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
No. 1-25
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.

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.

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.

killben
killben

"which they did in 2008 when Lehman went BK"

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

killben
killben

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