If you’re in the market for a full visual recap of what turned out to be a less-than-stellar first half for global equities despite January’s rambunctious rally, you can find all the chart candy you could possibly ask for in “Requiem For A Rally: 2018’s First Half In Charts“.
One of things that stands out when you look back at the first half of the year is the fact that U.S. tech stocks managed to make new highs despite the February VIX explosion. In the same vein, tech shook off the regulatory concerns that led to a pretty steep late March slide that culminated in a correction for the Nasdaq.
As we head into the back half of the year, “Long FANG” is still the most crowded trade on the planet according to BofAML’s Global Fund Manager Survey and if you want evidence that they do indeed ring bells at the top, look no further than a recent USA Today article that suggested college students could “turn [their] summer job pay into a fortune” by simply dedicating half of their “egg-slinging” lifeguard money to investments in four tech heavyweights. I lampooned that USA Today article mercilessly a couple of weeks ago in a humorous post for Dealbreaker. Here’s the BofAML chart that documents the evolution of the “most crowded trade”:
Part and parcel of the FANG debate is the notion that the market still depends too much on a handful of high-fliers which are driven inexorably higher by what Howard Marks has variously described as a “perpetual motion machine” dynamic.
In his latest missive, Marks reinforced that argument (originally put forth a year ago) and he also reiterated the points Goldman made in their famous FANG note from last summer about the extent to which the same names end up becoming synonymous with a variety of factors used to create smart-beta vehicles. That ends up channeling still more money into the shares, supercharging the self-feeding loop in the process.
Like, for instance, what happens when “momentum” becomes synonymous with “growth” or when an ongoing rally in stocks like the FAAMG constituents makes them synonymous with “low vol.”?
I’ll tell you what happens. What happens is that you end up with factor crowding. Recall this from the Goldman note referenced above:
While not exactly a Fields Medal worthy observation, we note that FAAMG is positively correlated with Growth and Momentum and this relationship has strengthened in recent months. The bigger anomaly, however, is that FAAMG is almost as highly correlated with Low Vol (as measured by standard deviation of 1Y daily price returns), which is not a characteristic typically associated with cyclically driven names.
And here’s an excerpt from Marks’s latest:
The third level concerns stocks in smart-beta funds. The more a stock is held in non-index passive vehicles receiving inflows (ceteris paribus, or everything else being equal), the more likely it is to appreciate relative to one that’s not. And stocks like Amazon that are held in a large number of smart-beta funds of a variety of types are likely to appreciate relative to stocks that are held in none or just a few. What all the above means is that for a stock to be added to index or smart-beta funds is an artificial form of increased popularity, and it’s relative popularity that determines the relative prices of stocks in the short run.
Well, in a testament to everything said above, Goldman was out on Friday evening with a pretty remarkable (albeit simultaneously unsurprising) observation about the S&P’s YTD performance.
“Growth stocks are highly represented among S&P 500’s top 10 return contributors [and] the top 10 stocks have contributed more than 100% of S&P 500’s YTD return,” the bank’s David Kostin writes, adding that “Amazon’s soaring 45% YTD return has contributed 36% of the index’s total return.”
Goldman goes on to make the point about market cap again, noting that while “other S&P 500 stocks have rallied even more in 2018 [they’ve] contributed less to the index return due to smaller market cap weights.”
I’m not sure this says much for market breadth:
As ever, the question is what happens if/when these names rollover or, more to the point, what happens if/when the “perpetual motion machine” dynamic goes into reverse?
On that note, I’ll just leave you with another quote from Howard’s latest:
The vast growth of ETFs and their popularity has coincided with the market rally that began roughly nine years ago. Thus we haven’t had a meaningful chance to see how they function on the downside. Might the inclusion and overweighting in ETFs of market darlings – a source of demand that may have driven up their prices – be a source of stronger-than-average selling pressure on the darlings during a retreat? Might it push down their prices more and cause investors to turn increasingly against them and against the ETFs that hold them? We won’t know until it happens, but it’s not hard to imagine the popularity that fueled the growth of ETFs in good times working to their disadvantage in bad times.