Expect More Pain, Much More Pain

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. 1-25

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.


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.


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.


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.


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.