Stock-market manias are contagious: They don’t just affect the stocks at the center of the mania. They spread, affecting everything else.
Most Read from MarketWatch
That’s a major and rising risk for ordinary 401(k) and IRA investors right now. It’s a danger as they get sucked into mania stocks like skyrocketing chip maker Nvidia NVDA (current value: $2.4 trillion, or 36 times last year’s … revenues). But it’s also a danger if you think you’re shunning these hot names by buying simple index funds like the SPDR S&P 500 ETF Trust SPY.
To understand this danger, listen to Francois Rochon, a veteran money manager for private clients who is based just north of the border in Montreal. In a fascinating letter to clients, the founder and CEO of Giverny Capital warns them to beware of the “index waltz.”
Here’s how it works. You start out with a few massive stocks that are booming and leaving the rest of the market behind. That’s what we’ve seen over the past year and change with the so-called Magnificent Seven technology stocks: Nvidia, Apple AAPL, Amazon AMZN, Google parent Alphabet GOOG, Facebook parent Meta META, Microsoft MSFT and Tesla TSLA. They were responsible for the lion’s share of the performance of the broader S&P 500 last year. Today those seven stocks alone account for just under 30% of the entire index’s total value.
What happens to the rest of the fund industry when a few big stocks leave the market in the dust? They start to look really bad. Any fund manager who either doesn’t own these stocks, or who holds a more rational weighting in them, wakes up to find they “are underperforming the index and a number of their clients are jumping ship to invest in index funds,” Rochon says.
Which has been pretty much the story for a while now.
And these managers, like most human beings, respond out of self-interest to the incentives being presented to them. “Some of those managers, motivated not to lose their jobs, are throwing in the towel and buying up the index’s largest stocks in increasing numbers to curb their underperformance,” Rochon points out. These desperate purchases “propel these stocks to new highs,” and that in return makes other fund managers who are holding out look even worse. So they eventually give in and rush to buy the booming megacaps.
It’s a vicious circle. (Or a virtuous one, if you happen to be holding the right stocks.)
This may be where we are now. It is notable that ordinary U.S. investors are now flooding into the stock market again, after shunning it during the bear market of the previous two years. According to the Investment Company Institute, the trade group for the mutual-fund and exchange-traded-fund industry, investors have bought $73 billion worth of U.S. stock funds since the latest market boom began around Halloween. That includes $45 billion in the first three weeks of March alone.
But in the first 10 months of 2023, when the market was much lower, they sold $155 billion worth of U.S. stock funds. In other words: Buy high, sell low.
But what can’t go on forever, won’t. Sooner or later, the music for this “index waltz” stops. We have seen this in previous manias. None of the 10 biggest companies in the S&P 500 50 years ago are still there today. None. Ah, yes, those Kodak, Sears and Xerox shares! Good times. Those companies couldn’t fail, right?
Rochon’s argument is not that investors should get out of the stock market, but simply that they should temper their euphoria for some of the biggest stocks on the market. Rochon, a so-called value investor and a devotee of the late Charlie Munger, is adamantly opposed to trying to time the market, arguing reasonably that nobody can predict its next short-term moves. But he must have some idea what he is doing, because his U.S. stock picks have beaten the S&P 500 by an average of 3.9 percentage points a year over a span of 30 years.
Meanwhile, the latest mania is especially concentrated among large-cap growth stocks, such as the Magnificent Seven. Cheaper, less exciting value stocks have been left behind. So the Vanguard Value ETF VUV has substantially underperformed the Vanguard Growth ETF VUG, especially since the mania around artificial intelligence and the Magnificent Seven really took off early last year. For that matter, so have international stocks. Dialing back on the euphoria doesn’t have to mean getting out of the market altogether.
Or you can just keep dancing to the index waltz.
Most Read from MarketWatch
Source: finance.yahoo.com