Expect More Pain, Much More Pain

Mike Mish Shedlock

If you think you can hide out in ETFs or high growth stocks and weather the downturn, please think again.

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.

Lesson Unlearned

The lesson is good companies do not necessarily make for good investments.

For sure, Apple, Amazon, and Google are excellent companies. That is why they are on nearly everyone's "must own" list.

The problem with must own lists is they never (and I doubt that is "never" is much of an overstatement) take into consideration valuation.

Mean Reversion

Earnings mean reversion is coming up. It's guaranteed. Timing is not guaranteed.

What appears to be reasonable based on silly forward estimates is an enormous value trap.

Meanwhile, "Stopped Clock" taunts pile in, just as they did in 2005, 2006, and November of 2007.

It Remains Impossible

It was impossible (in aggregate) for investors to heed such warnings in 2000, 2007, and it is also impossible now.

Individual persons can indeed take action, but given there is a buyer for every seller, it is mathematically impossible for the masses to do anything but ride this mess down as happened previously.

Mike "Mish" Shedlock

Comments (27)
No. 1-27
Rayner-Hilles
Rayner-Hilles

I'm pretty convinced at this point that most central banks are more concerned with stopping housing from overheating (futile that may be) than seeing the stock market propped up. Indeed haven't key monetary policy figures said themselves that valuations are too high? Seems pretty stupid to, just at this moment, be betting on Fed easing.

klausmkl
klausmkl

Mish you really do not know much about the stock market do you? The ES futures had been up for 15 straight months. That's 15 months that it had either higher highs or higher lows. I have went back over 20 years and could not find a single stretch that long on my monthly charts(they only go back 20 years on TOS). It is quite normal for digestion to take place with such a move. We also have seasonality to deal with soon as sell in may and go away takes place. Another move up will follow as the weak hands are shaken out. So either gets some learning on technical analysis or stop your meaningless dribble for click bait.

AWC
AWC

The Fed has worked tirelessly for a decade building this "Wealth Effect" behemoth (Bubble). They are quite proud of it. Not too sure I would short their resolve to maintain what they so ambitiously created here. Put it like this, if they lose this one, they pretty much lose everything. Their credibility will be shot, and Donny will likely fire them.

Blacklisted
Blacklisted

The Fed is raising for one reason, to delay the implosion of pensions. Stomachs are in the throats of the much more indebted foreign countries. Maybe a war will make the great unwashed forget that govt lies.

QTPie
QTPie

The market today is all about sentiment and momentum fueled by central bankers. However, eventually sentiment will shift from speculation to valuation. The fact that speculation has ruled the day for a very, very long time is not in and of itself proof that it will go on forever.

When the shift happens passive index investing will not save the day. The S&P 500 is the index of the 500 biggest companies. However, it is not necessarily the 500 “best”, “best value”, safest, best-managed, etc. companies. Nor are the companies composing the index weighted using any sort of “value” criteria.

In other words, size does not necessarily equal quality. When mean-reversion (which, over the long term, is perhaps the most powerful force in nature) takes hold of the stock market investors will learn this lesson the hard way.

AWC
AWC

@QT, I might add to your "Mean Reversion" comment, there is a significant Demographic Curve at play here, too. When Defined Contribution pension schemes go from net investing to net withdrawal, things will change even more so, hurrying that mean reversion process along. So much for John Bogle's 'Just buy the index and beat the active managers' meme. Every year this market mania continues, the smaller the exits become. That, and for all those who think they can hit "Sell" faster than the machines can,,,well, best of luck. Nano seconds count.

CzarChasm-Reigns
CzarChasm-Reigns

So despite being sold a nice BIG basket to put ALL our (nest) eggs in...it's STILL a bad idea? Great cartoon! T'is sad there was only the one life boat for the CEO's.

truthseeker
truthseeker

I have to say I’m somewhat surprised that the overseas futures markets are up as high as they are right now. Even before we blasted Syrian chemical weapon facilities, didn’t Trump place even more sanctions on Russia? At this point I don’t know how many warnings Putin has made, but he’s starting to look like Obama drawing lines in the sand over and over again. The former leader of th KGB has said that Russia will respond to this latest attack, especially since Israel has also started blowing things up in neighborhood. I put myself in Putin’s place, and I would tell my intelligence people to come up with a plan to really kick some ass! Mish I think geopolitical events certainly effects our markets so I don’t think I’ve gone off Topic here.

2banana
2banana

You want pain? Get back with enforcing GAAP, enforcing fraud laws, throwing bankers in jail and getting rid of "too big to fail..."

MntGoat
MntGoat

Nothing I disagree with on your post Mish, it all makes sense. But in terms of "stopped watches being right twice a day".....this refers to perma bears who ALSO said things were "about to fall apart any day" in 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 and now of course "the end is nigh" in 2018 too. Perma bears "stopped watches" may be about to be right for that 2nd time in a decade.....as we must be getting close to some type of big correction soon.

Carl_R
Carl_R

Tech Stocks have probably reached a "permanently high plateau."

Rayner-Hilles
Rayner-Hilles

I emphatically second that point on pension funds. The dollar will soar and foreign currencies collapse during the emerging debt deflationary period. Thumbs up for Victorian snobbery.

killben
killben

@MntGoat, this refers to perma bears who ALSO said things were "about to fall apart any day" in 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017 and now of course "the end is nigh" in 2018 too.

killben
killben

Yup. They were wrong. But then to be fair to them, was there one instance in the above when the central banks (The Fed, ECB, BoJ, PBoC) did not intervene and the market stood on its own.

killben
killben

The difference seems to be that the central banks themselves seem to be afraid of the monster they have created and thus look like wanting to burst it (by raising rates and QT). But then the central banksters are such slimy characters that I for one will not be surprised if they intervene if the market crashes. So even in 2018, the perma bears could be proven wrong. But the point is without the central banksters the perma bears would have been right. Let us see

MntGoat
MntGoat

@killben ....I agree with you things are more precarious now with how much higher asset prices are then 2010. I I agree things look grim. And I have agreed all along with the whole "permabear thesis" that this recovery is a "house of cards" built on zirp and QE. And full disclosure I myself am a permabear (currently in the 12 step recovery program....lol)....so I am allowed to make fun of fellow permabears. But if you went back and read perma bear blogs, newsletters, etc... - since the end of the recession in 2009, it has been all the same stuff non stop for 9 yrs now about how "hard times are right around the corner" and "things will all fall apart any minute now". They always say that. That is why most are broken clocks, right twice a day.

killben
killben

@MntGoat, The biggest permabear (though he would not agree) Hussman, probably put it correctly when he said that in one of his piece "looking back, people will say this is where they lost their mind".

How can you be sure how far these central banksters will go? I have been surprised that they went ALL IN to this extent as the problem now is ALL THE CENTRAL BANKS can never get out without crashing the markets. IMO, the only way out to ensure the markets do not crash is QE4EVER with ZIRP/NIRP all over the world for as far as the eye can see. Can you imagine a world like this?

I have also been out of market (so a fool) because while I am not sure how it will play out and the timeline I am sure of the ending. Thus since I am not sure of the timeline I do not want to be the one holding the bag. Who knows, the moment I get the bag is when this market goes down.

As James Grant said "Putting The Cart Of Asset Prices Before The Horse Of Enterprise", this has been what the central banks have been doing since Greenspan. It looks more and more likely that they have run out of steam. But then may be war (as did hurricane, wild fire) may change the scenario. But the good bit of the destruction better be in the country where you want asset prices to stay elevated.

By pushing for Asset prices the CBs are destroying the world. BY pulling forward the demand (by manipulating interest rates and making people go into risky assets, QE and central bank put), while they are pushing up asset prices they are also creating an artificial demand, which will hit air pocket unless you can do it indefinitely (when you run out of a greater fool). This is the stage CBs are in and they sure do not want to look like the fools they are so they are keeping the show going. BUT the question is only CAN THEY DO IT FOREVER? I sure do not think so!

I am an old stooge who believes in growth that comes through enterprise and savings and ability to buy (with a reasonable amount of debt backed by ability to pay). Thus I am convinced that this cannot work! But then I will not end rich because I am bad at timing.

MntGoat
MntGoat

@killben .... you are preaching to the choir, I agree with all your are saying. CB have painted the world into a corner and just kicked the can down the road. But there is a difference between being a permabear and a skeptic. 2006 was a great time to be a skeptic. But the problem with a permabears is the word "perma". They did not recognize the value in assets from 2009-2012, as they thought bad times would be "forever" and that everything would go to "zero". I'm more of a real estate & distressed debt buyer then stock market guy. 2009-2012 was a PHENOMENAL time to buy rental property and distressed mortgage debt for pennies on the dollar. Permabears missed this buying opportunity because as always, they thought back in 2009, 2010, 2011, 2012, etc... that another depression was "right around the corner" or hyperinflation, or some other calamity, etc... Neither which materialized....YET... of course it still might of course. I have friends that never picked up any rental property when prices were dirt cheap 2009-2012 because they though prices would only go lower. So its easy to be a permabear say for decades that "bad times are right around the corner". It's much harder to make the turn, and buy assets at bottoms whenever hates them, and thinks the world is headed into a endless depression.

killben
killben

@MntGoat, I agree with you on buying when there is blood on the streets which many cannot do. That is why only few end up rich. That said, the point remains that there was a recovery in Mar 2009 only after FASB rule change (did you envisage this at the time of buying?) and the CBs doing QE And then QE after QE every year thereon for some time (did you envisage this?). If you envisaged all this and bought then great buying indeed. If not, then if the CBs had not intervened to the extent they did this levitation of asset prices would not have happened and your friends might well have been proved right and the bottom in prices would not have been in. The CBs simply got away by saying that it would have been worse.

MntGoat
MntGoat

@killben .... I didn't envision any of the CB asset inflation...I don't buy for appreciation or greater fool theory...I buy stuff that cash flows day one with a margin of safety at a discount to replacement value. All the appreciation the FED created was gravy, I had no clue I would get. It's good to be a permabear at the end of cycles (which we must be close to now)...but the hard part is to buy when people think the world is coming to end (which they did in 2008 when Lehman went BK). If I had a crystal ball I would have bought A LOT MORE then I did. But of course I didn't and I have a lot of permabear blood in me which restrained my buying efforts.

killben
killben

@MntGoat " buy stuff that cash flows day one with a margin of safety at a discount to replacement value. " ... one can learn from you! sincerely said!! I would the courage of conviction helps.

killben
killben

"which we must be close to now" ... the problem is we cannot be sure of this also the way the CBs have managed for nearly a decade now. Close could be this year or 5 years hence.

killben
killben

Also this...

killben
killben

"which they did in 2008 when Lehman went BK"

without FASB and endless QE, would this have been proved right?

MntGoat
MntGoat

@killben ...."which we must be close to now" ..." the problem is we cannot be sure of this also the way the CBs have managed for nearly a decade now. Close could be this year or 5 years hence". ---------> What's REALLY different now vs. say 2010-2016 is the FED is now in tightening mode not loosening mode. This bull market has never been tested by a prolonged FED tightening phase, which it is being tested by now. And I think throughout history FED tightening phases have almost always led to recessions. And yes if we hit a bad stock crash and/or recession, the FED will likely reverse course....and I have no clue what that will entail for everything.

Stuki
Stuki

While you ultimately are bound to be correct, the lessons from Venezuela, Argentina and every other fully financialized dystopia, has still been that those who own stocks, bonds, housing etc., still come out ahead of those who sit in cash, relatively speaking. Simply because the Fed and government has the power to look out for their own. Hence will do so. Making up ever more obviously contrived excuses for ever more obviously crass theft, as the productive base they are dependent on preying on erodes.

Pretty much every single person who has ever been invited to speak in front of Congress, and/or been invited to the White House, or has ever written an opinion in a magazine read by politicians and Fed governors, owe somewhere between a very large and all of their wealth and social status, to pumped up asset prices. Just like in Venezuela, right up until there was simply nothing left whatsoever to steal for fuel on the asset pumping bonfire.

But while eventually the Venezuelan asset-pump freeriders did get a bit of a comeuppance, the important lesson is that this didn’t even begin to happen, before those dependent on cash rather than “assets” were literally starving to death for lack of available food. There is precious little reason to believe our local Chavez’ and Maduros, nor the theft rackets they head up, will go any easier on their designated livestock. Nor that the local livestock; dumbed down, overweight, hapless and indoctrinated as they are; will display any more Somalian like resolve to force the oppressors’ hand.

sachvik
sachvik
Stuki
Stuki said: While you ultimately are bound to be correct, the lessons from Venezuela, Argentina and every other fully financialized dystopia, has still been that those who own stocks, bonds, housing etc., still come out ahead of those who sit in cash, relatively speaking. Simply because the Fed and government has the power to look out for their own. Hence will do so. Making up ever more obviously contrived excuses for ever more obviously crass theft, as the productive base they are dependent on preying on erodes. Pretty much every single person who has ever been invited to speak in front of Congress, and/or been invited to the White House, or has ever written an opinion in a magazine read by politicians and Fed governors, owe somewhere between a very large and all of their wealth and social status, to pumped up asset prices. Just like in Venezuela, right up until there was simply nothing left whatsoever to steal for fuel on the asset pumping bonfire. But while eventually the Venezuelan asset-pump freeriders did get a bit of a comeuppance, the important lesson is that this didn’t even begin to happen, before those dependent on cash rather than “assets” were literally starving to death for lack of available food. There is precious little reason to believe our local Chavez’ and Maduros, nor the theft rackets they head up, will go any easier on their designated livestock. Nor that the local livestock; dumbed down, overweight, hapless and indoctrinated as they are; will display any more Somalian like resolve to force the oppressors’ hand.

@Stuki - Completely agree with you. I don't see why there is so much doom and gloom about the US economy. The Fed can easily reverse course and print even more money if it sees any of the dire predictions coming true.
After all, there is still the option to buy all of the listed stocks in the US market (other central banks are doing it, why not the Fed)? Asset prices can also go up a lot more - many PE funds will view reduction in property prices as an attractive investment opportunity (at least by recent historical standards)...
How long can the Fed continue this policy without the general public losing faith? No one can predict the future but I'd bet it'd be a lot longer than the next 5-10 years - even Japan is seeing a very slow decline instead of an instant collapse. Totally agree with Mish that some other economies are in even worse situation than the US - any sign of trouble and investors will flock back to the USD's relative safety...
Mish - What is your view on higher marginal tax rates as a way of income redistribution from the ultra-rich to the general population? Although, politicians don't have a great track record of investing money in the right places, it'd still be better than the current income concentration.


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