This is my first post on TMF in quite some time. I think that what is discussed in the linked podcast is important enough that, when combined with what I’ve read here over that absence, warrants at least providing the investors on this board with what I believe may be a paradigm-challenging argument. [ I recognize that many here may already be well-informed on the topics discussed.]
The podcast addresses the role of passive investing and macro market implication possibilities. I would urge listeners to await the end of the interview before coming to any conclusions (I know that this urging may be considered offensive to some, but I do not intend any disrespect).
For full disclosure, I do not own any products mentioned but find interesting the way some of them are constructed to protect against the possibility that Mike Green’s conclusions may pan out be correct. We are all flawed and, thus our constructs that help us define reality are likely flawed as well… a notion that I find myself forgetting in the press of day-to-day living.
The link to the podcast is the shortest podcast I could find so that members of this board could be exposed to thinking that, for me, has provided much food for thought.
If someone wants to probe deeper than a youtube search of ‘Mike Green investor’ (apparently there is a professional hockey player of that same name) will provide hours of thought-provoking interviews and panel discussions.
The most important and on the mark On Topic Post I have seen in quite some time. I hope people watch the extremely interesting video, reflect, and then comment. I will be watching this thread with great interest.
Mark Green’s linked video cogently presents an analysis of the systemic flaws emerging from massive passive investment, making a strong case for analysis that I have seen more roughly sketched out on this board from time to time over the last decade, and even earlier back to Mish days. It adds up to an undercutting of much long honored understanding of securities markets, exposure of extremely dangerous systemic issues that are NOT being addressed, and so to a Market Nihilism that will one day undercut cookie cutter investing.
I feel all sensible investors should listen and consider the implications carefully.
I am ever more relieved that I have been almost totally out of this market for the last six months, and that I started cutting near the beginning of the epidemic. I have passed up opportunities in securities (congrats! to those here have done marvellously), but have found other investments in Real Estate, real commodities, and private lending that do not bring me valuation nightmares.
The biggest problem with passive investing is that Wall Street makes less money off it. Their current business model demands that they skim 2% per annum from the average customer in fees, commissions and trading costs.
Limit “the skim” and you can retire early and become wealthy. It’s just arithmetic and decades of compounded returns, sans “skim”.
Mark Green’s linked video cogently presents an analysis of the systemic flaws emerging from massive passive investment,
The first message I heard was that the current inflation is temporary, caused by nervous buying and hoarding. Matches what Tom Nash is saying.
On passive investing I dissent. Maybe it does distort markets somewhat but this distortion is not what causes active investors to under perform. That is caused by the Power Law distribution of wealth. To beat the market average you have to be in the top quartile or quintile of investors.
For reference, back when Pareto noticed the wealth distribution in Italy he was not looking at the stock market and he still got the same results, a 20/80 distribution.
Mark Green emphasized that his efforts to fix the problem got him nowhere. That is an important lesson! Don’t fight City Hall, play it to your advantage.
I share the feeling that something might go wrong with passive market index funds, but didn’t find Mike Green’s clearly expressed comments much help. The stats on how much money is in passive was interesting (about 45% of US equities is ties to a passive strategy, and this is much higher for younger investors at around 90%). Passive investing is increasing, and demographics (older investors tend to directly hold stock) will accelerate this trend.
Green’s theory is that a passive market index fund will buy stocks based on market cap, but the liquidity does not scale (Apple has 200x market cap but only 40x liquidity). This results in higher prices for large cap stocks compared to small cap. Green states that index funds are based on the efficient market hypothesis (EMH), and the EMH prediction that prices will not change even with very high capital inflows doesn’t make sense. Green’s view is that as capital flows into the US equity market, the passive index funds will over allocate to large cap funds, resulting in a large cap bubble.
I disagree. Index funds are not based on EMH. Index funds are based on the idea of getting the average return. Passive index funds will always get the same return as the average investor. Even if a few investors have market beating insights (violating EMH), most people should still invest in passive index funds. Active investors have costs, and this reduces the average active investor return to less than the passive index return. As the Captain noted, the distribution can push this even further. For example, 20% of active could do much better and 80% slightly worse than passive.
Green thinks there is an overallocation of capital inflows to large cap stocks, but if the capital inflows had instead gone to active managers, the active managers might have bought the same amount of Apple stock. The stock owner is the one who decided to buy US equities.
Things might unravel when the average investor is a passive investor. Someone needs to set the prices that allocate capital. If there is no reward for that work, the markets might not work as well at price discovery. I think there’s plenty of interest and so am not worried. See Saul’s board for example.
Thanks for the responses so far, especially borisnand’s fine, fierce, intelligent response, as he is grappling with the actual content of what I linked. I always respect the Captain’s individualist triumphalism (although I am of a very different tribe), and have no criticism as he is sufficiently fast footed (documented in his detailed posts)(he obviously listens to his recent ancestors as I do to mine) that he would escape the harms I fear.
I see this as a systems engineer who specialized in catastrophe theory within complex systems. I see world wide economic securities markets, especially within the USA, as paralleling complicated “ecological systems”. Our markets are structured around an inheritance of a particular historical not immortal epoch of capitalsim originated in Amsterdam and then London, at all times overwhelming responsive to but independent of world power structures, and as vulnerable to external shocks as ancient Babylon.
So I SCREAM that our securities markets (and much more of complacent modernity) are not founded on granite but on ice frozen over a lake and as the temperature rises the ice will break, catastrophially, and all will change. Melting can and will occur, and melting empowers those gaming the system against the intent of using the system of widespread enrichment of wealth and knowledge.
https://www.youtube.com/watch?v=x-rJciYZmi0On passive investing I dissent. Maybe it does distort markets somewhat but this distortion is not what causes active investors to under perform. That is caused by the Power Law distribution of wealth. To beat the market average you have to be in the top quartile or quintile of investors.
I found [Google found for me!] an older Michael Green presentation discussing the effect of passive investing on markets, a presentation better supported by research, data, and charts.
The central takeaway for me is that active investing is valuation driven while passive investing is cash flow driven. While active investing tends to keep the P/E ratio in a range, passive investing inflows raise the P/E ratio without regard to valuation creating bubbles and making the market unstable, i.e. a positive feedback loop vs. active investing’s negative feedback loop. It makes perfect sense.
If companies report quarterly, how can you do valuations on a daily basis? The only thing that changes daily for certain is the stock’s price! While the numerator (price) changes daily the denominator (value/earning) tends to be steady state with periodic phase changes.* Value investing makes stocks mean reverting! That being the case one should be able to trade around the stock’s volatility. The difficulty is that in addition to ‘mean reverting’ there is a bull in the china shop, ‘animal spirits’ Lord Keynes called it. The way to tame the ‘animal spirits’ is to exercise patience. While this sounds very theoretical, I have tested it on small positions over a number of years. As with covered calls, it works best in bull markets and as with covered calls it works best with volatile stocks.
Louis Navellier researches ‘What is Working on Wall Street Now’ on a quarterly basis.
PS: In the Q&A it was revealed that the real purpose of indexes, ETFs, and other Wall Street ‘products’ is to siphon your money to Wall Street. Who would have guessed! Wall Street is not a charitable organization! Amazing!
The difficulty is that in addition to ‘mean reverting’ there is a bull in the china shop, ‘animal spirits’ Lord Keynes called it. The way to tame the ‘animal spirits’ is to exercise patience.
The way to tame the ‘mean reverting’ and ‘animal spirits’ is to periodically rebalance the portfolio to maintain a desired equity/fixed income ratio (e.g. 60% stock/40% fixed income) As stock prices rise, you’re taking money off the table and putting it in fixed income when you rebalance.
I see this as a systems engineer who specialized in catastrophe theory within complex systems. I see world wide economic securities markets, especially within the USA, as paralleling complicated “ecological systems”. Our markets are structured around an inheritance of a particular historical not immortal epoch of capitalsim originated in Amsterdam and then London, at all times overwhelming responsive to but independent of world power structures, and as vulnerable to external shocks as ancient Babylon.
What a lovely description of capital markets! Well done!
Yet there is a method to the madness! Years ago The First National City Bank funded the Santa Fe Institute to study markets in the context of complex systems. Anyone who wants to be up-to-date should have at least a passing understanding of complex systems which respond to physics’ laws but obey biology’s laws – if you can call them that.
Melting can and will occur, and melting empowers those gaming the system against the intent of using the system of widespread enrichment of wealth and knowledge.
Human nature is what has brought us to where we are. Without human nature we might still be hunting and hunted on the African savannah.
Thank you for recommending this post to our Best of feature.
The biggest problem with passive investing is that Wall Street makes less money off it. …
Limit “the skim” and you can retire early and become wealthy. It’s just arithmetic and decades of compounded returns, sans “skim”.
intercst
It works even better if you have inflation indexed Federal pensions added to the mix. I buy only Canuck dividend payers (4% minimum) with a long history. I also buy only (new feature for 2022) in Tax Free accounts (TFSA) and closed my only taxable account last year. Now I have to decide what to buy with the new space in my tax free accounts. My energy guys were up a bunch in 2021 and my Canadian Banks have done really well.
Of course wealthy is a relative term but debt free also helps and we have rebooked our two weeks in Cuba for early March and are invited to visit family in California when we get back if COVID rules allow. Nice thing about Sunwing is direct flights between Halifax and Varadero Cuba. If we end up in quarantine when we return we can do it in our condo.
As stock prices rise, you’re taking money off the table and putting it in fixed income when you rebalance.
As the Captain says, that is not very Foolish.
Rebalancing worked back in days of lore, over relatively long periods, when stocks and bonds were sinusodal and were inversely related to each other. So as the stocks go up you trim and buy bonds when they are cheap. In a few years the reverse happens and the stocks go down as the bonds go up. But at this point you now have fewer stock shares to fall and more bond shares to rise. And if bonds go up enough you trim those at high prices and buy stocks at low prices. Rinse, repeat. I think those days have been over for at least a decade if not more.
Thank you all for your replies and sharing your thoughts. I have no desire to comment for or against any expressed ideas…that was not my intent in starting this thread. Creating a topic of a paradigm-challenging ideas from a highly skilled, high dollar portfolio manager was my major intent.
Danielle DiMartino Booth has interviews on youtube with not only Mike Green, but a number of other interesting thinkers as well.
This past year (2021) has had an outcome of having me search for ideas and potential insights as to what not-so-obvious market influences may be impacting US markets in ways that, to many, have resulted in valuation multiples rising to what some claim to be unsustainable levels. However, in line with the seeming increase in populism and polarity (domestic and internationally) there are also quite a few arguments that claim the major reason for the pessimism is a lack of understanding of newly evolving metrics.
A lot of food for thought.
Thanks again to all that chose to visit the link and spent more time in responding.
I would certainly disagree with that. If you have the ability to approximately value a company,and the temperament to not panic sell,markets will present many opportunities over any ten year period.