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Speaker 1: Hello and welcome to another episode of the All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 1: Joe, do you remember when you first heard the term
Speaker 1: mag seven?
Speaker 3: You know, I don't if I'm being honest, but you
Speaker 3: know these achronyms that for big tech stocks, like they
Speaker 3: kind of you know, people used to talk about Fang, right.
Speaker 1: I know, I was just thinking that, like, when did
Speaker 1: the handoff from Fang to mag seven actually happen.
Speaker 3: We need to do one of those like Google trends
Speaker 3: and gram things. That's a good question because and then
Speaker 3: there was like fang plus and then fam and but
Speaker 3: they're all kind of the same thing. It's just big
Speaker 3: tech stocks, right.
Speaker 1: So the terminology the acronyms might change, but I think
Speaker 1: the subject is always kind of the same and the
Speaker 1: concern is always the same. It's this idea that there
Speaker 1: is like a handful of big companies, usually tech stocks,
Speaker 1: that are driving the entire market.
Speaker 3: Yeah, and it drives people crazy, right, they're so big,
Speaker 3: and they've grown so much, stocks have done so well
Speaker 3: over the years, and all these old strategies of like
Speaker 3: oh we're gonna like buy cheap or buy cheap low
Speaker 3: book value, you know, price to book and all these
Speaker 3: traditional investing patterns. It never mean reverts for years and
Speaker 3: years and years, except for like five minutes in twenty
Speaker 3: twenty two. They just go straight up. And the only
Speaker 3: test of whether you're a good investor or not is
Speaker 3: whether you're over whether you bought ten Yeah.
Speaker 4: That's it, is it?
Speaker 1: Really? That really is the alpha now is But you know,
Speaker 1: you see these numbers thrown around like I think Goldman
Speaker 1: Sachs said that the top ten stocks now account for
Speaker 1: something like thirty eight percent of the S and P
Speaker 1: five hundred, which is a record, yeah, and seems quite
Speaker 1: a lot on the face of it. And I saw
Speaker 1: another number out there saying twenty six stocks now account
Speaker 1: for half of the entire value of the S and
Speaker 1: P five hundred. So I think it brings up a
Speaker 1: bunch of interesting questions. How bad is the concentration? Is
Speaker 1: it intrinsically bad in and of itself? Is it actually
Speaker 1: that risky?
Speaker 3: Yeah?
Speaker 1: And also how are financial professionals and the market itself
Speaker 1: actually reacting to this concentration risk?
Speaker 4: So I think we should talk about it totally.
Speaker 3: You know, I look at myself in the mirror, and
Speaker 3: I say to myself.
Speaker 1: Do you point at yourself like that meme?
Speaker 3: I And some days I point and say you're a
Speaker 3: good because you know, I'm just like a boring index
Speaker 3: fund investor for my retirement, you know, So I point say, oh,
Speaker 3: you're a good investor because you've been really long tech.
Speaker 3: And then I and then on other days they wake
Speaker 3: up and say, oh, you are really heavily exposed to
Speaker 3: twenty six stocks, And so you know, it's like to
Speaker 3: you know, glass half full. It's like good, but also
Speaker 3: makes me a little anxious.
Speaker 1: You shouldn't take credit. You should give that credit to
Speaker 1: SMP and thank you, and then when the market collapses
Speaker 1: you should blame them.
Speaker 4: I do.
Speaker 3: I say thank you to the wonderful fund managers at SMP.
Speaker 3: I only wish you hadn't. You know, every once in
Speaker 3: a while they have a dud. It's like why did
Speaker 3: you pick that one anyway?
Speaker 1: Or why didn't you include?
Speaker 2: Yeah?
Speaker 1: Kay, exactly, all right, Well, without further ado, we do,
Speaker 1: in fact have the perfect guest for this topic, someone
Speaker 1: that I've wanted to speak to for a long time
Speaker 1: and I can't believe we haven't had him on the
Speaker 1: podcast before major oversight on our part. We're going to
Speaker 1: be speaking with Kevin Muhror. He is, of course the
Speaker 1: Macro tourist and a long time voice on finn Twit
Speaker 1: and writing on his blog as well. So Kevin, thank
Speaker 1: you so much for coming on all thoughts.
Speaker 4: It's great to be here. Thanks Joe and Tracy.
Speaker 1: Maybe just to begin with, it's the first time you're
Speaker 1: on the show. I've always sort of known you as
Speaker 1: this voice that's hanging around in the finance BLOGI sphere.
Speaker 1: But what's your background?
Speaker 5: So I was the equity derivative institutional equity derivtive trader
Speaker 5: at RBC Dominion Securities in the nineties. I was kind
Speaker 5: of at the forefront of the technological boom and the
Speaker 5: automated trading and the index trading and the taking off
Speaker 5: of all these index products. And then in two thousand
Speaker 5: I actually went off on my own and I thought, maybe,
Speaker 5: you know, I'll go work for a hedge fund. And
Speaker 5: I thought, well, at the same time, I could go
Speaker 5: and trade for myself for a little bit and see
Speaker 5: how that goes. And that's kind of twenty five years
Speaker 5: later and I'm still doing it.
Speaker 3: You write the macro Tourist, what's your goal? What do
Speaker 3: you for those I we're both big fans of your writing,
Speaker 3: But what do you what do you like to write about?
Speaker 3: What's your sort of goal with your writing?
Speaker 5: Well, Joe, it originally started off as a diary, and
Speaker 5: I just kind of good traders, you're supposed to keep
Speaker 5: a diary, and and I would start writing things and
Speaker 5: then people would pull me up and ask me what
Speaker 5: I thought of the market, and I would send it
Speaker 5: off into the mot just so well, here's what I
Speaker 5: wrote my diary. Eventually they started to ask often enough
Speaker 5: that we just started to put it up on the net,
Speaker 5: and then it took off from there, and from there
Speaker 5: I ended up going and actually started my podcast and
Speaker 5: meeting all sorts of people. And one of the kind
Speaker 5: of just great parts about being on the podcast is
Speaker 5: the fabulous people I got to meet along the way.
Speaker 5: I meet people like Jim Lightner and I've had Mike
Speaker 5: Masters on the podcast, and those people are market wizards.
Speaker 5: They're terrific, and I get to share ideas with them,
Speaker 5: and it's just that considers myself one of the luckiest
Speaker 5: guys in the world.
Speaker 1: So let's get to the topic at hand. Then give
Speaker 1: us some context around concentration risk in something like the
Speaker 1: S and P five hundred right now. I threw out
Speaker 1: some numbers earlier, But how extensive is this concentration and
Speaker 1: should we be worried about it?
Speaker 5: Well, Tracy, one of the things that people will kind
Speaker 5: of push back on when you say that the US
Speaker 5: has become more concentrated is they'll say things like, oh,
Speaker 5: but if you go look at other indexes around the world,
Speaker 5: they're also very concentrated. And that's absolutely correct, There's no
Speaker 5: doubt about it. This is something that is experienced in Canada.
Speaker 5: As I mentioned, I'm a Canadian and I was on
Speaker 5: the index desk at a time when Noortel was actually
Speaker 5: thirty five percent of the entire index.
Speaker 1: Wow.
Speaker 5: So if you think that you guys are we're having
Speaker 5: troubled dealer with this, now, just imagine having thirty five
Speaker 5: percent of the index being one stock. It was actually
Speaker 5: even worse than that because we had kind of a
Speaker 5: palm at triple M situation where Bell Canada was one
Speaker 5: of our next biggest stocks and it main holding with
Speaker 5: all of its Nortel holding. So it ended up being
Speaker 5: that the index managers were stuck because if you think
Speaker 5: about it from a fiduciary point of view, it doesn't
Speaker 5: make sense to have fifty percent of your portfolio, you know,
Speaker 5: exposed to one stock. It's risky. And so one of
Speaker 5: the things that I well that I'm hearing now when
Speaker 5: you bring up the problems about concentration risk in the
Speaker 5: US is they'll say, oh, no, but don't worry. It's
Speaker 5: actually much better than the rest of the world. And
Speaker 5: I won't deny that for a second. But isn't that
Speaker 5: kind of like saying, you know, my Mercedes is now
Speaker 5: using plastic knobs, but don't worry, the Honda uses plastic
Speaker 5: knobs too. Part of the reason that we've been that
Speaker 5: investors have been attracted to the US is that it
Speaker 5: is a diversified basket of many stocks. And just think
Speaker 5: about you know, Warren Buffett, Warren Buffett tells you can
Speaker 5: buy the S and P five hundred, you can sleep
Speaker 5: at night. But if you go and talk to investment
Speaker 5: advisors around the world and you ask them, do you
Speaker 5: think your clients really truly know what's underlying that basket?
Speaker 5: I think they most of them would say they would
Speaker 5: assume that it's it's roughly equal weight, and they would
Speaker 5: be shocked to learn that, you know, Microsoft and Navidia
Speaker 5: Apple are each almost seven percent of their basket for
Speaker 5: a total of twenty one percent. And so it's ends
Speaker 5: up being it's a worrisome kind of new development in
Speaker 5: the US. And I don't buy the argument that just
Speaker 5: because other countries are more, you know, it's concentrated, that
Speaker 5: we shouldn't worry about.
Speaker 4: It in the US. And all you have to do
Speaker 4: is look you, Teresa.
Speaker 5: You mentioned that Goldman Sachs stat and they have another
Speaker 5: one that they published and they went back, they looked
Speaker 5: at concentration risk throughout the last century, and if you
Speaker 5: look at it, we are now just as concentrated as
Speaker 5: we were right in front of the Great Depression in
Speaker 5: nineteen twenty nine, in the nifty to fifty in the
Speaker 5: early seventies, and the dot com bubble in the late nineties. Well,
Speaker 5: all those times were not good times to buy stocks
Speaker 5: for forward returns. So increasingly I think that we need
Speaker 5: to be aware that this is a risk, and there's
Speaker 5: more and more conversation happening around that.
Speaker 3: I'm happy that in Nvidia has been seven percent or
Speaker 3: somewhere south of that. In my portfolio, I didn't even
Speaker 3: have to do anything, and I made a big allocation
Speaker 3: to one of the best performing stocks in the world.
Speaker 3: And not only that, I mean, I take your point
Speaker 3: about concentration and et cetera, and obviously very alarming. These
Speaker 3: are also account for a huge share of the actual
Speaker 3: earnings too, So I mean, you know, there was a
Speaker 3: lot of concentration in ninety nine, two thousandth tech, but
Speaker 3: a lot of those companies weren't really making that much money.
Speaker 3: These companies are earnings juggernauts.
Speaker 5: Well, no doubt, you're absolutely correct, Joe. And that's kind
Speaker 5: of the pushback to this argument that we're concentrated world.
Speaker 5: They'll say, oh, it's bang seven. It's a wide variety
Speaker 5: of different companies that do with different things. It's not
Speaker 5: like it's all one industry. And not only that, the
Speaker 5: valuations aren't as crazy as they might seem, no doubt
Speaker 5: about it. You can make that argument. But let's just
Speaker 5: imagine tomorrow that the AI bubble doesn't live up to
Speaker 5: its hype. Let's imagine that all of a sudden we
Speaker 5: have some sort of earning surprise and these stocks get had.
Speaker 5: It's not that hard to imagine. We went through it
Speaker 5: in twenty twenty two. So if that occurs, I think
Speaker 5: that people will be quite shocked at how they're supposedly
Speaker 5: diversified basket of stocks performs. And more importantly than that
Speaker 5: is that we can sit around and we can debate
Speaker 5: whether you should own this or whether this is prudent.
Speaker 5: But more and more fiduciaries, more and more risk managers,
Speaker 5: more and more institutional portfolio managers are looking at it.
Speaker 5: And saying this is dangerous and they're looking for ways
Speaker 5: around it. And one of the things that many of
Speaker 5: these managers are bumping up against is that although the
Speaker 5: S and P five hundred is actually in line with
Speaker 5: this following rule of this thing called the twenty five
Speaker 5: five point fifty, which means that no one stock can
Speaker 5: have more than twenty five percent and the five stock
Speaker 5: the biggest stocks that are over five percent can't add
Speaker 5: up to more than fifty percent of your portfolio. That's
Speaker 5: an IRS rule that is called the twenty five five
Speaker 5: to fifty rule. There's no problem with the SMP five
Speaker 5: hundred currently with that rule, but there is some thing
Speaker 5: called the Russell one thousand growth index, and increasingly more
Speaker 5: and more institutional managers are benched to that index. And
Speaker 5: what we're seeing is within that index, we're bumping up
Speaker 5: against that. And what's happened now is that Russell's realized
Speaker 5: that this isn't just kind of a fiduciary point of view,
Speaker 5: this is actually an IRS issue in terms of that
Speaker 5: they cannot go over those things. So what we're seeing
Speaker 5: is there's changes in the rules coming to make sure
Speaker 5: that these indexes capped.
Speaker 3: By the way Tracy Kevin mentioning how exposed everyone is
Speaker 3: to AI beta, so to speak, And I just want
Speaker 3: to give a plug. We had a really good contribution
Speaker 3: in the odd Lot's Newsletter from a Skanda recently on
Speaker 3: this whole thing. There's just both in stocks and the
Speaker 3: economy and the real economy. There's just this like we
Speaker 3: get they better get this AI thing right.
Speaker 1: Yeah, seems kind of important. Kevin. You mentioned finance professionals
Speaker 1: reacting to this concentration risk. So okay, maybe your average
Speaker 1: mom and pop retail investor doesn't realize that the S
Speaker 1: and P five hundred is not you know, five hundred
Speaker 1: equal weighted stocks, but certainly finance professionals do, and they're
Speaker 1: aware of both the risk involved in having a large
Speaker 1: concentration in just a handful of stocks and also some
Speaker 1: of the requirements around diversification, so legal requirements that you
Speaker 1: just mentioned. Before we get into some of those changes,
Speaker 1: can you maybe just give us a little bit of
Speaker 1: background on the importance of the index providers to the
Speaker 1: finance industry itself. This is sort of a pet topic
Speaker 1: of mine that I've written about occasionally, But how big
Speaker 1: a deal are the index providers now?
Speaker 5: Well, You're absolutely right to highlight that, Tracy, and I'm
Speaker 5: glad to see you have such a an enthusiastic come
Speaker 5: attraction to index providers.
Speaker 4: One of the you're the only one that gets excited
Speaker 4: about it. But it is a big story.
Speaker 5: And one of the issues is that as indexing has
Speaker 5: become more popular, some of the kind of traditional the
Speaker 5: first of the indexers have started charging more, which has
Speaker 5: created an opportunity for other index providers to jump into
Speaker 5: the loop. So obviously we all know the S and
Speaker 5: P five hundred, but then there's the foot seat, which
Speaker 5: is rustle, but there's also things like morning Star and
Speaker 5: even you guys at Bloomberg have a lot of great
Speaker 5: indexes and you're competing on a lot of these things
Speaker 5: as well. So what's driving that is kind of two factors.
Speaker 5: One of them is that there is the cost associated
Speaker 5: with the big ones, so they're just trying to clients
Speaker 5: that have to pay tens and hundreds of thousand dollars
Speaker 5: for this index data. Is our changing the providers trying
Speaker 5: to get something cheaper. And then the other thing is
Speaker 5: is a little more kind of nefair. There's some indexes
Speaker 5: that are easier to beat, so if you have an
Speaker 5: index that you know the rules, you can actually front
Speaker 5: run them. The When I was researching this and learning
Speaker 5: about this, someone told me that it's important that you
Speaker 5: buy the products of the index of the indexes that
Speaker 5: are difficult to beat, and then from a kind of
Speaker 5: client perspective, you choose. If you are a portfolio manager,
Speaker 5: you choose the indexes that are easier to beat, because
Speaker 5: if you're using, you know, for example, the S and
Speaker 5: P five hundred as your benchmark, that's a lot more
Speaker 5: difficult than to beat than another index that might have
Speaker 5: one annual revision that is easy to kind of forecast
Speaker 5: and run ahead of.
Speaker 4: Joe.
Speaker 1: I should just mention Kevin was kind enough just then,
Speaker 1: because he's a very polite Canadian, to basically do our
Speaker 1: disclaim for us, which is that Bloomberg LP, the parent
Speaker 1: company of Bloomberg News, does own a bunch of different indices,
Speaker 1: but probably most prominent among them are the Bloomberg bond indices,
Speaker 1: and those were the Barclays indices before. So I should
Speaker 1: just mention.
Speaker 3: That there you go, Thank you, Kevin, and thank you.
Speaker 5: Can I jump in with you a little since a
Speaker 5: lot of people are getting Bloomberg users. One of the
Speaker 5: things is if you go when you want to see,
Speaker 5: for example, the index move and the S and P
Speaker 5: five hundred, and you to type in hmov, you'll see
Speaker 5: that they actually unless you pay for that data, you
Speaker 5: don't get the index point changes. But Bloomberg has the
Speaker 5: B five hundred, which is very similar, and you can
Speaker 5: plot it in and then all that functionality that you
Speaker 5: have to pay for on the other things, it actually
Speaker 5: works quite well on the Bloomberg indyssees.
Speaker 3: There you go. So if you have a Bloomberg terminal
Speaker 3: but don't feel like paying for the S and P
Speaker 3: data specifically, Kevin just gave you a little bit of
Speaker 3: a little bit of alpha there.
Speaker 2: But you know it.
Speaker 3: Actually you talked about foot running index changes. Why said
Speaker 3: it easier?
Speaker 1: Right?
Speaker 3: Like S and P they announced, oh, some new company
Speaker 3: is joining an index. How can you make money from
Speaker 3: those announcements?
Speaker 4: Well, you used to be able to.
Speaker 5: There's a huge opportunities before, and there was hedge funds
Speaker 5: that devoted themselves to doing it. But now everyone knows
Speaker 5: the ones that are due to go in. And then
Speaker 5: there's hedge funds who actually have portfolios of all the
Speaker 5: stocks that are due to go in and even not
Speaker 5: just hedge funds, even pension funds will quote and front
Speaker 5: run them because they realize that there's some malfa there.
Speaker 5: So at the end of the day, Joe, the problem
Speaker 5: is that the more people look at it, the less
Speaker 5: money there is to be made. Yeah, and kind of
Speaker 5: trying to guess those things.
Speaker 1: All right, So let's get into how not just the
Speaker 1: benchmark index providers are reacting to increased concentration, but also
Speaker 1: how finance professionals are. You mentioned the Russell one thousand,
Speaker 1: so give us a little bit more detail on what's
Speaker 1: happening there. So Russell one thousand is aware that there's
Speaker 1: intense concentration risk.
Speaker 5: Right, so they're jumping so they are actually getting ahead
Speaker 5: of their problems of potentially going and bumping up against
Speaker 5: this twenty five to five fifty rule. And for those
Speaker 5: who don't aren't aware of it, this isn't a new phenomenon.
Speaker 5: We actually had this in the summer of twenty twenty
Speaker 5: three when Microsoft became too large of a position within
Speaker 5: the QQQS and there needed to be an emergency rebalance
Speaker 5: where they reduced the size of Microsoft. And then we
Speaker 5: also saw this in the sector select XLK spider where
Speaker 5: Navidia ran up and it actually ended up again we
Speaker 5: bumped up against that twenty five to five to fifty
Speaker 5: rule and they needed to be an emergency rebalancing there.
Speaker 5: And that was the situation where there was the way
Speaker 5: that their capping worked. It was this kind of very
Speaker 5: violent shift from selling Apple and buying Navidia, and then
Speaker 5: kind of the next quarter it flipped the other way
Speaker 5: because of the way that the stock price has moved
Speaker 5: and they had to do this rebalance again the other way.
Speaker 5: And so this is the problem with that many of
Speaker 5: these index providers are are kind of bumping up against
Speaker 5: it in terms of they don't want to be too
Speaker 5: violent with their shifts. They don't want to go and
Speaker 5: get into situations where they're rebalancing all the time, trying
Speaker 5: to keep within this limits. And that is why the
Speaker 5: Russell in this R one thousand growth which is one
Speaker 5: of the most popular growth indexes out there, they chose
Speaker 5: instead of using the five and the fifty rule, they
Speaker 5: used four and a half and forty five, meaning that
Speaker 5: any stock above four and a half, if all those
Speaker 5: stocks add up to forty five percent, then they do
Speaker 5: this rebalance. So they've kind of given themselves a little
Speaker 5: bit of extra, you know, room there in terms of
Speaker 5: the rebounce. What's interesting is that they had announced this
Speaker 5: I don't know what's a year ago because they saw
Speaker 5: this problem coming. Nobody was talking about it.
Speaker 1: Oh yeah. I actually went back to try to find
Speaker 1: articles on this. I couldn't find any.
Speaker 4: Yeah.
Speaker 5: The way that I came upon this idea and this
Speaker 5: kind of revelation about that this is coming up was
Speaker 5: actually one of my subscribers and a buddy sent me
Speaker 5: something from Kevin Ja from Discipline Alpha, and he'd written
Speaker 5: this whole piece about it and just highlighting it. One
Speaker 5: of the reasons that he highlighted is he was a
Speaker 5: mid cap manager during the two thousands and he distinctly
Speaker 5: remembers Sebel Systems and another one. I can't remember the
Speaker 5: other one, but there was two big stocks in the
Speaker 5: S and P four hundred that were due to go
Speaker 5: into the S and P five hundred, and when they
Speaker 5: did it, the trouble was that the guys that all
Speaker 5: bought it for the S and P five hundred, and
Speaker 5: then when the SNB four hundred guys went to sell it,
Speaker 5: there was no bids. And then coincided with the top
Speaker 5: of the Nasdaq market, and he's very kind of adamant
Speaker 5: that this is could be another situation where we have
Speaker 5: a situation where the MAG seven has to go down
Speaker 5: in waiting in one of the biggest indexes out there
Speaker 5: in terms of after the S and P five hundred,
Speaker 5: this is probably the next biggest growth index out there.
Speaker 5: And when this rebalance occurs, which again is in March, ironically,
Speaker 5: it's the same deal. There's going to be millions and
Speaker 5: millions of shares of these mag sevens for sale. And
Speaker 5: so for me, when I was trying to learn about it,
Speaker 5: I went and said, okay, I went to an old
Speaker 5: buddy at TD and they were one of the few,
Speaker 5: and I think he said he was the first cell
Speaker 5: side dealer to actually start talking about this. But increasingly
Speaker 5: over the last month there's been more and more folks
Speaker 5: paying attention and realizing that this is a bigger deal
Speaker 5: than they really.
Speaker 3: By the way, as tracing those I love dot com
Speaker 3: you're trivia and talking about that, and so like you
Speaker 3: talk about Sebel and you talking about the three comm
Speaker 3: Palm situation and all the these are like these are
Speaker 3: some of my CATNP for Yeah, this is a total cat.
Speaker 2: You know.
Speaker 3: It occurs to me like the sort of the very
Speaker 3: strict Chicago school. There's no such thing. Everyone people love
Speaker 3: to say, there's no such thing as that you can't
Speaker 3: as passive investing. You can sort of get close to it,
Speaker 3: you know, the strict Chicago school people is like, you know,
Speaker 3: you buy the global market portfolio at their market value,
Speaker 3: every investable asset in the world. These rules essentially make
Speaker 3: it impossible, right because if you had some stock that
Speaker 3: was I don't know, got so big it was twenty
Speaker 3: five percent of the index or whatever, but you're not
Speaker 3: allowed to do it technically, like you really couldn't buy
Speaker 3: the true market portfolio given some of these constraints.
Speaker 5: That's correct, and that's an IRS constraint. And then not
Speaker 5: only that, just stop and think about if you go
Speaker 5: and you try to recreate these portfolios at a broker.
Speaker 5: I spoke to one investment advisor. He said, if I
Speaker 5: went and made a portfolio of the qqqs, like if
Speaker 5: I just made it from scratch and did all those things,
Speaker 5: that compliance would tell me that I'm too concentrated in
Speaker 5: tech stocks. So he says, I'm not allowed to buy
Speaker 5: this from a compliance point of view, but I'm allowed
Speaker 5: to buy the client's qqqs. And that's back to my
Speaker 5: point is that we all just kind of been lulled
Speaker 5: into this feeling that everything's okay. It's a it's a
Speaker 5: broad index, and it's no longer as broad. And ironically,
Speaker 5: you're talking about this idea about the mart the indexing,
Speaker 5: and if you remember Mike Green and his theory that
Speaker 5: the big will get bigger because of indexing, and more
Speaker 5: and more people will just continue and this will create
Speaker 5: a situation where the biggest stocks will continue to just
Speaker 5: get bigger and bigger and bigger. Well, we're here, this
Speaker 5: is happening. And my pushback to that argument has always
Speaker 5: been that he's assuming the market doesn't work. He's assuming
Speaker 5: nobody goes and says, hey, wait, those stocks are too big.
Speaker 5: I'm going to go and no longer be benched to
Speaker 5: the S and P five hundred. I'm going to be
Speaker 5: benched to Russell one thousand or maybe three thousand. I'll
Speaker 5: change it and see. This is the problem is that
Speaker 5: many clients have kind of career risk, So if they're
Speaker 5: bench to the S and P five hundred, they can't
Speaker 5: go and put this huge bet where they don't own
Speaker 5: the mag seven or they just say no, I can't
Speaker 5: own it, it's too expensive. They need to go and
Speaker 5: they need to own those stocks. But if you're a
Speaker 5: fiduciary that's managing money for someone, and you go and
Speaker 5: you say, listen, this doesn't make any sense.
Speaker 4: We're buying this s and P.
Speaker 5: Five hundred And the original reason what we did it
Speaker 5: was because it it was supposed to be this diversified
Speaker 5: basket of the whole market. This no longer makes sense.
Speaker 5: Let's go try to find something else so you can
Speaker 5: change your benchmark. Now, ironically, that actually takes a lot
Speaker 5: of hassle and it's difficult.
Speaker 4: You have to go and you have to convince all.
Speaker 5: The users of your product or the or the end
Speaker 5: clients to switch it. And that is why in this
Speaker 5: situation with the Russell one thousand growth, instead of making
Speaker 5: a new benchmark that is capped, they said, no, we're
Speaker 5: just going to change the existing rules of the existing index.
Speaker 5: So if you want an unconstrained Russell one thousand growth,
Speaker 5: there is a new index that Russell has created, But
Speaker 5: in this case it's going to be everyone that is
Speaker 5: the Russell one thousand growth, and it's a lot of them.
Speaker 5: Like you go, you pull it up, you'll see twenty billion,
Speaker 5: forty billion, lots of people with big, big accounts that
Speaker 5: are benched to this. They're gonna all of a sudden
Speaker 5: find themselves overweight mag seven because there's a shift that's
Speaker 5: occurring on the March expiry March twenty first.
Speaker 1: So, Kevin, you mentioned Russell making this decision to change
Speaker 1: the existing index rather than create a new one, And
Speaker 1: this is exactly what I wanted to ask you about,
Speaker 1: which is, you know, when we talk about benchmark index providers,
Speaker 1: we talk about them as being passive, right. They always
Speaker 1: say they create these indices that are basically holding up
Speaker 1: a mirror to markets and trying to reflect them as
Speaker 1: they exist right now, and that kind of I'm a
Speaker 1: little skeptical of that approach because I do think index
Speaker 1: construction affects things like flows. It's kind of reflexive, and
Speaker 1: I do think there are a lot of you know,
Speaker 1: judgment calls that are embedded when you're deciding what to
Speaker 1: include and what to exclude. But if they're making an
Speaker 1: active decision to change the weighting on something like tech,
Speaker 1: does that perhaps open them up to more or scrutiny
Speaker 1: perhaps from regulators.
Speaker 5: Well, I wouldn't say from regulators. It's more scrutiny from
Speaker 5: the clients. But in this case, they're not actually saying
Speaker 5: they don't want more tech. They're saying, we need to
Speaker 5: comply with this twenty five to five point fifty rule,
Speaker 5: which is an IRS rule. It has nothing to do with,
Speaker 5: you know, a decision that they think that the mag
Speaker 5: seven's gotten too risky.
Speaker 4: Right.
Speaker 5: The index providers are there to provide whatever index they
Speaker 5: think they can sell to their clients. If their clients
Speaker 5: want something, they're going to do it and by that token.
Speaker 5: Interestingly enough, we see the S and P five hundred
Speaker 5: Earlier this spring introduced a capped version of the S
Speaker 5: and P five hundred, which has individual stocks capped to
Speaker 5: three percent. Now Here in Canada, we've actually already listed
Speaker 5: an ETF based upon this index. But the reason that
Speaker 5: SMP has created in nexus because there's a demand for
Speaker 5: it and ultimately the clients will drive it. What I
Speaker 5: thought was so interesting about this whole development is that
Speaker 5: we're seeing index providers having to change their rules because
Speaker 5: of this twenty five five point fifty. Then we're also
Speaker 5: seeing institutional pension funds endowments starting to question whether they
Speaker 5: want to continue with benchmarks that have such a large concentration.
Speaker 5: And this is combined with the fact that many retail
Speaker 5: don't really understand what they're buying when they buy the
Speaker 5: S and P five hundred. So when I look at
Speaker 5: this situation and think about how this is going to
Speaker 5: play out going forward, I can make the argument that
Speaker 5: we're kind of at the peak of concentration here and
Speaker 5: that this is the market correcting what has become too
Speaker 5: concentrated of a market.
Speaker 3: You know, going back to this idea that the big
Speaker 3: just keep getting bigger, and you mentioned some of Mike
Speaker 3: Green's theories, and you know, there is this view that
Speaker 3: some have that like the funds themselves, the ETFs, the
Speaker 3: index funds like create this mechanical flows and that flows
Speaker 3: to the biggest stocks and they keep going up and
Speaker 3: et cetera.
Speaker 1: Flows before pros.
Speaker 3: As Tracy has coined it, Do you still have that
Speaker 3: in your message, Nim Tracy?
Speaker 1: I think I do, but only because I'm lazy and
Speaker 1: haven't been bothered to replace it.
Speaker 3: But on the other hand, we're recording this January twenty
Speaker 3: second and one of the biggest stocks in the market.
Speaker 3: Apple has significantly underperformed all year. So the QQQ the
Speaker 3: indices are up, but Apple's actually significantly down this year
Speaker 3: concerns about iPhone sales. It still looks to me that
Speaker 3: maybe there's some mechanical flows going on, but there is
Speaker 3: individual security selection and marginal price setting still happening, so
Speaker 3: that despite like all these the flows that on some
Speaker 3: level you know that they're you know, if a company
Speaker 3: is if they're concerns about a company's performance, it doesn't
Speaker 3: just mechanically go higher.
Speaker 5: You're right, Joe, But I would push back and say
Speaker 5: that I'm cliff as in Camp that it's become a
Speaker 5: lot less efficient. There's less and less fundamental investors going
Speaker 5: out and actually buying and selling stocks based upon fundamentals.
Speaker 5: And not only that, Cliff won't tell you this, but
Speaker 5: if you think about it, part of the reason the
Speaker 5: market has become less efficient is because of quants themselves.
Speaker 5: They become a larger and larger portion of the trading
Speaker 5: in the market. These pod shops, and I have nothing
Speaker 5: against them, they're producing some absolutely stellar returns risk adjusted.
Speaker 4: They're out of the world.
Speaker 5: They're terrific but a lot of it is based upon
Speaker 5: following momentum and doing things like earnings revisions and other
Speaker 5: kind of pro like short term pro cyclical movements, so
Speaker 5: there's very little of the kind of dual David Einhorn,
Speaker 5: I'm buying a stock because it's for you know, a
Speaker 5: four pe, and I'm planning on selling it at seven pe.
Speaker 5: When everyone figures out that earnings are going to be
Speaker 5: better than expected, now it's much more. Next quarters, EPs
Speaker 5: is going to be slightly higher. That means the earnings
Speaker 5: revisions ticked up, and therefore all of our models mean
Speaker 5: that you need to buy, and everyone rushes into it,
Speaker 5: and then the CTAs follow and it just ends.
Speaker 4: Up feeding upon itself.
Speaker 5: So I'm not quite sure I completely agree with you, Joe,
Speaker 5: that that everything is great with the markets. It really
Speaker 5: does feel to me like it's become less efficient, not more.
Speaker 1: All Right, Kevin Muir, I am so glad that we
Speaker 1: finally got you on the show and we have to
Speaker 1: do it again. Thank you so.
Speaker 4: Much, my pleasure, Thank you for having me on.
Speaker 1: Thanks that's great, Joe, that was so much fun. I'm
Speaker 1: so glad we finally had Kevin on the show and
Speaker 1: he even brought you, you know, dot com era of femine.
Speaker 3: I know, I love it. I love this topic. I
Speaker 3: mean I just think about it all the time. I
Speaker 3: even wrote about it in the newsletter this week. Every
Speaker 3: month Bank of America does their hedge fund or their
Speaker 3: fund manager survey, and one of the questions they ask
Speaker 3: is what do you perceive as the most crowded trade?
Speaker 3: And basically, like almost every month for years now, it's
Speaker 3: been some it's some version of big tech. And you know,
Speaker 3: like you're like, typically you think, oh, this is a
Speaker 3: crowded trade, it can't go on. But the move has
Speaker 3: been to play the crowded trade.
Speaker 1: Yeah. Absolutely, and you're right to some extent that's been
Speaker 1: justified by earnings. But I think I think there is
Speaker 1: like this reflexivity that I mentioned at play in the market,
Speaker 1: where you know, the big attract more inflows, they get
Speaker 1: more capital, they get bigger, maybe they get more pricing power,
Speaker 1: and then that leads to more earnings. So you have
Speaker 1: this sort of cycle going on.
Speaker 3: I mean, well, for whatever reason, we're in an era
Speaker 3: and I would say there is a winner take all
Speaker 3: this across the economy. Yeah, that you see for sure,
Speaker 3: And how much of that is financial flows, how much
Speaker 3: of it is real economic outcomes. I guess my inclination
Speaker 3: is still to look and say, you know, the earnings
Speaker 3: growth of these names are unbelievable, but whatever the reason,
Speaker 3: everyone is now all in on the same bet. And
Speaker 3: Kevin made the point about career risk, which is really key,
Speaker 3: which is that even if you think you've identified something
Speaker 3: else or maybe a better way to diversify, et cetera,
Speaker 3: do you really want to be the one person who like, oh,
Speaker 3: I'm gonna like shave down my Nvidia exposure or do
Speaker 3: you just want to ride with everyone else at the
Speaker 3: same time.
Speaker 1: You know, one of my favorite benchmark controversies is there's
Speaker 1: actually a lot of if you think about, you know,
Speaker 1: like including Chinese bonds, including Chinese shares and things like that.
Speaker 1: But there there was this big kerfuffle among frontier and
Speaker 1: em investors.
Speaker 4: About Kuwait huh.
Speaker 1: Kuwait was included in the MSCI Frontier Index for the
Speaker 1: longest time, and a lot of people didn't like that
Speaker 1: because Kuwait is this like fairly small country with only
Speaker 1: four million people and like a pretty small GDP, and
Speaker 1: everyone was like, why can't we have more Vietnam or
Speaker 1: something like that. So eventually they kicked Kuwait out of
Speaker 1: the Frontier Index and sent it to em and everyone
Speaker 1: was happy, that's a good story starting Kuwait. Presumably it's
Speaker 1: a good story. Yeah, thanks. Shall we leave it there?
Speaker 3: Let's leave it there, all right.
Speaker 1: This has been another episode of the Odd Lots podcast.
Speaker 1: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3: And I'm Jill Wisenthal. You can follow me at the
Speaker 3: Stalwart Follow or guest Kevin Muir. He's at Kevin Follow.
Speaker 3: Our producers Kerman Rodriguez at Kerman ermann Dashel Bennett at
Speaker 3: dashbot and kill Brooks at Kilbrooks. For more Oddlots content,
Speaker 3: go to Bloomberg dot com slash odd Lots. We have
Speaker 3: transcripts a blog in the newsletter, and you can shout
Speaker 3: about all of these topics, including index concentration and markets
Speaker 3: and investing in our discord discord dot gg slash odlog.
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