ETFs and passive investing has been all the rage these past few years and it's easy to see why. Stats show that most active fund managers can't beat their benchmark index and so it's better to just buy the index and save on fees as well. Seems like the smart thing to do right? It is, but think about what would happen if everyone just bought the indexes and nothing else. All that money pouring in would hyper inflate the indexes on a bitcoin-like trajectory. In the short to medium term, fundamentals like p/e ratios and such wouldn't matter, it would all be about fund flows. So long as more money is coming in than is going out, the indexes could soar to unlimited heights This is not unlike how bitcoin and other bubbles function, but as you know, all bubbles eventually burst and ALWAYS end badly. Obviously, not all the money is pouring into passive investments but there's definitely a big movement towards it in recent years. At what point do you call it a bubble and how do you know when the bubble is close to its peak? Very tough questions to answer because you can't really know for sure until after the fact, but there are symptoms of bubbles to watch for and anytime some investment strategy or sector becomes very popular with the general public you got the makings of a possible bubble.
Bubbles usually begin from sound premises which then get taken too far. The tech bubble that burst in 2000 originated from the sound premise in the mid 90s that the internet was going to revolutionize the world. The problem is that once something becomes embraced by the general public, greed and herd behavior can take things too far and whatever the sound premise was becomes a victim of its own success. I think we are seeing this play out with this movement towards passive investing but again,the key question is at what phase of the bubble are we in? Did the 3 month spike in inflows from November 2017-January 2018 mark the final top or is it just a temporary one? We will only know in hindsight, but my instincts tell me there's a good chance that it was not the final top and what we saw in December was a warning shot across the bow as to what will end up happening once the party is really over. For my hunch to be correct, it will hinge on whether this slowdown in the global economy can end soon and turn back up. If so, the bull market will resume and likely do so with a vengeance leading to what would likely be the final phase which could take 1-2 years to play out. In that final phase we would probably see ETF inflows surge once again with the SPX blowing past 3000. I'm not saying I expect this to happen for sure but rather that that it's a plausible possibility i.e. that the window of opportunity is there.
Try to picture yourself in 1998 when the markets dropped 20% 8 years into a bull market. Just prior to that peak the market was fundamentally very overvalued, more so than what it was at the peak of 2018 with interest rates notably higher back then too. Any reasonable person could have been inclined to believe that the bull market was over but it wasn't. Then just like now, the decline was largely due to global concerns while the US economy was relatively sound. I get that there's plenty of different circumstances now vs 98, but my point is that don't count out a bull market just because of valuations and its duration. Major global downturns which end bull markets like 2000-2002 and 2007-2008 have occurred when the US triggered it, not China, or Europe. It was the US that had the major issues which infected everyone else. Yes, this doesn't have to be a pre-requisite, but you have to be mindful of history and be open minded that this bull market can still be alive. So far as I've mentioned before, there is wall of worry behavior in this rally which supports this notion, but that could change. We'll just have to wait and see. Pick your spots and keep your emotions in check. Don't force trades.. .if you missed the bus another one will eventually come....the market is not going to disappear.
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