20 Dec INTEREST RATES, CONCENTRATIONS AND INDEXING
An argument can be made the world’s sovereign debt markets just got a lot riskier as Sweden just ended a half of decade of negative rates. The question at hand will other central banks follow their lead? Everything in the world is priced off the US Treasury and global yields have a direct impact upon Treasury yields.
As noted many times if the yield on the 10-year US Treasury rises to last year’s year ending yield of 2.82%, according to the Blomberg analytics this “risk free” benchmark would have a negative annual return of 14.45%. From its September low yield, the 10-year would have a negative 22.07% annual return.
Interest rates are the largest component of valuation formulas and a rise in rates will impact the issues that are trading at the highest multiples.
Speaking of which, Bloomberg writes the concentration of wealth in five companies has now exceeded the previous record concentration of wealth achieved in 1999. Bloomberg suggests the reason for this massive concentration is indexing and momentum trading that does not entail any type of fundamental or macro-economic research.
Speaking of which analyst jobs on Wall Street is plummeting. Citicorp writes analyst ranks shrank again in 2019, falling by 8%, the sharpest decline since the 2012 inception of this survey. Since 2012, Citi writes analyst headcount is down over 25%.
Citicorp references “The Perfect Storm” that is hitting the analyst community, a storm of regulation, technology, cost, performance and the incessant rise of passive indexing via ETFs that by definition favors the largest capitalized issues, where past performance is indicative of future performance.
The introductory paragraph of today’s comments was about the rising risks in the world’s sovereign debt market, a risk that most appear oblivious given the decimation of the analyst ranks and the subsequent rise in passive investing…aka indexing.
As written several times, negative interest rates occur 0.0001% of the time, a statistical aberration. It is a black swan event, one that could have massive ramifications with mean reversion.
Indexing and passive investing is the most crowded trade in history; I believe eclipsing the infamous tulip bulb frenzy. Wall Street has a boom/bust history and as suggested a strong argument can be made that today’s boom is the biggest ever given the massive concentration of wealth in just five names.
Regressing a moment, how can a trillion dollar company be viewed as a growth company? Is not a growth company one that is considerably smaller, growing at above the market rate and has no following on Wall Street?
Several times I referenced the late Jack Bogle who commented the blended return for the next 10 years would be less than 1.5%. Bogle also suggested that individual security analysis may offer a greater probability of gain than the indices. Wow! These comments are hyperbolic given that Bogle is credited with the idea of indexing.
I am an ardent believer in the phrase it is not what one does but rather why one does it. Unfortunately many on Wall Street are more focused on style rather than substance.
Some have stated 2019 was the year of surprises. Can I remotely suggest that 2020 would be the year of even bigger surprises if macroeconomic, geopolitical and security specific analysis again comes back in vogue?
Radically changing topic, the accepted yield curve between the 2 year and 10 year Treasury is now the greatest since October 2018. Three months ago everyone was declaring a recession was at hand because of the extremely narrowly inverted yield curve. Will these same pundits suggest economic activity will exceed expectations because of the yield curve?
Last night the foreign markets were up. London was up 0.07%, Paris up 0.49% and Frankfurt up 0.54%. China was down 0.40%, Japan down 0.20% and Hang Sang up 0.25%.