Frank Thoughts: The Unwinding of Crowds
Frank Boland
May 08, 2023

As we all know, it is difficult to go against a crowd’s belief. Religious scrolls are filled with stories of those who did … and died. Such conflict often crosses over from religious to secular situations. Such a juxtaposition occurred in the 17thcentury as Galileo hypothesized that the earth revolved around the sun. The crowd, with the hierarchy of the Catholic church, imprison him for the last 11 years of his life. Considering that western civilization is 5,000 years old, and his defiance of it occurred just 300 years ago, his rebuke of the crowd’s opinion would seem to be a given sequitur. But it wasn’t to the crowd.

A crowd’s belief – when it is true – is a matter of timing. My good friend Ed Noonan used to say, “A crowd can be very right … for long periods of time. But what the crowd always misses is the inflection point of change.” In a similar vein, Ruchir Sharma recently wrote, “There is no good idea that too much money can’t spoil.” We have repeatedly seen this over the past 67 years of the modern era’s investment experience. It all started in 1955 with the crowd’s infatuation with the new growth stock concept. It lasted for 27 years until 1982. This time it will end with its opposite; the crowd’s unwinding of the past 25 years of indexation. The implication of this is a sideways movement for the S&P 500.

Throughout these investments shifts, there have been numerous subtexts. The first was the crowd’s love of the “Gun Slingers.” Adam Smith (aka Jerry Goodman) wrote a book about it in the late 1960s titled “The Money Game.” The book may have contributed to John Bogle losing his job as C.E.O. of Wellington Management … and the start of indexation. The firm had been a 60/40 balanced portfolio manager. Bogle succumbed to the new growth crowd by buying the Ivy Fund in 1968. It was a “hot” gun slinger shop for young portfolio managers. But a new bear market started in 1969.  

However, it wasn’t until the bear market of 1973-1974 that he lost his job. Before that a new growth crowd had evolved pushing the mythological of the Vestal Virgins metaphor. There were fifty of these stocks and they became known as the “Nifty-Fifty.” Their investment premise was that an investor could pay any price for them – so consistent was their growth – it wouldn’t matter. And for years, it didn’t. Alphabetically the list ran from Avon to Xerox. Even today, I can recall sitting at my desk trying to make sense of the price earnings multiples. It didn’t make sense. But it was a crowd effort that demanded – and received - total belief much as today’s crowd demands with indexation and ETFs.

In the Nifty-Fifty era, if you didn’t own a significant number of the issues, you were destined to lag the S&P 500. The same experience occurred in this century as FAANG continued to move higher with just five stocks! In both cases, breath in the market had been deteriorating for years. At its peak, FAANG came to represent 28% of the market value of the S&P 500 index! The “new” crowd saw this as further validation prolonging the continuation of the experience with ever expanding acolytes. This set up a wonderful positive feedback loop which works until it doesn’t. And therein is the danger. A feedback loop that unwinds goes down faster than it ever went up. The crowd doesn’t yet realize it.

Effective normalization of interest rates will cause that realization. We define this as historically 3% in real terms plus the inflation rate. If we accept the Fed’s 2% inflation goal then the reality is, it could take years. The last time, it took 17 years. But Microsoft, Walmart, Nike, Apple and Intel were created in that time frame. As rates move higher and stay higher it will benefit active managers and end the existence of the indexation and ETF crowd. But another “new” crowd will emerge a generation later.


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