History Doesn’t Repeat Itself, But It Often Rhymes
Dave Canal
September 26, 2019

History Doesn’t Repeat Itself, But It Often Rhymes” –Mark Twain

When examining the current equity market landscape, I can’t help but think back to the late 1990s and recognize the similarities between investor psychology today and back then.  While the contributing macro factors are different, the resulting investor behavior has been very consistent.  The .com bubble of the late 1990s was a very speculative era for equities characterized by very narrow leadership (large cap technology growth stocks) and a massive rush by investors into passive strategies that held a disproportionate amount of exposure to those leadership themes.  Sound familiar?

Today, we are seeing a very similar dynamic play out in the equity markets.  As Josh Vail of Investment Advisor notes in the article below, “Passive products now comprise more than 50% of all U.S. large-cap equity investable assets, a critical mass that has created distortions within equity markets.  When assets pour into ETFs of passive funds replicating an index such as the S&P 500, more money is allocated toward the largest names in the index.  For perspective on how this dynamic has played out, the valuation gap between the quintile of the largest stocks in the Russell 1000 and the quintile of the smallest stocks is at its widest since the unwinding of the internet bubble in 2000 and 2001.”

Investors have plowed into passive strategies convinced that they offer a low cost, low risk (relative to active) solution to satisfy their equity allocations.  Gone are the days of price discovery as investors are blindly buying companies regardless of their underlying fundamental and technical outlook.  This “herd mentality” creates significant risk for investors.  As Vail points out, “The market distortions stemming from the recent passive push have set equities up for a new set of risks and dislocations when these trends unwind.  When a volatility event strikes and money flows out of equities, much of it will come from all the flows that recently poured into passive products.”  Again, sound familiar? 

When the .com bubble burst and large cap growth stocks imploded, it launched a decade of dominance for value-oriented, broad market equity themes.  Price discovery became relevant again as passive strategies suffered massive outflows and active management thrived.  It’s clear that today’s equity landscape, while not identical, certainly has a lot of similarities to the late 1990s and investors should understand the inherit risks associated with today’s passive investing.  As George Santayana famously said, “Those who do not learn history are doomed to repeat it.”  

-David Canal


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