Don't Read The Comments!
"Informed" YouTube commentary provides the excuse for a useful illustration while the increased accuracy of GDP models raises some questions
Summary:
Public Figure Mockery: Mike Green looks like Troy Aikman. Full stop. Also, there’s a reason you no longer hear much weight attached to the Shiller P/E… since 1995, it’s had a negative correlation to S&P500 returns.
Market Behavior and Passive Investing: Recent fund flows have offered strong validation of the Inelastic Market Hypothesis
GDP Data Analysis and Skepticism: Lower survey response rates lead to more estimates rather than actual data, which may explain the improved accuracy of models like GDPNow over traditional forecasts.
What I’ve Been Reading & Watching
If you haven’t read Brad DeLong’s “Slouching Towards Utopia” (a play on Robert Bork’s “Slouching Towards Gomorrah”) put it on your August reading list. It’s brilliant even if it’s a few years old.
Ben Hunt’s recent talk at his Nashville conference (which I will not miss again) was absolutely stellar. Prepare for religious symbolism. My arguments against passive, in many ways, are a so fa futile attempt to beat back the hive.
Vanguard lobbed a grenade over the wall as regulators began to push back against the special treatment of passive. I am skeptical we will win this battle, but Vanguard’s arguments reek of increasing desperation.
The Main Event
One of the odder outcomes of becoming an unexpectedly public figure is being treated to YouTube comments. My personal favorite remains:
“Mike Green looks like meth head Troy Aikman.”
Now Mrs. Plum knows that my physical resemblance to Troy Aikman worked wonders for my bar pickup prowess in my early 20s, so to know that the resemblance has carried through was heartening. And for the record, I’ve never done methamphetamines.
But close behind it is this recent comment from my Adam Taggart’s “Thoughtful Money” appearance:
“Just think about it guys before you call this uber bear 'the smartest guy in the room', if what he is saying was that scary, then we would be seeing a very different performance from the S&P in the last few years since passive investing has become more popular to what we have seen in the past. Here are the numbers for the annual return of the S&P from its inception. What strikes me is that they aren't that different from what happened in the past and that it always goes up over time. Just because we are currently choosing a different kind of asset to allocate the funds to doesn't mean it's a ponzi scheme and there is going to be some kind of massive crash because of this. It MIGHT mean that you should think twice about large cap stocks but that is very questionable.”
Regular readers of YIGAF know that I relish being mocked. It’s a sure sign that I’m likely right. “The Dumbest Man Alive” is a sobriquet I carry with pride. But just for the heck of it, I ran a regression that helps illustrate just how little the returns of the S&P500 have to do with anything. While the Shiller P/E now has a poor reputation, it’s easy to forget that post Dotcom it was “the answer.” Like systematic value investing, it “just made sense” that valuation determined returns. Strategic asset allocation became a popular past-time. For obvious reasons, that has given way to largely fixed model portfolios that assume endogenous returns free of valuation inputs:
The adaptive markets at work? Well, yes… but as you now know, passive is playing a role as well.
The past few weeks have been a textbook lesson on fund flow impact. $IWM has been on fire as L/S traders have used it to unwind their long Fang/short IWM books. This has powered the small-cap indices higher as the FANGs have retreated.
There is some evidence that retail is joining the party with modestly increased allocations to Vanguard's Small Cap ETF. Still, the numbers pale in comparison. Vanguard small-cap inflows were ~$500MM versus $IWM inflows of ~$7.5B. While these are far from the only flows, dimensionalizing them is helpful. On roughly $8-10B of inflows into small-cap ETFs, the market cap of the R2000 has climbed nearly $200B. Unfortunately, this is uncomfortably close to my 2022 estimate of 17:1 market cap:$ inflow.
However, for those pitching the rotation story, there has been no meaningful sector selection or style shift. Where we are seeing inflows (other than “Small Cap!” [h/t Ben Hunt]) is Small-Cap Growth, not Value.
And flows into QQQ took a short dip… but that’s all it was — a short dip followed by renewed inflows into QQQ.
And for those who prefer their investments to be “truly passive,” buying all US stocks in proportion to their market cap via Vanguard’s total market index ETF, the entire story likely leaves them wondering what the fuss is about. There has been no change in trend.
While we are hearing about record inflows into ETFs, this has almost exclusively occurred in “trader” dominated IWM. Mutual funds continue to hemorrhage. While we won’t have the monthly data for Vanguard’s mutual fund variant, June was yet again another declining month for the total market mutual fund. In an unprecedented shift, flows into Vanguard’s dominant mutual fund for QDIA and Target Date Fund usage have been flat since March 2020. It’s all about ETFs now.
But sometimes, we need a little more detail before we can dismiss the narrative entirely… like Thursday’s GDP print. A surprisingly strong number (more on that later) ultimately led to the Nasdaq 100 to sell off while the R2000 rallied roughly 1%. By the end of the day, a clear narrative had taken hold: “A soft/no landing scenario would benefit smaller companies while good results on the GDP deflator would assist the Fed in rate cuts. The rotation continues!” It’s possible but unlikely.
As noted above, we are starting to see additional buying of Vanguard’s small-cap ETF (VB). However, the entirety of the move was tied to the opening 30 minutes — when pre-orders for ETFs are unloaded into the market. The R2000 again rose on the open while the NDX (powered by single stocks) declined. After 10 am, they traded in lockstep. A perverse way to deliver negative correlation for the day — 30 minutes of opposite and then 6 hours of lockstep price action:
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