knowing what the stocks are in it.

Where maybe where is it focused on?

Is it focused on tech technology?

Is it fo focused on Europe for whatever uh classification.

It might be.

It's all about the nutrition label.

I have a question though, if you're going to invest in a, in a simple tech ETF and it has, it has meta and it has Microsoft and it has Apple.

Why don't you just buy apple?

I, I get the di di diversification argument but when it's these large cap companies, why don't you just buy them?

I, I am not opposed to the idea of saying, OK, I feel strongly about Apple products.

I'm going to buy Apple, but just in case Apple goes through a challenging time, you can bounce it off with an ETF that has less Apple weight in it.

Maybe it's an equal weight tech ETF.

So you're going to get the benefits of if Apple's losing market share, who's taking that market share, then it could be Microsoft or pick anyone out there.

So you kind of balance out that part of your portfolio with, with the other portion of the ETF as opposed to the single stock.

All right, we wanna talk about flows for a second here.

We've been seeing a lot of flows into.

We could argue that it's a crowded trade, but I just want to get your take.

What are you noticing here?

So flows AAA are not a signal to me, right?

We don't buy or solve them, but I love them as they read on investor psychology.

What are investors doing?

Sentiment, exactly sentiment.

Where are they putting their allocations um and they flows have been all in on tech rightfully so because that's been the correct place to be, but I am worried about maybe a little bit of too aggressive positioning and a and a summer speed bump of sorts where that everyone is.

So all in on tech, the reverse happens, right.

Kind of like the crowd isn't leaning in too much, too much of one direction and then all non tech sectors if you were to dial it back about a year ago are actually negative since then.

So if I'm looking for areas that investors haven't been too interested in, it's anything but tech, right?

That's where the financials and healthcare industrials come in.

So there is risk that everyone loves tech a little bit too much.

Is it enough to derail the bull case?

I don't think so, but of course, just keep that in mind as the summer and the election come into view.

There's a lot of, a lot of uh events out there.

Yes, there is and hold that thought we need to take a short break.

But coming up, we're gonna be talking big tech earnings and a look abroad for the latest.

Who wore it better.

We are back in this episode brought to you by the number 73.

That's the percent of S and P 500 companies that are beating on earnings this quarter.

And uh this is according to B of a just with the tally here.

And by the way, we're pretty, we're pretty early into the season.

But for those that have beat it is with a 5% beat.

Um, and that, oh, also I should say 20% of earnings are in so basically 80% left.

And then as I said, this, 73%.

That is the beat.

How many are beating on EPS?

It's a little bit above the average.

I'll just lay it out for you, lay it out for us.

So what do you look at when you come to earnings season?

Because you're not necessarily worried about individual companies here.

You're trading ETS, right?

So from my perspective, it's all about the sectors and aggregate and are they beating expectations?

Wall Street is all about expectations?

Is it better or is it worse?

That's all it comes down to the numbers themselves can probably confuse most of us.

Um So I'm all about expectations.

The expectations for tech companies are really high, right?

The, the mag seven, the top 10 weights.

So how does the market react to their earnings?

And then can the rest of the index, the bench of the S and P 500 all 490 other companies?

Can they continue to improve their earnings after a challenging few years if they can meet and exceed those expectations will be in pretty good shape.

I have a question about when to sell ETF S you know, how do you make that decision?

What we're seeing the rotation right now out of big tech and into small caps?

Does that mean you should just straight up start selling all of your tech ETF S?

I'm being a little dramatic there.

You know, how, how do you kind of make that determination and pegging into earnings?

You know, if you see Apple hasn't done well, I'm making this up obviously for 50 orders in a row.

And, ok. Sell Apple.

How do you make that decision when it comes to earnings when it's an ETF?

And it's kind of a basket of stocks.

It all comes down to your time frame.

I think in a way if you are investing for the next 30 to 40 years, you want to stick with these things, these speed bumps will happen, correct.

The S and P average is about a 14% correction here.

That's a great opportunity to continue to add exposure and build your wealth over time.

If you're someone who's playing more tactically quarter to quarter and these things matter to you, you could say, ok, I've had a great run in tech.

I'm a little bit overweight.

It's a little too much exposure for my liking.

Let me sell a quarter or half of that position.

That can get a little bit more trick, more tricky.

Right.

There's tax consequences there too.

Um, so I think it all comes down to your time frame and then also also setting a plan, I may have been long tech for a year, I could say, oh, well, if tech declines by 10% I'm gonna sell, you know, that's, that's probably a little bit too simple, but there's so many different mechanics you can use out there if it crosses below a moving average or, um, could be time based.

Right.

I could sell it at the end of the quarter just because I need to rebalance out.

I need to put more money into other positions that are not technology.

So it depends on time frame.

I think you're, you're risk tolerance to and the person involved.

Let's um I wanna circle back.

Uh You asked a really interesting question just a few minutes ago, you were asking, you know, why ETF S instead of an individual stock?

And just as we've been talking about this, a few other reasons kind of ticked off in my head, individual stocks can be expensive.

I mean, Berkshire Hathaway, a shares are something like $300,000.

So you might not have the money.

Um But then you can also gain tax advantages and we haven't talked about that in particular.

I was just wondering how closely do you look at the tax advantages of different ETF S uh when you're looking to buy or sell them because there can be different tax advantages depending on the corporate structure?

Yeah.

So the majority of passive ETF S, right?

Passive, meaning they track an index which usually has very low turnover.

So you're not buying and selling all different constituents within there.

And so the vast vast majority, I wanna say 99% of index based ETF S don't pay out capital gains because the ETF S are able to defer those taxes using what's called the create and redeem mechanism.

It's, it's the secret sauce.

Uh If you are going to play with something that is more active or in a case, international base, that has different consequences in terms of taxes.

But more often than not, you're not getting a tax bill until you click sell on your brokerage account to get rid of the ETF.

Um And this makes the ETF S a great long term investment vehicle because there's no bill tax bill at the end of the year for you.

Rarely.

I want also draw a stick uh distinction between um exchange, trade traded funds and exchange traded notes and arguably ETF S fall under ETNS and we'll put some definitions up on the screen so we don't get too turned around, but um exchange traded notes uh can trade a little bit differently.

And I think an example that comes to mind is the gray scale uh Bitcoin Investment Trust, which kind of became dislocated from the price.

They didn't have the ability to be an A TF they had to sue uh the SEC to gain, to eventually gain that.

But when they didn't, there was a big price dislocation just wondering if you pay attention to those kinds of things.

We, we look at ETNS, they an etn is tch a debt security.

It's issued by a bank in a way.

Um And so, and, and those are in a way becoming more endangered.

There's just less demand for them.

They're not great for investors.

They don't have the, the, the tax efficiency out there.

Um And if a, if the issuer it comes with a lot of counter party risk, if I'm the bank and I say, you know what, this fund has got too big, I'm just gonna close it.

That can happen.

You can't really close an ETF unless there's low.

A um, and the issuer decides, ok, we've had no more and it's structured as a debt security.

Exactly.

So it just ties back.

So the consequences are much different for an exchange rated fund versus exchange rated note.

You said they're becoming less popular, correct?

So, is there room for most people for the, for exchange traded notes in most people's portfolios?

Should that be something you consider?

Or I would avoid them personally?

Honestly?

Because they just come with very different risks.

There's counter party risk and the number of products are shrinking.

I think they're going away with in due time.

Of course, always be one off cases where someone wants it for whatever reason, you know, like there's a four X leverage S and P exchange trade note, that's not for everybody, you know, it raises, um, you know, when we're investing, we gotta think of the worst case scenario.

So one of the things I think about is the flash crash when we saw a lot of problems with everything, individual securities ETF setns.

Um but as I understand the counter party aspect of ETNS just makes them a little bit more dangerous in a high volatility scenario.

What else?

Um What else should ETF investors think about when they're worried about uh the worst case scenario?

Well, E ETF S can act as shock absorbers involve high environments, especially because they are so liquid, they have intraday liquidity.

And so if I'm an investor and I have a position in a single stock and I'm worried about it declining or whatever risk is out there, I can then go buy an ETF of its peers in order to diversify during, especially during volatile environments or if I'm in stocks and I want to go to a treasury bill ETF if the market is declining in a panic like scenario, I can do that with it in, in a click.

So ETF S are great in volatile environments, they're not exacerbating any sort of market structures.

They're helping smooth things out.

Let me ask you the classic, like 6040 like stocks to bonds.

Do you have an opinion on how much of your equity portfolio should be?

ETF S versus other stocks.

Me personally, as someone who loves ETF, 100% 100%.

Of course.

So, you know, I, I always, I, I think, um, I don't know if it was Bogle who was like this, but I've always read that there are some investors out there who have this small, small, small allocation in their portfolio for, I don't want to call it gambling, but that stock or too money, money, money that they're obsessed with.

Exactly.

So I, I love the idea of ETF S because they're diversified and they great tax efficiency for the long run.

But if there's a company out there that you're saying, I just, I just love this company.

Ok, allocate a very small percentage of it in your portfolio just to, to scratch the itch and if it benefits you in the long run, great.

And if not, you didn't lose the whole boat there.

All right, I'm all about FOMO prevention here.

All right.

We spend a lot of time talking about us equities, but today we're gonna be looking abroad to the land of the rising sun.

That would be Japan home of the Nikkei Stock index which has risen 18% this year best in the S and P 500 in the US, which is up still a respectable 16%.

So Japan has a small edge on the year so far.

But what we want your expert opinion is where the opportunity lies in the second half of the year and a quick reminder that it was only a few months ago that the Nikkei hit its first record high in 35 years.

Eclipsing its December 1989 bubble peak and yes, Japan was in a bubble back then.

So who's, well, let's, let's bring this uh full circle here who's wearing the prospects for the second half of the year better.

Is it Japan's Nikkei or the US S and P 500?

I would love if I could say equal weight S and P 500.

Do you feel strong?

You know, we can, we can let me just cross this side here.

All right.

S and P 500 equal weight.

Which one do you like better?

I like the equal weight S and P 500.

I think Japan has had great momentum.

I, I like the story there.

Um It's also a very different constituency, right?

The ingredients are different.

There's a lot more automobiles and consumer companies, there's a lot less tech than the Ss and P. Um I think my preference is still equate S and P 500 but I do like Japan as part of a global diversified portfolio.

And I'll add to your uh comment about the new high.

One of my favorite pop culture facts is that the DK is at a new high.

Um this year Michael Keaton's playing beetle juice and then he was like, oh, I like where this is going, he played Batman in the flash movie last year.

And the last time the Nike was at new high was when Batman and Beetle Juice came out.

The original ones in 1989 my random popcorn, I love that.

Is there a correlation?

Probably not, but it's just really speaks to me as someone who's a fan of that stuff.

I have a question.

How for, for, again, for this uh investor who's not very experienced, how much do you think they should allocate towards global international equities?

ETF S kind of anything, I think.

And it depends on your, your risk tolerance.

If you have $100.60 of it goes to stocks, right?

6040 portfolio, 40% of bonds of that 60%.

It can't, I don't think it can hurt to allocate 10 to 20% internationally.

So Japan Europe, if you wanted to put emerging markets in there, you can, that's a little bit different of an animal but having Japan and Europe as this kind of counter tech heavyweight to the U si.

Do I do believe it makes a lot of sense as much as they have lagged the US historically.

All right, we're gonna pivot but it's not too hard to pivot because um I want to ask you about Disney.

Now.

You have been, you've been to all the parks around the world, including including one in the land of the rising sun.

We'll let you talk about that?

Which one is your favorite?

So, Tokyo Disney, I'm with it.

I visited there eight years ago and it's an amazing resort.

It's actually only a subway ride away from downtown Tokyo.

I imagine everything in is a subway right away from everything and their, their transportation there is amazing.

And they have two parks, one is very similar to the parks here in the US.

Uh And then they have Disney Sea, which is completely different than anything else in the world.

Does your love of Disney extend to the stock?

That's a loaded question.

A loaded question.

Believe me, I would like that.

So they're in a hard time right now.

The media business, I think uh between Disney and Comcast and whatnot, they're, they're going through a different environment.

Streaming been difficult.

When, when you go to a Disney Park though, do you think of how it's translating towards the financials of the company?

You just enjoy yourself?

You just Mickey Mouse.

One question I would say mostly enjoying or trying to enjoy it depending on how hot it is in Florida.

Um But I do try to pay attention.

OK. What are the business levels?

How crowded is it?

But that's only one part of their business television and advertising a huge part for them too, as well as film studios.

We have 30 seconds.

Any last minute word for investors.

I think ETF S are a great vehicle of choice.

Always look at the ingredients and stick with it for the long run too.

Excellent words to end on here.

Thank you for joining us and uh we're gonna see you next time in the meantime, keep your dial lock to Yahoo Finance.