Today I want to continue on the theme of the “Passive Bubble”.
Right now, there is “EUPHORIA” for passive products, both index matching products and sector ETFs.
As I wrote last week [1], I think it’s exactly the wrong time of the investment cycle to be blindly buying passive products.
When the world decides that there’s no need for fundamental research and investors can just blindly purchase index funds and ETFs without any regard to valuation, then the contrarian in me says it is time to be active, very active because the distortions and opportunities caused by the passive bubble will prove through time to be enormous. Only in hindsight will the opportunities be clear to all.
The flood of money into passive products is making stock prices move in lockstep and creating markets increasingly divorced from fundamentals.
The US ETF market alone now has about $2.7 trillion in assets. ETFs have attracted + $160billion of flows already this year.
Worldwide, investors ploughed $197b into ETFs between January and March, a quarterly record. This compares to the $390b that flowed in total into ETFs in 2016, which was a record itself.
On top of this, actively managed funds have seen net global outflows of $523b over the last 12 months, while passive equity funds have attracted inflows of $434b. Vanguard and Blackrock dominate these passive inflows.
But where this gets dangerous is when passive index and sector ETF demand collide in the same stock. That means a given stock has buying demand support on a daily basis, irrespective of its fundamentals. All that matters is its index weight in the given index or sector.
A classic example of this is ExxonMobil (XOM), the $347b leader of the US Oil/Gas/Refining industry. Not only is XOM a heavyweight member of the S&P500 (1.66%) and Dow Jones Industrial Average (2.68%), but apparently this commodity stock fits every ETF strategy below. It’s a stock for all strategies! That is truly ridiculous and underlines the extremities of the passive bubble.
This brings me to Apple Inc (AAPL), the $773b market cap monster.
Apple represents the largest weighting in the S&P500 (3.77%), Dow Jones Industrial Average (4.82%) and Nasdaq Composite (8.43%).
Apple therefore attracts more “passive” dollars on a daily basis of any stock on the planet. It is the biggest index weighting in the biggest market.
It’s also in a similar number of ETFs to Exxon, but more with a technology bias.
Apple is a great company, but its move this year to date (+27% or +$200b in market cap) is utterly unjustified on fundamentals and driven, in my view, solely by passive flows. Its size has been a self-fulfilling virtuous circle to the point where I now believe Apple is overvalued.
Apple’s earnings on Tuesday night were lower than Wall St expectations and will lead to consensus earnings downgrades. Margins are not as good as expected and I personally believe we are at “peak smartphone” and smartphones will start being priced more like a commodity. I suspect most of us have had the same smartphone for a few years now. The difference is we are all using Amazon, Netflix, Uber, Google and Facebook more from them.
Just like telcos have become a “commodity”, as you can see all around the world and in Australia (TLS, VOC, TPM etc.), I believe smartphone makers are next. Remember when Nokia and Blackberry were big companies?? Technology is a cycle and I reckon the smartphone cycle is peaking. That is another reason I am cautious on Apple and Samsung.
But let’s just look at Apple itself, the biggest stock in the biggest market in the world in a passive bubble.
The charts below confirm the major effect (+$200b in market cap) passive buying has had on Apple this year to date.
[2]The chart above shows while APPL consensus EPS (yellow) has been falling over the last six months, the stock price (white) has risen +27%.
[3]What that translates to is P/E expansion. APPL’s P/E has moved from around 10.5 (yellow) to around 17x over the last 12 months. It’s basically gone from value to overvalued driven by unprecedented passive flows.
In my career, I can remember many similar events to this. Do you remember when News Corporation (NWS) was the biggest weighting in the ASX200 at the peak of the dotcom boom? Do you remember when BHP Billiton peaked at 10% of the ASX200 at the peak of the commodity boom?? Do you also remember what happened next?
I feel Apple is exactly the same now, the stock being most distorted by passive flows anywhere in the world at what could prove to be the peak of its earnings cycle.
This is the key flaw with passive investing: you buy big weightings in stocks because they are big. HOW DUMB IS THAT! HOW LIKELY IS THAT TO DELIVER YOU LONG-TERM CAPITAL GAINS?
Well also think about this: when the day comes and markets actually GO DOWN, and that day will come, firstly your index fund will go down EXACTLY the index and the biggest stock weightings in those indexes will go down MORE because of the proliferation of ETFs and structured product also owning those stocks.
Apple and ExxonMobil are two classic examples of stocks that will be SLAMMED the day the equity markets turn down. That day may not be tomorrow, but you need to understand the risks in the world’s largest stocks.
There’s NOTHING safe in PASSIVE investing: in fact I think it’s now outright dangerous as passive inflows reach a crescendo.
The time for active stock pickers is right now. I am genuinely excited about the opportunities the passive bubble have thrown up and will continue to take advantage of them for my fund.
I know there are plenty of cheerleaders for Apple out there, but my view is APPL around US$150.00 is a short.
It could well be the bubble on a bubble on a bubble stock. You have been warned.
BHP at $50 was 10% of the ASX200. We all know how that ended.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.