What, Me Worry?
What, Me Worry? by John Mauldin – Gold Seek
Sell to Whom?
(Almost) Everything Is Awesome
Bending the Yield Curve
The Dangers of Passive Investing
Getting Married on St. Thomas, Omaha, San Francisco, and Freedom Fest in Las Vegas
“Forget the past. The future will give you plenty to worry about.”
– George Allen, Sr.
“I try not to worry about the future, so I take each day just one anxiety attack at a time.”
– Tom Wilson
Welcome to the new, improved, faster-to-read, better yet still-free Thoughts from the Frontline. My team and I have been doing a lot of research on what my readers want. The reality is that my newsletter writing has experienced a sort of “mission creep” over the years. Bluntly, the letter is just a lot longer today than it was five or ten years ago. And when I’m out talking to readers and friends, especially those who give me their honest opinions, many tell me it’s just too much. There are some of you who love the length and wish it were even longer, but you are not the majority. Not even close. We all have time constraints, and I wish to honor those. So I am going to cut my letter back to its former size, which was about 50% of the length of more recent letters. (Note: this paragraph is going to open the letter for the next month or so, since not everybody clicks on every letter. Sigh. Surveys showed us it’s not because you don’t love me but because of demands on your time. I want you to understand that I get it.) Now to your letter…
The middle ground can be uncomfortable. As someone now widely known as the “muddle-through guy,” I have learned this the hard way. My bullish friends call me a worrywart, and the bearish ones think I am Pollyanna incarnate.
The irony here is that I’ve never claimed to be a great trader or a short-term forecaster. I think I have a pretty good record of calling major turning points. Next week or next month is another matter. Anything can happen, and it probably will.
That said, the fact that my forecast may be wrong doesn’t prevent me from making one. So, with all the usual disclaimers, today I will review some recent analysis from my reliable sources and let you take a peek into my worry closet.
One point we all agree on: We live in unusual times.
Last week Doug Kass sent around an e-mail comparing today’s markets to Queen’s classic “Bohemian Rhapsody.” I know that seems odd, but it was actually a good fit. I shared Doug’s full message with my Over My Shoulder subscribers. For everyone else, the point is that, like the song says, “Nothing really matters” to whoever is buying stocks these days. They just keep buying and pushing prices higher. As Jared Dillian says, “It’s a bull market, dude!” Stock prices do go higher in a bull market; and sometimes, as the end approaches, they make value investors very uncomfortable.
Neither Doug nor I quite understand the “Nothing really matters” attitude, though we have some theories. Doug is probably more bearish than I am. He has a long list of open questions. I zeroed in on the last one, which is critical: “When ETFs sell, who will buy?”
The stratospheric ascent of passive indexing is having side effects that I suspect will make markets sick at some point. Passive investing is perverting the financial markets’ core economic function, i.e., efficient capital allocation. In terms of stimulating buying interest, a company’s fundamental business prospects are now much less important than its presence in (or absence from) popular indexes.
We’ve created this environment in which badly managed companies can still see their stock prices rise along with those of well-managed companies. The actual facts about a company don’t mean all that much in a passive-investing world. Capitalization-weighted indexes aggravate this already problematic phenomenon. Money is pouring into stocks like Apple (AAPL) and Amazon (AMZN) simply because they are big. The resulting higher prices make them bigger still, and they pull in yet more capital. Here’s a look at the five largest stocks in the S&P 500.
What about the QQQ or the NDX? The five stocks above represent 42% of the NDX and 13% of the S&P 500. That means every time you buy an index based on the NASDAQ, 42% of your money goes into just five stocks, leaving 58% for the remaining 95. By the time you get past the largest 25, you are under 1% per stock. Apple alone is 12% of the NASDAQ 100 Index and 4% of the S&P 500. That explains, in part, why the NASDAQ has outperformed the S&P 500.
For the record, Goldman Sachs researchers recently released a paper with a strong fundamental forecast for those stocks. That is, they expect them to continue to go up, absent a recession or something else that triggers a bear market. I keep scanning the horizons in every direction, and I just can’t see anything that would trigger more than a minor correction today. Of course, a minor correction could deliver outsized impacts, given the heavy weighting of a few stocks and passive index investing. Be careful out there.
Doug asks, “When ETFs sell, who will buy?” The ETFs of the world may quickly begin trading below their actual net asset values (NAV). This is called price discovery, and the arbitrageurs will not be slow to take advantage of that difference. This means the indexes will drop much faster than they have gone up. I am neither a fortuneteller nor the son of a fortuneteller, but there are a few things I’ve picked up along the way. One of them is that, next time, stocks are going to go down breathtakingly fast once they begin to roll over.
This bull can’t end well, but it will end. At that point, Doug’s question becomes critical: Who will buy? I don’t know, but someone will. Prices for good and bad stocks will drop to whatever levels attract buyers. The indexes will eventually fall lower than any of us think likely right now. Whether that will happen next month, next year, or next decade is anyone’s guess.
Sidebar: You should think of cash as an option on your ability to buy the stocks that will lose 50% of their value and suddenly become the value stocks of the future. The option value on your cash today is not that much. You don’t make much on it, but you don’t lose much holding it. The time is going to come when you will be glad you have a little cash to put to work. Think March 2009.
(Almost) Everything Is Awesome
While Doug was musing about Queen, Louis Gave was thinking about rugby. Should one go where the ball is now, or try to figure out where the ball will be?
Louis asks that question while noting that it has been extremely difficult to lose money this year. Almost every tradable asset class has been climbing. You are probably making good.