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The "Dumbest Market in History?" |
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Dear Reader, |
Is the present stock market the "dumbest market in history?" |
History is to its neck with dumb markets — examples run and run. |
Can we then declare this stock market truly the dumbest? |
I do not know. Yet MarketWatch's Brett Arends believes it is. |
The rock of his argument is the "passive investing" that predominates today. |
I have cited passive investing recently. |
In brief reminder, passive investing tracks an overall index or asset category — not its individual components. |
Passively managed funds undertake no effort to pinpoint winners. |
They are passive because they sit back on their oars… and let the flowing tide lift their boat. |
Passive investing disregards fundamentally — if you'll forgive the expression in the current contest — "fundamentals." |
Fundamentals no longer were of concern. "Active" asset managers on the hunt for market inefficiencies could no longer separate winner from loser. |
Dumb and Crazy! |
Passive investing is a strategy that yields handsome dividends under a flood tide of rising waters. Yet as I also detailed recently, passive investing's central risk is this: |
When the tide recedes… it recedes. |
And the multiple water craft that rose up together… sink down together. Mr. Arends: |
At one level, there is no doubt that this is the dumbest market in history, because at this point it is completely dominated by "passive" index investing — the very definition of dumb money, because indexers buy stocks without any regard to valuation. Index funds chase the crowd, but increasingly index funds are the crowd — which is both dumb and crazy. |
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Both dumb and crazy! More: |
Private-client fund manager St. James Investment Co….calculates that the total amount of assets managed by passive investors, typically index funds, now exceeds the total amount managed by active investors, who — for good or ill — actually look at things like balance sheets and income statements before investing in a stock. |
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The lines, St. James estimates, crossed in February of last year. |
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Who's Minding the Store? |
Yet why is this time well and truly different? |
At the last two stock-market cliffs, in 2000 and 2007, active investing still dwarfed passive investing by orders of magnitude… |
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What this means is that fewer and fewer people are actually making a market in stocks using their brains. Most, as indexers, are just blindly buying — assuming that somebody else is minding the store… |
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This dumb stock market, built entirely on blind faith, wouldn't matter so much if the numbers passed a sanity test. But they don't. Not even close. |
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I have written extensively about preposterously stretched valuations and other manifestations of market lunacy. |
Mr. Arends, by way of validation: |
The S&P 500 index now trades for 26 times trailing per-share earnings, far above historic norms. It sells for 40 times the inflation-adjusted earnings of the past 10 years, the so-called CAPE, or cyclically adjusted price-to-earnings ratio, popularized by Nobel-winning economist Robert Shiller of Yale. |
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The market, by this measure, is near the all-time peak reached during the epic bubble around the turn of the millennium, when the CAPE briefly touched 44. It is… about one-third higher than it was at the peak in 1929 — a moment that needs no introduction. |
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You Can Be Right and Wrong at the Same Time |
"But wait," you counter — "this boom is being driven by AI, which is a true game-changer. It's not just another bubble, it has real legs." |
You may be correct. You may be incorrect. |
You may even be both correct and incorrect at the same precise time. Mr. Arends continues: |
Let's assume AI can live up to the hype and will transform business. |
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People said exactly the same thing about the internet in 1999, and they were right about that. But it took a lot longer than they had expected, and meantime the bills came due and valuations became unsustainable. |
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If you invested in the Nasdaq-100 at the start of 2000 (not even at the peak a few months later), you were absolutely right about technology and you were right about history, but you were oh-so-wrong about investing. |
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And oh-so-wrong you were. Assume you placed the sucker's bet at the start of 2000. |
You would not poke your head above the waterline — in real terms — for 16 years: |
You lost about three-quarters of your money over the next three years. By the time Steve Jobs was unveiling the first iPhone in 2007, you were still down about 50%. You had to hang on until 2014 just to break even. |
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Once you factor in inflation, you had to wait until the end of 2016, approaching two decades after investing your money, before you started to see a positive return. |
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I do not know if the stock market has yet attained its summit. |
Yet even if it is months and months from its summit… the Johnny-come-lasts who purchase near the top will put in several hard years scratching to claw even. |
It is a bleak, bleak prospect. |
Look on the Bright Side |
Yet even the gray cloud features its silver edging. |
Misery is misery, it is true. Yet as the phrase runs, misery loves company. |
And I hazard the immiserated will enjoy abundant company in future years: |
The good news for investors, though, is that… everyone is eagerly buying the same stocks as you at these same sky-high valuations. |
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And as citizens of this democratic republic, the immiserated can even draw wisdom from the democratic nature of their immiseration. |
"Democracy," argued the late Henry Louis Mencken, "is a pathetic belief in the collective wisdom of individual ignorance." |
He likewise maintained that "Democracy is the theory that the common people know what they want, and deserve to get it good and hard." |
Now consider the common investor. |
"I may be ignorant," he concedes. Yet he is a passive investor. Thus he places his trust in the market's collective wisdom: |
"Everyone's getting rich buying stocks right now. I don't want to miss out, so I'm buying too. I mean, everyone can't be wrong, right?" |
He will learn a subsequent lesson in the collective wisdom of individual ignorance — good and hard. |
Regards, |
Brian Maher |
for Freedom Financial News |
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