Expect More Pain, Much More Pain
Expect More Pain, Much More Pain by Mike Mish Shedlock – The Maven
In case you failed to notice, investment sentiment has changed. The stock market struggles to go up on good news. Investors wonder if the Fed still has their back.
Some think they can weather the storm by diversifying into ETFs or by owning high quality growth stocks. In reality, the co-dependence between big tech and passive and algorithmic investing will cause far more pain than most anticipate.
Throughout the near-decade-long bull run, tech giants and passive and algorithmic investing ascended hand-in-hand. The more a small group of tech companies dominated market returns, the less active investors could outperform tech-heavy indexes. And the more capital herded to passive and quant strategies, the less firm-by-firm price discovery could restrain tech stock inflation. It was a virtual feedback loop and the consequence is historic capital concentration in the tech sector.
Companies in the NYSE FANG+ Index are valued at a multiple that’s almost three times that of the broader gauge, a greater divergence than at the top of the dot-com bubble. According to a Morgan Stanley analysis, “the e-commerce bubble” — which includes FANG plus Twitter and Ebay — has inflated 617% since the financial crisis, making it the third largest bubble of the past 40 years behind only tech in 2000 and U.S. housing in 2008.
The topline stats are staggering regardless of how often they’re repeated. From the 2009 low to the recent highs, the S&P 500 advanced 331%. Meanwhile, Facebook advanced 413% (from its 2013 IPO), Amazon surged 2,102%, Apple 1,123%, Netflix 5,349%, and Google 586%. Combining those names with Microsoft and Nvidia, just eight tech stocks now account for over 15% of the entire S&P 500 index, and a staggering 48% of the Nasdaq 100.
The S&P 500 Growth Index has a 41.3% weighting to technology. The Russell 1000 Growth Index carries similar exposure, at 39%. At the average of the two, this represents a 60% overweight versus the S&P 500’s 25% exposure to technology stocks.
This brings us to passive investing’s great illusion: diversification. As Jared Dillian, former head of Lehman Brothers’ ETF desk, explained to Bloomberg in November: “Retail investors who are buying ETFs or indexed funds are being sold on the idea that they’re diversified. What [they] don’t realize is that the trade is very crowded — like 20 million-other-people crowded.”
As Morgan Stanley warned in a report released last week: “[The sectors] now occupy top rankings within the momentum trade that are ‘grossly’ out of proportion with their share of the market”:
Hiding Out in ETF? High Quality Growth?
Investors are about to re-learn a “Nifty-Fifty” lesson that they should have memorized in 2000 and again in 2007.
The lesson is good companies do not necessarily make for good investments.