January 24, 2025 • 36 mins
There's a lot of talk right now about concentration risk in US equities. For instance, the top 10 stocks in the S&P 500 currently account for 38% of the total index, compared to just 17.5% a decade ago. And all the big winners have been tech companies like Apple, Nvidia, Meta, etc., prompting questions about whether investors are getting overly-enthused about AI. For some, it's also bringing back memories of the dotcom bubble. So just how concentrated is the US stock market right now? What exactly is "concentration risk" anyway? What does this trend say about the power of benchmark index providers like S&P? And -- crucially -- are market participants doing anything about it? In this episode we speak with Kevin Muir, a.k.a. the Macro Tourist, about why he thinks the market is now at "peak concentration," and what could change to reduce Big Tech's dominance.
Read more: Index Providers Rule the World—For Now, at Least
Nvidia and Five Tech Giants Now Command 30% of the S&P 500 Index
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Speaker 1 (00:00):
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Speaker 2 (00:42):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 1 (00:58):
Hello and welcome to another episode of the All Thoughts Podcast.
I'm Tracy Alloway.
Speaker 3 (01:02):
And I'm Joe Wisenthal.
Speaker 1 (01:04):
Joe, do you remember when you first heard the term
mag seven?
Speaker 3 (01:08):
You know, I don't if I'm being honest, but you
know these achronyms that for big tech stocks, like they
kind of you know, people used to talk about Fang, right.
Speaker 1 (01:17):
I know, I was just thinking that, like, when did
the handoff from Fang to mag seven actually happen.
Speaker 3 (01:24):
We need to do one of those like Google trends
and gram things. That's a good question because and then
there was like fang plus and then fam and but
they're all kind of the same thing. It's just big
tech stocks, right.
Speaker 1 (01:37):
So the terminology the acronyms might change, but I think
the subject is always kind of the same and the
concern is always the same. It's this idea that there
is like a handful of big companies, usually tech stocks,
that are driving the entire market.
Speaker 3 (01:54):
Yeah, and it drives people crazy, right, they're so big,
and they've grown so much, stocks have done so well
over the years, and all these old strategies of like
oh we're gonna like buy cheap or buy cheap low
book value, you know, price to book and all these
traditional investing patterns. It never mean reverts for years and
years and years, except for like five minutes in twenty
(02:17):
twenty two. They just go straight up. And the only
test of whether you're a good investor or not is
whether you're over whether you bought ten Yeah.
Speaker 4 (02:24):
That's it, is it?
Speaker 1 (02:25):
Really? That really is the alpha now is But you know,
you see these numbers thrown around like I think Goldman
Sachs said that the top ten stocks now account for
something like thirty eight percent of the S and P
five hundred, which is a record, yeah, and seems quite
a lot on the face of it. And I saw
another number out there saying twenty six stocks now account
(02:47):
for half of the entire value of the S and
P five hundred. So I think it brings up a
bunch of interesting questions. How bad is the concentration? Is
it intrinsically bad in and of itself? Is it actually
that risky?
Speaker 3 (03:03):
Yeah?
Speaker 1 (03:03):
And also how are financial professionals and the market itself
actually reacting to this concentration risk?
Speaker 4 (03:12):
So I think we should talk about it totally.
Speaker 3 (03:13):
You know, I look at myself in the mirror, and
I say to myself.
Speaker 1 (03:17):
Do you point at yourself like that meme?
Speaker 3 (03:19):
I And some days I point and say you're a
good because you know, I'm just like a boring index
fund investor for my retirement, you know, So I point say, oh,
you're a good investor because you've been really long tech.
And then I and then on other days they wake
up and say, oh, you are really heavily exposed to
twenty six stocks, And so you know, it's like to
you know, glass half full. It's like good, but also
(03:40):
makes me a little anxious.
Speaker 1 (03:41):
You shouldn't take credit. You should give that credit to
SMP and thank you, and then when the market collapses
you should blame them.
Speaker 4 (03:48):
I do.
Speaker 3 (03:48):
I say thank you to the wonderful fund managers at SMP.
I only wish you hadn't. You know, every once in
a while they have a dud. It's like why did
you pick that one anyway?
Speaker 1 (03:58):
Or why didn't you include?
Speaker 2 (04:00):
Yeah?
Speaker 1 (04:00):
Kay, exactly, all right, Well, without further ado, we do,
in fact have the perfect guest for this topic, someone
that I've wanted to speak to for a long time
and I can't believe we haven't had him on the
podcast before major oversight on our part. We're going to
be speaking with Kevin Muhror. He is, of course the
Macro tourist and a long time voice on finn Twit
(04:23):
and writing on his blog as well. So Kevin, thank
you so much for coming on all thoughts.
Speaker 4 (04:28):
It's great to be here. Thanks Joe and Tracy.
Speaker 1 (04:30):
Maybe just to begin with, it's the first time you're
on the show. I've always sort of known you as
this voice that's hanging around in the finance BLOGI sphere.
But what's your background?
Speaker 5 (04:42):
So I was the equity derivative institutional equity derivtive trader
at RBC Dominion Securities in the nineties. I was kind
of at the forefront of the technological boom and the
automated trading and the index trading and the taking off
of all these index products. And then in two thousand
I actually went off on my own and I thought, maybe,
(05:03):
you know, I'll go work for a hedge fund. And
I thought, well, at the same time, I could go
and trade for myself for a little bit and see
how that goes. And that's kind of twenty five years
later and I'm still doing it.
Speaker 3 (05:14):
You write the macro Tourist, what's your goal? What do
you for those I we're both big fans of your writing,
But what do you what do you like to write about?
What's your sort of goal with your writing?
Speaker 5 (05:26):
Well, Joe, it originally started off as a diary, and
I just kind of good traders, you're supposed to keep
a diary, and and I would start writing things and
then people would pull me up and ask me what
I thought of the market, and I would send it
off into the mot just so well, here's what I
wrote my diary. Eventually they started to ask often enough
that we just started to put it up on the net,
and then it took off from there, and from there
(05:48):
I ended up going and actually started my podcast and
meeting all sorts of people. And one of the kind
of just great parts about being on the podcast is
the fabulous people I got to meet along the way.
I meet people like Jim Lightner and I've had Mike
Masters on the podcast, and those people are market wizards.
They're terrific, and I get to share ideas with them,
and it's just that considers myself one of the luckiest
(06:09):
guys in the world.
Speaker 1 (06:10):
So let's get to the topic at hand. Then give
us some context around concentration risk in something like the
S and P five hundred right now. I threw out
some numbers earlier, But how extensive is this concentration and
should we be worried about it?
Speaker 5 (06:29):
Well, Tracy, one of the things that people will kind
of push back on when you say that the US
has become more concentrated is they'll say things like, oh,
but if you go look at other indexes around the world,
they're also very concentrated. And that's absolutely correct, There's no
doubt about it. This is something that is experienced in Canada.
As I mentioned, I'm a Canadian and I was on
(06:50):
the index desk at a time when Noortel was actually
thirty five percent of the entire index.
Speaker 1 (06:57):
Wow.
Speaker 5 (06:57):
So if you think that you guys are we're having
troubled dealer with this, now, just imagine having thirty five
percent of the index being one stock. It was actually
even worse than that because we had kind of a
palm at triple M situation where Bell Canada was one
of our next biggest stocks and it main holding with
all of its Nortel holding. So it ended up being
that the index managers were stuck because if you think
(07:20):
about it from a fiduciary point of view, it doesn't
make sense to have fifty percent of your portfolio, you know,
exposed to one stock. It's risky. And so one of
the things that I well that I'm hearing now when
you bring up the problems about concentration risk in the
US is they'll say, oh, no, but don't worry. It's
actually much better than the rest of the world. And
(07:41):
I won't deny that for a second. But isn't that
kind of like saying, you know, my Mercedes is now
using plastic knobs, but don't worry, the Honda uses plastic
knobs too. Part of the reason that we've been that
investors have been attracted to the US is that it
is a diversified basket of many stocks. And just think
(08:02):
about you know, Warren Buffett, Warren Buffett tells you can
buy the S and P five hundred, you can sleep
at night. But if you go and talk to investment
advisors around the world and you ask them, do you
think your clients really truly know what's underlying that basket?
I think they most of them would say they would
assume that it's it's roughly equal weight, and they would
(08:22):
be shocked to learn that, you know, Microsoft and Navidia
Apple are each almost seven percent of their basket for
a total of twenty one percent. And so it's ends
up being it's a worrisome kind of new development in
the US. And I don't buy the argument that just
because other countries are more, you know, it's concentrated, that
we shouldn't worry about.
Speaker 4 (08:42):
It in the US. And all you have to do
is look you, Teresa.
Speaker 5 (08:45):
You mentioned that Goldman Sachs stat and they have another
one that they published and they went back, they looked
at concentration risk throughout the last century, and if you
look at it, we are now just as concentrated as
we were right in front of the Great Depression in
nineteen twenty nine, in the nifty to fifty in the
early seventies, and the dot com bubble in the late nineties. Well,
(09:09):
all those times were not good times to buy stocks
for forward returns. So increasingly I think that we need
to be aware that this is a risk, and there's
more and more conversation happening around that.
Speaker 3 (09:37):
I'm happy that in Nvidia has been seven percent or
somewhere south of that. In my portfolio, I didn't even
have to do anything, and I made a big allocation
to one of the best performing stocks in the world.
And not only that, I mean, I take your point
about concentration and et cetera, and obviously very alarming. These
(10:00):
are also account for a huge share of the actual
earnings too, So I mean, you know, there was a
lot of concentration in ninety nine, two thousandth tech, but
a lot of those companies weren't really making that much money.
These companies are earnings juggernauts.
Speaker 5 (10:15):
Well, no doubt, you're absolutely correct, Joe. And that's kind
of the pushback to this argument that we're concentrated world.
They'll say, oh, it's bang seven. It's a wide variety
of different companies that do with different things. It's not
like it's all one industry. And not only that, the
valuations aren't as crazy as they might seem, no doubt
about it. You can make that argument. But let's just
(10:38):
imagine tomorrow that the AI bubble doesn't live up to
its hype. Let's imagine that all of a sudden we
have some sort of earning surprise and these stocks get had.
It's not that hard to imagine. We went through it
in twenty twenty two. So if that occurs, I think
that people will be quite shocked at how they're supposedly
(11:00):
diversified basket of stocks performs. And more importantly than that
is that we can sit around and we can debate
whether you should own this or whether this is prudent.
But more and more fiduciaries, more and more risk managers,
more and more institutional portfolio managers are looking at it.
(11:20):
And saying this is dangerous and they're looking for ways
around it. And one of the things that many of
these managers are bumping up against is that although the
S and P five hundred is actually in line with
this following rule of this thing called the twenty five
five point fifty, which means that no one stock can
(11:41):
have more than twenty five percent and the five stock
the biggest stocks that are over five percent can't add
up to more than fifty percent of your portfolio. That's
an IRS rule that is called the twenty five five
to fifty rule. There's no problem with the SMP five
hundred currently with that rule, but there is some thing
called the Russell one thousand growth index, and increasingly more
(12:04):
and more institutional managers are benched to that index. And
what we're seeing is within that index, we're bumping up
against that. And what's happened now is that Russell's realized
that this isn't just kind of a fiduciary point of view,
this is actually an IRS issue in terms of that
they cannot go over those things. So what we're seeing
(12:27):
is there's changes in the rules coming to make sure
that these indexes capped.
Speaker 3 (12:34):
By the way Tracy Kevin mentioning how exposed everyone is
to AI beta, so to speak, And I just want
to give a plug. We had a really good contribution
in the odd Lot's Newsletter from a Skanda recently on
this whole thing. There's just both in stocks and the
economy and the real economy. There's just this like we
(12:56):
get they better get this AI thing right.
Speaker 1 (12:59):
Yeah, seems kind of important. Kevin. You mentioned finance professionals
reacting to this concentration risk. So okay, maybe your average
mom and pop retail investor doesn't realize that the S
and P five hundred is not you know, five hundred
equal weighted stocks, but certainly finance professionals do, and they're
aware of both the risk involved in having a large
(13:23):
concentration in just a handful of stocks and also some
of the requirements around diversification, so legal requirements that you
just mentioned. Before we get into some of those changes,
can you maybe just give us a little bit of
background on the importance of the index providers to the
(13:43):
finance industry itself. This is sort of a pet topic
of mine that I've written about occasionally, But how big
a deal are the index providers now?
Speaker 5 (13:53):
Well, You're absolutely right to highlight that, Tracy, and I'm
glad to see you have such a an enthusiastic come
attraction to index providers.
Speaker 4 (14:03):
One of the you're the only one that gets excited
about it. But it is a big story.
Speaker 5 (14:08):
And one of the issues is that as indexing has
become more popular, some of the kind of traditional the
first of the indexers have started charging more, which has
created an opportunity for other index providers to jump into
the loop. So obviously we all know the S and
P five hundred, but then there's the foot seat, which
(14:29):
is rustle, but there's also things like morning Star and
even you guys at Bloomberg have a lot of great
indexes and you're competing on a lot of these things
as well. So what's driving that is kind of two factors.
One of them is that there is the cost associated
with the big ones, so they're just trying to clients
(14:49):
that have to pay tens and hundreds of thousand dollars
for this index data. Is our changing the providers trying
to get something cheaper. And then the other thing is
is a little more kind of nefair. There's some indexes
that are easier to beat, so if you have an
index that you know the rules, you can actually front
run them. The When I was researching this and learning
(15:11):
about this, someone told me that it's important that you
buy the products of the index of the indexes that
are difficult to beat, and then from a kind of
client perspective, you choose. If you are a portfolio manager,
you choose the indexes that are easier to beat, because
if you're using, you know, for example, the S and
(15:32):
P five hundred as your benchmark, that's a lot more
difficult than to beat than another index that might have
one annual revision that is easy to kind of forecast
and run ahead of.
Speaker 4 (15:45):
Joe.
Speaker 1 (15:45):
I should just mention Kevin was kind enough just then,
because he's a very polite Canadian, to basically do our
disclaim for us, which is that Bloomberg LP, the parent
company of Bloomberg News, does own a bunch of different indices,
but probably most prominent among them are the Bloomberg bond indices,
(16:06):
and those were the Barclays indices before. So I should
just mention.
Speaker 3 (16:10):
That there you go, Thank you, Kevin, and thank you.
Speaker 5 (16:13):
Can I jump in with you a little since a
lot of people are getting Bloomberg users. One of the
things is if you go when you want to see,
for example, the index move and the S and P
five hundred, and you to type in hmov, you'll see
that they actually unless you pay for that data, you
don't get the index point changes. But Bloomberg has the
(16:33):
B five hundred, which is very similar, and you can
plot it in and then all that functionality that you
have to pay for on the other things, it actually
works quite well on the Bloomberg indyssees.
Speaker 3 (16:44):
There you go. So if you have a Bloomberg terminal
but don't feel like paying for the S and P
data specifically, Kevin just gave you a little bit of
a little bit of alpha there.
Speaker 2 (16:55):
But you know it.
Speaker 3 (16:56):
Actually you talked about foot running index changes. Why said
it easier?
Speaker 1 (17:01):
Right?
Speaker 3 (17:01):
Like S and P they announced, oh, some new company
is joining an index. How can you make money from
those announcements?
Speaker 4 (17:10):
Well, you used to be able to.
Speaker 5 (17:11):
There's a huge opportunities before, and there was hedge funds
that devoted themselves to doing it. But now everyone knows
the ones that are due to go in. And then
there's hedge funds who actually have portfolios of all the
stocks that are due to go in and even not
just hedge funds, even pension funds will quote and front
run them because they realize that there's some malfa there.
So at the end of the day, Joe, the problem
is that the more people look at it, the less
(17:33):
money there is to be made. Yeah, and kind of
trying to guess those things.
Speaker 1 (17:37):
All right, So let's get into how not just the
benchmark index providers are reacting to increased concentration, but also
how finance professionals are. You mentioned the Russell one thousand,
so give us a little bit more detail on what's
happening there. So Russell one thousand is aware that there's
intense concentration risk.
Speaker 5 (17:59):
Right, so they're jumping so they are actually getting ahead
of their problems of potentially going and bumping up against
this twenty five to five fifty rule. And for those
who don't aren't aware of it, this isn't a new phenomenon.
We actually had this in the summer of twenty twenty
three when Microsoft became too large of a position within
(18:19):
the QQQS and there needed to be an emergency rebalance
where they reduced the size of Microsoft. And then we
also saw this in the sector select XLK spider where
Navidia ran up and it actually ended up again we
bumped up against that twenty five to five to fifty
(18:40):
rule and they needed to be an emergency rebalancing there.
And that was the situation where there was the way
that their capping worked. It was this kind of very
violent shift from selling Apple and buying Navidia, and then
kind of the next quarter it flipped the other way
because of the way that the stock price has moved
and they had to do this rebalance again the other way.
(19:02):
And so this is the problem with that many of
these index providers are are kind of bumping up against
it in terms of they don't want to be too
violent with their shifts. They don't want to go and
get into situations where they're rebalancing all the time, trying
to keep within this limits. And that is why the
Russell in this R one thousand growth which is one
(19:24):
of the most popular growth indexes out there, they chose
instead of using the five and the fifty rule, they
used four and a half and forty five, meaning that
any stock above four and a half, if all those
stocks add up to forty five percent, then they do
this rebalance. So they've kind of given themselves a little
bit of extra, you know, room there in terms of
(19:47):
the rebounce. What's interesting is that they had announced this
I don't know what's a year ago because they saw
this problem coming. Nobody was talking about it.
Speaker 1 (19:56):
Oh yeah. I actually went back to try to find
articles on this. I couldn't find any.
Speaker 4 (20:01):
Yeah.
Speaker 5 (20:02):
The way that I came upon this idea and this
kind of revelation about that this is coming up was
actually one of my subscribers and a buddy sent me
something from Kevin Ja from Discipline Alpha, and he'd written
this whole piece about it and just highlighting it. One
of the reasons that he highlighted is he was a
mid cap manager during the two thousands and he distinctly
(20:25):
remembers Sebel Systems and another one. I can't remember the
other one, but there was two big stocks in the
S and P four hundred that were due to go
into the S and P five hundred, and when they
did it, the trouble was that the guys that all
bought it for the S and P five hundred, and
then when the SNB four hundred guys went to sell it,
(20:48):
there was no bids. And then coincided with the top
of the Nasdaq market, and he's very kind of adamant
that this is could be another situation where we have
a situation where the MAG seven has to go down
in waiting in one of the biggest indexes out there
in terms of after the S and P five hundred,
(21:09):
this is probably the next biggest growth index out there.
And when this rebalance occurs, which again is in March, ironically,
it's the same deal. There's going to be millions and
millions of shares of these mag sevens for sale. And
so for me, when I was trying to learn about it,
I went and said, okay, I went to an old
(21:30):
buddy at TD and they were one of the few,
and I think he said he was the first cell
side dealer to actually start talking about this. But increasingly
over the last month there's been more and more folks
paying attention and realizing that this is a bigger deal
than they really.
Speaker 3 (22:00):
By the way, as tracing those I love dot com
you're trivia and talking about that, and so like you
talk about Sebel and you talking about the three comm
Palm situation and all the these are like these are
some of my CATNP for Yeah, this is a total cat.
Speaker 2 (22:19):
You know.
Speaker 3 (22:20):
It occurs to me like the sort of the very
strict Chicago school. There's no such thing. Everyone people love
to say, there's no such thing as that you can't
as passive investing. You can sort of get close to it,
you know, the strict Chicago school people is like, you know,
you buy the global market portfolio at their market value,
(22:41):
every investable asset in the world. These rules essentially make
it impossible, right because if you had some stock that
was I don't know, got so big it was twenty
five percent of the index or whatever, but you're not
allowed to do it technically, like you really couldn't buy
the true market portfolio given some of these constraints.
Speaker 5 (23:02):
That's correct, and that's an IRS constraint. And then not
only that, just stop and think about if you go
and you try to recreate these portfolios at a broker.
I spoke to one investment advisor. He said, if I
went and made a portfolio of the qqqs, like if
I just made it from scratch and did all those things,
that compliance would tell me that I'm too concentrated in
(23:24):
tech stocks. So he says, I'm not allowed to buy
this from a compliance point of view, but I'm allowed
to buy the client's qqqs. And that's back to my
point is that we all just kind of been lulled
into this feeling that everything's okay. It's a it's a
broad index, and it's no longer as broad. And ironically,
(23:44):
you're talking about this idea about the mart the indexing,
and if you remember Mike Green and his theory that
the big will get bigger because of indexing, and more
and more people will just continue and this will create
a situation where the biggest stocks will continue to just
get bigger and bigger and bigger. Well, we're here, this
(24:04):
is happening. And my pushback to that argument has always
been that he's assuming the market doesn't work. He's assuming
nobody goes and says, hey, wait, those stocks are too big.
I'm going to go and no longer be benched to
the S and P five hundred. I'm going to be
benched to Russell one thousand or maybe three thousand. I'll
(24:26):
change it and see. This is the problem is that
many clients have kind of career risk, So if they're
bench to the S and P five hundred, they can't
go and put this huge bet where they don't own
the mag seven or they just say no, I can't
own it, it's too expensive. They need to go and
(24:46):
they need to own those stocks. But if you're a
fiduciary that's managing money for someone, and you go and
you say, listen, this doesn't make any sense.
Speaker 4 (24:55):
We're buying this s and P.
Speaker 5 (24:57):
Five hundred And the original reason what we did it
was because it it was supposed to be this diversified
basket of the whole market. This no longer makes sense.
Let's go try to find something else so you can
change your benchmark. Now, ironically, that actually takes a lot
of hassle and it's difficult.
Speaker 4 (25:14):
You have to go and you have to convince all.
Speaker 5 (25:17):
The users of your product or the or the end
clients to switch it. And that is why in this
situation with the Russell one thousand growth, instead of making
a new benchmark that is capped, they said, no, we're
just going to change the existing rules of the existing index.
So if you want an unconstrained Russell one thousand growth,
(25:40):
there is a new index that Russell has created, But
in this case it's going to be everyone that is
the Russell one thousand growth, and it's a lot of them.
Like you go, you pull it up, you'll see twenty billion,
forty billion, lots of people with big, big accounts that
are benched to this. They're gonna all of a sudden
find themselves overweight mag seven because there's a shift that's
(26:03):
occurring on the March expiry March twenty first.
Speaker 1 (26:08):
So, Kevin, you mentioned Russell making this decision to change
the existing index rather than create a new one, And
this is exactly what I wanted to ask you about,
which is, you know, when we talk about benchmark index providers,
we talk about them as being passive, right. They always
say they create these indices that are basically holding up
(26:29):
a mirror to markets and trying to reflect them as
they exist right now, and that kind of I'm a
little skeptical of that approach because I do think index
construction affects things like flows. It's kind of reflexive, and
I do think there are a lot of you know,
judgment calls that are embedded when you're deciding what to
(26:49):
include and what to exclude. But if they're making an
active decision to change the weighting on something like tech,
does that perhaps open them up to more or scrutiny
perhaps from regulators.
Speaker 5 (27:04):
Well, I wouldn't say from regulators. It's more scrutiny from
the clients. But in this case, they're not actually saying
they don't want more tech. They're saying, we need to
comply with this twenty five to five point fifty rule,
which is an IRS rule. It has nothing to do with,
you know, a decision that they think that the mag
(27:24):
seven's gotten too risky.
Speaker 4 (27:27):
Right.
Speaker 5 (27:27):
The index providers are there to provide whatever index they
think they can sell to their clients. If their clients
want something, they're going to do it and by that token.
Interestingly enough, we see the S and P five hundred
Earlier this spring introduced a capped version of the S
and P five hundred, which has individual stocks capped to
(27:49):
three percent. Now Here in Canada, we've actually already listed
an ETF based upon this index. But the reason that
SMP has created in nexus because there's a demand for
it and ultimately the clients will drive it. What I
thought was so interesting about this whole development is that
(28:10):
we're seeing index providers having to change their rules because
of this twenty five five point fifty. Then we're also
seeing institutional pension funds endowments starting to question whether they
want to continue with benchmarks that have such a large concentration.
And this is combined with the fact that many retail
(28:33):
don't really understand what they're buying when they buy the
S and P five hundred. So when I look at
this situation and think about how this is going to
play out going forward, I can make the argument that
we're kind of at the peak of concentration here and
that this is the market correcting what has become too
(28:55):
concentrated of a market.
Speaker 3 (28:58):
You know, going back to this idea that the big
just keep getting bigger, and you mentioned some of Mike
Green's theories, and you know, there is this view that
some have that like the funds themselves, the ETFs, the
index funds like create this mechanical flows and that flows
to the biggest stocks and they keep going up and
et cetera.
Speaker 1 (29:18):
Flows before pros.
Speaker 3 (29:19):
As Tracy has coined it, Do you still have that
in your message, Nim Tracy?
Speaker 1 (29:24):
I think I do, but only because I'm lazy and
haven't been bothered to replace it.
Speaker 3 (29:28):
But on the other hand, we're recording this January twenty
second and one of the biggest stocks in the market.
Apple has significantly underperformed all year. So the QQQ the
indices are up, but Apple's actually significantly down this year
concerns about iPhone sales. It still looks to me that
(29:48):
maybe there's some mechanical flows going on, but there is
individual security selection and marginal price setting still happening, so
that despite like all these the flows that on some
level you know that they're you know, if a company
is if they're concerns about a company's performance, it doesn't
just mechanically go higher.
Speaker 5 (30:08):
You're right, Joe, But I would push back and say
that I'm cliff as in Camp that it's become a
lot less efficient. There's less and less fundamental investors going
out and actually buying and selling stocks based upon fundamentals.
And not only that, Cliff won't tell you this, but
if you think about it, part of the reason the
(30:30):
market has become less efficient is because of quants themselves.
They become a larger and larger portion of the trading
in the market. These pod shops, and I have nothing
against them, they're producing some absolutely stellar returns risk adjusted.
Speaker 4 (30:47):
They're out of the world.
Speaker 5 (30:48):
They're terrific but a lot of it is based upon
following momentum and doing things like earnings revisions and other
kind of pro like short term pro cyclical movements, so
there's very little of the kind of dual David Einhorn,
I'm buying a stock because it's for you know, a
(31:08):
four pe, and I'm planning on selling it at seven pe.
When everyone figures out that earnings are going to be
better than expected, now it's much more. Next quarters, EPs
is going to be slightly higher. That means the earnings
revisions ticked up, and therefore all of our models mean
that you need to buy, and everyone rushes into it,
and then the CTAs follow and it just ends.
Speaker 4 (31:29):
Up feeding upon itself.
Speaker 5 (31:31):
So I'm not quite sure I completely agree with you, Joe,
that that everything is great with the markets. It really
does feel to me like it's become less efficient, not more.
Speaker 1 (31:41):
All Right, Kevin Muir, I am so glad that we
finally got you on the show and we have to
do it again. Thank you so.
Speaker 4 (31:47):
Much, my pleasure, Thank you for having me on.
Speaker 1 (31:50):
Thanks that's great, Joe, that was so much fun. I'm
so glad we finally had Kevin on the show and
he even brought you, you know, dot com era of femine.
Speaker 3 (32:11):
I know, I love it. I love this topic. I
mean I just think about it all the time. I
even wrote about it in the newsletter this week. Every
month Bank of America does their hedge fund or their
fund manager survey, and one of the questions they ask
is what do you perceive as the most crowded trade?
And basically, like almost every month for years now, it's
(32:33):
been some it's some version of big tech. And you know,
like you're like, typically you think, oh, this is a
crowded trade, it can't go on. But the move has
been to play the crowded trade.
Speaker 1 (32:45):
Yeah. Absolutely, and you're right to some extent that's been
justified by earnings. But I think I think there is
like this reflexivity that I mentioned at play in the market,
where you know, the big attract more inflows, they get
more capital, they get bigger, maybe they get more pricing power,
and then that leads to more earnings. So you have
this sort of cycle going on.
Speaker 3 (33:07):
I mean, well, for whatever reason, we're in an era
and I would say there is a winner take all
this across the economy. Yeah, that you see for sure,
And how much of that is financial flows, how much
of it is real economic outcomes. I guess my inclination
is still to look and say, you know, the earnings
(33:29):
growth of these names are unbelievable, but whatever the reason,
everyone is now all in on the same bet. And
Kevin made the point about career risk, which is really key,
which is that even if you think you've identified something
else or maybe a better way to diversify, et cetera,
do you really want to be the one person who like, oh,
(33:49):
I'm gonna like shave down my Nvidia exposure or do
you just want to ride with everyone else at the
same time.
Speaker 1 (33:55):
You know, one of my favorite benchmark controversies is there's
actually a lot of if you think about, you know,
like including Chinese bonds, including Chinese shares and things like that.
But there there was this big kerfuffle among frontier and
em investors.
Speaker 4 (34:11):
About Kuwait huh.
Speaker 1 (34:13):
Kuwait was included in the MSCI Frontier Index for the
longest time, and a lot of people didn't like that
because Kuwait is this like fairly small country with only
four million people and like a pretty small GDP, and
everyone was like, why can't we have more Vietnam or
something like that. So eventually they kicked Kuwait out of
(34:36):
the Frontier Index and sent it to em and everyone
was happy, that's a good story starting Kuwait. Presumably it's
a good story. Yeah, thanks. Shall we leave it there?
Speaker 3 (34:47):
Let's leave it there, all right.
Speaker 1 (34:48):
This has been another episode of the Odd Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (34:54):
And I'm Jill Wisenthal. You can follow me at the
Stalwart Follow or guest Kevin Muir. He's at Kevin Follow.
Our producers Kerman Rodriguez at Kerman ermann Dashel Bennett at
dashbot and kill Brooks at Kilbrooks. For more Oddlots content,
go to Bloomberg dot com slash odd Lots. We have
transcripts a blog in the newsletter, and you can shout
about all of these topics, including index concentration and markets
(35:17):
and investing in our discord discord dot gg slash odlog.
Speaker 1 (35:21):
And if you enjoy all lots, if you like it
when we talk about benchmark index providers, then please leave
us a positive review on your favorite podcast platform. And remember,
if you are a Bloomberg subscriber, you can listen to
all of our episodes absolutely ad free. All you need
to do is find the Bloomberg channel on Apple Podcasts
and follow the instructions there. Thanks for listening behind it
Hey, they're Odd Lots listeners. We have a very special announcement.
Joe and I are hosting our annual Front Lots Pub
Quiz on Thursday, February thirteenth in New York City, and
it's gonna feature some very special guests and prizes. So
come test your wits in finance, markets and economics for
a chance to win the ultimate Odd Lots glory and
(00:23):
hang out with your fellow listeners. Tickets are on sale
now at events dot Bloomberg Live dot com, slash Odlots
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feeds or in the newsletter, and you can find the
link also on our show notes. We hope to see
you there.
Speaker 2 (00:42):
Bloomberg Audio Studios, Podcasts, Radio News.
Speaker 1 (00:58):
Hello and welcome to another episode of the All Thoughts Podcast.
I'm Tracy Alloway.
Speaker 3 (01:02):
And I'm Joe Wisenthal.
Speaker 1 (01:04):
Joe, do you remember when you first heard the term
mag seven?
Speaker 3 (01:08):
You know, I don't if I'm being honest, but you
know these achronyms that for big tech stocks, like they
kind of you know, people used to talk about Fang, right.
Speaker 1 (01:17):
I know, I was just thinking that, like, when did
the handoff from Fang to mag seven actually happen.
Speaker 3 (01:24):
We need to do one of those like Google trends
and gram things. That's a good question because and then
there was like fang plus and then fam and but
they're all kind of the same thing. It's just big
tech stocks, right.
Speaker 1 (01:37):
So the terminology the acronyms might change, but I think
the subject is always kind of the same and the
concern is always the same. It's this idea that there
is like a handful of big companies, usually tech stocks,
that are driving the entire market.
Speaker 3 (01:54):
Yeah, and it drives people crazy, right, they're so big,
and they've grown so much, stocks have done so well
over the years, and all these old strategies of like
oh we're gonna like buy cheap or buy cheap low
book value, you know, price to book and all these
traditional investing patterns. It never mean reverts for years and
years and years, except for like five minutes in twenty
(02:17):
twenty two. They just go straight up. And the only
test of whether you're a good investor or not is
whether you're over whether you bought ten Yeah.
Speaker 4 (02:24):
That's it, is it?
Speaker 1 (02:25):
Really? That really is the alpha now is But you know,
you see these numbers thrown around like I think Goldman
Sachs said that the top ten stocks now account for
something like thirty eight percent of the S and P
five hundred, which is a record, yeah, and seems quite
a lot on the face of it. And I saw
another number out there saying twenty six stocks now account
(02:47):
for half of the entire value of the S and
P five hundred. So I think it brings up a
bunch of interesting questions. How bad is the concentration? Is
it intrinsically bad in and of itself? Is it actually
that risky?
Speaker 3 (03:03):
Yeah?
Speaker 1 (03:03):
And also how are financial professionals and the market itself
actually reacting to this concentration risk?
Speaker 4 (03:12):
So I think we should talk about it totally.
Speaker 3 (03:13):
You know, I look at myself in the mirror, and
I say to myself.
Speaker 1 (03:17):
Do you point at yourself like that meme?
Speaker 3 (03:19):
I And some days I point and say you're a
good because you know, I'm just like a boring index
fund investor for my retirement, you know, So I point say, oh,
you're a good investor because you've been really long tech.
And then I and then on other days they wake
up and say, oh, you are really heavily exposed to
twenty six stocks, And so you know, it's like to
you know, glass half full. It's like good, but also
(03:40):
makes me a little anxious.
Speaker 1 (03:41):
You shouldn't take credit. You should give that credit to
SMP and thank you, and then when the market collapses
you should blame them.
Speaker 4 (03:48):
I do.
Speaker 3 (03:48):
I say thank you to the wonderful fund managers at SMP.
I only wish you hadn't. You know, every once in
a while they have a dud. It's like why did
you pick that one anyway?
Speaker 1 (03:58):
Or why didn't you include?
Speaker 2 (04:00):
Yeah?
Speaker 1 (04:00):
Kay, exactly, all right, Well, without further ado, we do,
in fact have the perfect guest for this topic, someone
that I've wanted to speak to for a long time
and I can't believe we haven't had him on the
podcast before major oversight on our part. We're going to
be speaking with Kevin Muhror. He is, of course the
Macro tourist and a long time voice on finn Twit
(04:23):
and writing on his blog as well. So Kevin, thank
you so much for coming on all thoughts.
Speaker 4 (04:28):
It's great to be here. Thanks Joe and Tracy.
Speaker 1 (04:30):
Maybe just to begin with, it's the first time you're
on the show. I've always sort of known you as
this voice that's hanging around in the finance BLOGI sphere.
But what's your background?
Speaker 5 (04:42):
So I was the equity derivative institutional equity derivtive trader
at RBC Dominion Securities in the nineties. I was kind
of at the forefront of the technological boom and the
automated trading and the index trading and the taking off
of all these index products. And then in two thousand
I actually went off on my own and I thought, maybe,
(05:03):
you know, I'll go work for a hedge fund. And
I thought, well, at the same time, I could go
and trade for myself for a little bit and see
how that goes. And that's kind of twenty five years
later and I'm still doing it.
Speaker 3 (05:14):
You write the macro Tourist, what's your goal? What do
you for those I we're both big fans of your writing,
But what do you what do you like to write about?
What's your sort of goal with your writing?
Speaker 5 (05:26):
Well, Joe, it originally started off as a diary, and
I just kind of good traders, you're supposed to keep
a diary, and and I would start writing things and
then people would pull me up and ask me what
I thought of the market, and I would send it
off into the mot just so well, here's what I
wrote my diary. Eventually they started to ask often enough
that we just started to put it up on the net,
and then it took off from there, and from there
(05:48):
I ended up going and actually started my podcast and
meeting all sorts of people. And one of the kind
of just great parts about being on the podcast is
the fabulous people I got to meet along the way.
I meet people like Jim Lightner and I've had Mike
Masters on the podcast, and those people are market wizards.
They're terrific, and I get to share ideas with them,
and it's just that considers myself one of the luckiest
(06:09):
guys in the world.
Speaker 1 (06:10):
So let's get to the topic at hand. Then give
us some context around concentration risk in something like the
S and P five hundred right now. I threw out
some numbers earlier, But how extensive is this concentration and
should we be worried about it?
Speaker 5 (06:29):
Well, Tracy, one of the things that people will kind
of push back on when you say that the US
has become more concentrated is they'll say things like, oh,
but if you go look at other indexes around the world,
they're also very concentrated. And that's absolutely correct, There's no
doubt about it. This is something that is experienced in Canada.
As I mentioned, I'm a Canadian and I was on
(06:50):
the index desk at a time when Noortel was actually
thirty five percent of the entire index.
Speaker 1 (06:57):
Wow.
Speaker 5 (06:57):
So if you think that you guys are we're having
troubled dealer with this, now, just imagine having thirty five
percent of the index being one stock. It was actually
even worse than that because we had kind of a
palm at triple M situation where Bell Canada was one
of our next biggest stocks and it main holding with
all of its Nortel holding. So it ended up being
that the index managers were stuck because if you think
(07:20):
about it from a fiduciary point of view, it doesn't
make sense to have fifty percent of your portfolio, you know,
exposed to one stock. It's risky. And so one of
the things that I well that I'm hearing now when
you bring up the problems about concentration risk in the
US is they'll say, oh, no, but don't worry. It's
actually much better than the rest of the world. And
(07:41):
I won't deny that for a second. But isn't that
kind of like saying, you know, my Mercedes is now
using plastic knobs, but don't worry, the Honda uses plastic
knobs too. Part of the reason that we've been that
investors have been attracted to the US is that it
is a diversified basket of many stocks. And just think
(08:02):
about you know, Warren Buffett, Warren Buffett tells you can
buy the S and P five hundred, you can sleep
at night. But if you go and talk to investment
advisors around the world and you ask them, do you
think your clients really truly know what's underlying that basket?
I think they most of them would say they would
assume that it's it's roughly equal weight, and they would
(08:22):
be shocked to learn that, you know, Microsoft and Navidia
Apple are each almost seven percent of their basket for
a total of twenty one percent. And so it's ends
up being it's a worrisome kind of new development in
the US. And I don't buy the argument that just
because other countries are more, you know, it's concentrated, that
we shouldn't worry about.
Speaker 4 (08:42):
It in the US. And all you have to do
is look you, Teresa.
Speaker 5 (08:45):
You mentioned that Goldman Sachs stat and they have another
one that they published and they went back, they looked
at concentration risk throughout the last century, and if you
look at it, we are now just as concentrated as
we were right in front of the Great Depression in
nineteen twenty nine, in the nifty to fifty in the
early seventies, and the dot com bubble in the late nineties. Well,
(09:09):
all those times were not good times to buy stocks
for forward returns. So increasingly I think that we need
to be aware that this is a risk, and there's
more and more conversation happening around that.
Speaker 3 (09:37):
I'm happy that in Nvidia has been seven percent or
somewhere south of that. In my portfolio, I didn't even
have to do anything, and I made a big allocation
to one of the best performing stocks in the world.
And not only that, I mean, I take your point
about concentration and et cetera, and obviously very alarming. These
(10:00):
are also account for a huge share of the actual
earnings too, So I mean, you know, there was a
lot of concentration in ninety nine, two thousandth tech, but
a lot of those companies weren't really making that much money.
These companies are earnings juggernauts.
Speaker 5 (10:15):
Well, no doubt, you're absolutely correct, Joe. And that's kind
of the pushback to this argument that we're concentrated world.
They'll say, oh, it's bang seven. It's a wide variety
of different companies that do with different things. It's not
like it's all one industry. And not only that, the
valuations aren't as crazy as they might seem, no doubt
about it. You can make that argument. But let's just
(10:38):
imagine tomorrow that the AI bubble doesn't live up to
its hype. Let's imagine that all of a sudden we
have some sort of earning surprise and these stocks get had.
It's not that hard to imagine. We went through it
in twenty twenty two. So if that occurs, I think
that people will be quite shocked at how they're supposedly
(11:00):
diversified basket of stocks performs. And more importantly than that
is that we can sit around and we can debate
whether you should own this or whether this is prudent.
But more and more fiduciaries, more and more risk managers,
more and more institutional portfolio managers are looking at it.
(11:20):
And saying this is dangerous and they're looking for ways
around it. And one of the things that many of
these managers are bumping up against is that although the
S and P five hundred is actually in line with
this following rule of this thing called the twenty five
five point fifty, which means that no one stock can
(11:41):
have more than twenty five percent and the five stock
the biggest stocks that are over five percent can't add
up to more than fifty percent of your portfolio. That's
an IRS rule that is called the twenty five five
to fifty rule. There's no problem with the SMP five
hundred currently with that rule, but there is some thing
called the Russell one thousand growth index, and increasingly more
(12:04):
and more institutional managers are benched to that index. And
what we're seeing is within that index, we're bumping up
against that. And what's happened now is that Russell's realized
that this isn't just kind of a fiduciary point of view,
this is actually an IRS issue in terms of that
they cannot go over those things. So what we're seeing
(12:27):
is there's changes in the rules coming to make sure
that these indexes capped.
Speaker 3 (12:34):
By the way Tracy Kevin mentioning how exposed everyone is
to AI beta, so to speak, And I just want
to give a plug. We had a really good contribution
in the odd Lot's Newsletter from a Skanda recently on
this whole thing. There's just both in stocks and the
economy and the real economy. There's just this like we
(12:56):
get they better get this AI thing right.
Speaker 1 (12:59):
Yeah, seems kind of important. Kevin. You mentioned finance professionals
reacting to this concentration risk. So okay, maybe your average
mom and pop retail investor doesn't realize that the S
and P five hundred is not you know, five hundred
equal weighted stocks, but certainly finance professionals do, and they're
aware of both the risk involved in having a large
(13:23):
concentration in just a handful of stocks and also some
of the requirements around diversification, so legal requirements that you
just mentioned. Before we get into some of those changes,
can you maybe just give us a little bit of
background on the importance of the index providers to the
(13:43):
finance industry itself. This is sort of a pet topic
of mine that I've written about occasionally, But how big
a deal are the index providers now?
Speaker 5 (13:53):
Well, You're absolutely right to highlight that, Tracy, and I'm
glad to see you have such a an enthusiastic come
attraction to index providers.
Speaker 4 (14:03):
One of the you're the only one that gets excited
about it. But it is a big story.
Speaker 5 (14:08):
And one of the issues is that as indexing has
become more popular, some of the kind of traditional the
first of the indexers have started charging more, which has
created an opportunity for other index providers to jump into
the loop. So obviously we all know the S and
P five hundred, but then there's the foot seat, which
(14:29):
is rustle, but there's also things like morning Star and
even you guys at Bloomberg have a lot of great
indexes and you're competing on a lot of these things
as well. So what's driving that is kind of two factors.
One of them is that there is the cost associated
with the big ones, so they're just trying to clients
(14:49):
that have to pay tens and hundreds of thousand dollars
for this index data. Is our changing the providers trying
to get something cheaper. And then the other thing is
is a little more kind of nefair. There's some indexes
that are easier to beat, so if you have an
index that you know the rules, you can actually front
run them. The When I was researching this and learning
(15:11):
about this, someone told me that it's important that you
buy the products of the index of the indexes that
are difficult to beat, and then from a kind of
client perspective, you choose. If you are a portfolio manager,
you choose the indexes that are easier to beat, because
if you're using, you know, for example, the S and
(15:32):
P five hundred as your benchmark, that's a lot more
difficult than to beat than another index that might have
one annual revision that is easy to kind of forecast
and run ahead of.
Speaker 4 (15:45):
Joe.
Speaker 1 (15:45):
I should just mention Kevin was kind enough just then,
because he's a very polite Canadian, to basically do our
disclaim for us, which is that Bloomberg LP, the parent
company of Bloomberg News, does own a bunch of different indices,
but probably most prominent among them are the Bloomberg bond indices,
(16:06):
and those were the Barclays indices before. So I should
just mention.
Speaker 3 (16:10):
That there you go, Thank you, Kevin, and thank you.
Speaker 5 (16:13):
Can I jump in with you a little since a
lot of people are getting Bloomberg users. One of the
things is if you go when you want to see,
for example, the index move and the S and P
five hundred, and you to type in hmov, you'll see
that they actually unless you pay for that data, you
don't get the index point changes. But Bloomberg has the
(16:33):
B five hundred, which is very similar, and you can
plot it in and then all that functionality that you
have to pay for on the other things, it actually
works quite well on the Bloomberg indyssees.
Speaker 3 (16:44):
There you go. So if you have a Bloomberg terminal
but don't feel like paying for the S and P
data specifically, Kevin just gave you a little bit of
a little bit of alpha there.
Speaker 2 (16:55):
But you know it.
Speaker 3 (16:56):
Actually you talked about foot running index changes. Why said
it easier?
Speaker 1 (17:01):
Right?
Speaker 3 (17:01):
Like S and P they announced, oh, some new company
is joining an index. How can you make money from
those announcements?
Speaker 4 (17:10):
Well, you used to be able to.
Speaker 5 (17:11):
There's a huge opportunities before, and there was hedge funds
that devoted themselves to doing it. But now everyone knows
the ones that are due to go in. And then
there's hedge funds who actually have portfolios of all the
stocks that are due to go in and even not
just hedge funds, even pension funds will quote and front
run them because they realize that there's some malfa there.
So at the end of the day, Joe, the problem
is that the more people look at it, the less
(17:33):
money there is to be made. Yeah, and kind of
trying to guess those things.
Speaker 1 (17:37):
All right, So let's get into how not just the
benchmark index providers are reacting to increased concentration, but also
how finance professionals are. You mentioned the Russell one thousand,
so give us a little bit more detail on what's
happening there. So Russell one thousand is aware that there's
intense concentration risk.
Speaker 5 (17:59):
Right, so they're jumping so they are actually getting ahead
of their problems of potentially going and bumping up against
this twenty five to five fifty rule. And for those
who don't aren't aware of it, this isn't a new phenomenon.
We actually had this in the summer of twenty twenty
three when Microsoft became too large of a position within
(18:19):
the QQQS and there needed to be an emergency rebalance
where they reduced the size of Microsoft. And then we
also saw this in the sector select XLK spider where
Navidia ran up and it actually ended up again we
bumped up against that twenty five to five to fifty
(18:40):
rule and they needed to be an emergency rebalancing there.
And that was the situation where there was the way
that their capping worked. It was this kind of very
violent shift from selling Apple and buying Navidia, and then
kind of the next quarter it flipped the other way
because of the way that the stock price has moved
and they had to do this rebalance again the other way.
(19:02):
And so this is the problem with that many of
these index providers are are kind of bumping up against
it in terms of they don't want to be too
violent with their shifts. They don't want to go and
get into situations where they're rebalancing all the time, trying
to keep within this limits. And that is why the
Russell in this R one thousand growth which is one
(19:24):
of the most popular growth indexes out there, they chose
instead of using the five and the fifty rule, they
used four and a half and forty five, meaning that
any stock above four and a half, if all those
stocks add up to forty five percent, then they do
this rebalance. So they've kind of given themselves a little
bit of extra, you know, room there in terms of
(19:47):
the rebounce. What's interesting is that they had announced this
I don't know what's a year ago because they saw
this problem coming. Nobody was talking about it.
Speaker 1 (19:56):
Oh yeah. I actually went back to try to find
articles on this. I couldn't find any.
Speaker 4 (20:01):
Yeah.
Speaker 5 (20:02):
The way that I came upon this idea and this
kind of revelation about that this is coming up was
actually one of my subscribers and a buddy sent me
something from Kevin Ja from Discipline Alpha, and he'd written
this whole piece about it and just highlighting it. One
of the reasons that he highlighted is he was a
mid cap manager during the two thousands and he distinctly
(20:25):
remembers Sebel Systems and another one. I can't remember the
other one, but there was two big stocks in the
S and P four hundred that were due to go
into the S and P five hundred, and when they
did it, the trouble was that the guys that all
bought it for the S and P five hundred, and
then when the SNB four hundred guys went to sell it,
(20:48):
there was no bids. And then coincided with the top
of the Nasdaq market, and he's very kind of adamant
that this is could be another situation where we have
a situation where the MAG seven has to go down
in waiting in one of the biggest indexes out there
in terms of after the S and P five hundred,
(21:09):
this is probably the next biggest growth index out there.
And when this rebalance occurs, which again is in March, ironically,
it's the same deal. There's going to be millions and
millions of shares of these mag sevens for sale. And
so for me, when I was trying to learn about it,
I went and said, okay, I went to an old
(21:30):
buddy at TD and they were one of the few,
and I think he said he was the first cell
side dealer to actually start talking about this. But increasingly
over the last month there's been more and more folks
paying attention and realizing that this is a bigger deal
than they really.
Speaker 3 (22:00):
By the way, as tracing those I love dot com
you're trivia and talking about that, and so like you
talk about Sebel and you talking about the three comm
Palm situation and all the these are like these are
some of my CATNP for Yeah, this is a total cat.
Speaker 2 (22:19):
You know.
Speaker 3 (22:20):
It occurs to me like the sort of the very
strict Chicago school. There's no such thing. Everyone people love
to say, there's no such thing as that you can't
as passive investing. You can sort of get close to it,
you know, the strict Chicago school people is like, you know,
you buy the global market portfolio at their market value,
(22:41):
every investable asset in the world. These rules essentially make
it impossible, right because if you had some stock that
was I don't know, got so big it was twenty
five percent of the index or whatever, but you're not
allowed to do it technically, like you really couldn't buy
the true market portfolio given some of these constraints.
Speaker 5 (23:02):
That's correct, and that's an IRS constraint. And then not
only that, just stop and think about if you go
and you try to recreate these portfolios at a broker.
I spoke to one investment advisor. He said, if I
went and made a portfolio of the qqqs, like if
I just made it from scratch and did all those things,
that compliance would tell me that I'm too concentrated in
(23:24):
tech stocks. So he says, I'm not allowed to buy
this from a compliance point of view, but I'm allowed
to buy the client's qqqs. And that's back to my
point is that we all just kind of been lulled
into this feeling that everything's okay. It's a it's a
broad index, and it's no longer as broad. And ironically,
(23:44):
you're talking about this idea about the mart the indexing,
and if you remember Mike Green and his theory that
the big will get bigger because of indexing, and more
and more people will just continue and this will create
a situation where the biggest stocks will continue to just
get bigger and bigger and bigger. Well, we're here, this
(24:04):
is happening. And my pushback to that argument has always
been that he's assuming the market doesn't work. He's assuming
nobody goes and says, hey, wait, those stocks are too big.
I'm going to go and no longer be benched to
the S and P five hundred. I'm going to be
benched to Russell one thousand or maybe three thousand. I'll
(24:26):
change it and see. This is the problem is that
many clients have kind of career risk, So if they're
bench to the S and P five hundred, they can't
go and put this huge bet where they don't own
the mag seven or they just say no, I can't
own it, it's too expensive. They need to go and
(24:46):
they need to own those stocks. But if you're a
fiduciary that's managing money for someone, and you go and
you say, listen, this doesn't make any sense.
Speaker 4 (24:55):
We're buying this s and P.
Speaker 5 (24:57):
Five hundred And the original reason what we did it
was because it it was supposed to be this diversified
basket of the whole market. This no longer makes sense.
Let's go try to find something else so you can
change your benchmark. Now, ironically, that actually takes a lot
of hassle and it's difficult.
Speaker 4 (25:14):
You have to go and you have to convince all.
Speaker 5 (25:17):
The users of your product or the or the end
clients to switch it. And that is why in this
situation with the Russell one thousand growth, instead of making
a new benchmark that is capped, they said, no, we're
just going to change the existing rules of the existing index.
So if you want an unconstrained Russell one thousand growth,
(25:40):
there is a new index that Russell has created, But
in this case it's going to be everyone that is
the Russell one thousand growth, and it's a lot of them.
Like you go, you pull it up, you'll see twenty billion,
forty billion, lots of people with big, big accounts that
are benched to this. They're gonna all of a sudden
find themselves overweight mag seven because there's a shift that's
(26:03):
occurring on the March expiry March twenty first.
Speaker 1 (26:08):
So, Kevin, you mentioned Russell making this decision to change
the existing index rather than create a new one, And
this is exactly what I wanted to ask you about,
which is, you know, when we talk about benchmark index providers,
we talk about them as being passive, right. They always
say they create these indices that are basically holding up
(26:29):
a mirror to markets and trying to reflect them as
they exist right now, and that kind of I'm a
little skeptical of that approach because I do think index
construction affects things like flows. It's kind of reflexive, and
I do think there are a lot of you know,
judgment calls that are embedded when you're deciding what to
(26:49):
include and what to exclude. But if they're making an
active decision to change the weighting on something like tech,
does that perhaps open them up to more or scrutiny
perhaps from regulators.
Speaker 5 (27:04):
Well, I wouldn't say from regulators. It's more scrutiny from
the clients. But in this case, they're not actually saying
they don't want more tech. They're saying, we need to
comply with this twenty five to five point fifty rule,
which is an IRS rule. It has nothing to do with,
you know, a decision that they think that the mag
(27:24):
seven's gotten too risky.
Speaker 4 (27:27):
Right.
Speaker 5 (27:27):
The index providers are there to provide whatever index they
think they can sell to their clients. If their clients
want something, they're going to do it and by that token.
Interestingly enough, we see the S and P five hundred
Earlier this spring introduced a capped version of the S
and P five hundred, which has individual stocks capped to
(27:49):
three percent. Now Here in Canada, we've actually already listed
an ETF based upon this index. But the reason that
SMP has created in nexus because there's a demand for
it and ultimately the clients will drive it. What I
thought was so interesting about this whole development is that
(28:10):
we're seeing index providers having to change their rules because
of this twenty five five point fifty. Then we're also
seeing institutional pension funds endowments starting to question whether they
want to continue with benchmarks that have such a large concentration.
And this is combined with the fact that many retail
(28:33):
don't really understand what they're buying when they buy the
S and P five hundred. So when I look at
this situation and think about how this is going to
play out going forward, I can make the argument that
we're kind of at the peak of concentration here and
that this is the market correcting what has become too
(28:55):
concentrated of a market.
Speaker 3 (28:58):
You know, going back to this idea that the big
just keep getting bigger, and you mentioned some of Mike
Green's theories, and you know, there is this view that
some have that like the funds themselves, the ETFs, the
index funds like create this mechanical flows and that flows
to the biggest stocks and they keep going up and
et cetera.
Speaker 1 (29:18):
Flows before pros.
Speaker 3 (29:19):
As Tracy has coined it, Do you still have that
in your message, Nim Tracy?
Speaker 1 (29:24):
I think I do, but only because I'm lazy and
haven't been bothered to replace it.
Speaker 3 (29:28):
But on the other hand, we're recording this January twenty
second and one of the biggest stocks in the market.
Apple has significantly underperformed all year. So the QQQ the
indices are up, but Apple's actually significantly down this year
concerns about iPhone sales. It still looks to me that
(29:48):
maybe there's some mechanical flows going on, but there is
individual security selection and marginal price setting still happening, so
that despite like all these the flows that on some
level you know that they're you know, if a company
is if they're concerns about a company's performance, it doesn't
just mechanically go higher.
Speaker 5 (30:08):
You're right, Joe, But I would push back and say
that I'm cliff as in Camp that it's become a
lot less efficient. There's less and less fundamental investors going
out and actually buying and selling stocks based upon fundamentals.
And not only that, Cliff won't tell you this, but
if you think about it, part of the reason the
(30:30):
market has become less efficient is because of quants themselves.
They become a larger and larger portion of the trading
in the market. These pod shops, and I have nothing
against them, they're producing some absolutely stellar returns risk adjusted.
Speaker 4 (30:47):
They're out of the world.
Speaker 5 (30:48):
They're terrific but a lot of it is based upon
following momentum and doing things like earnings revisions and other
kind of pro like short term pro cyclical movements, so
there's very little of the kind of dual David Einhorn,
I'm buying a stock because it's for you know, a
(31:08):
four pe, and I'm planning on selling it at seven pe.
When everyone figures out that earnings are going to be
better than expected, now it's much more. Next quarters, EPs
is going to be slightly higher. That means the earnings
revisions ticked up, and therefore all of our models mean
that you need to buy, and everyone rushes into it,
and then the CTAs follow and it just ends.
Speaker 4 (31:29):
Up feeding upon itself.
Speaker 5 (31:31):
So I'm not quite sure I completely agree with you, Joe,
that that everything is great with the markets. It really
does feel to me like it's become less efficient, not more.
Speaker 1 (31:41):
All Right, Kevin Muir, I am so glad that we
finally got you on the show and we have to
do it again. Thank you so.
Speaker 4 (31:47):
Much, my pleasure, Thank you for having me on.
Speaker 1 (31:50):
Thanks that's great, Joe, that was so much fun. I'm
so glad we finally had Kevin on the show and
he even brought you, you know, dot com era of femine.
Speaker 3 (32:11):
I know, I love it. I love this topic. I
mean I just think about it all the time. I
even wrote about it in the newsletter this week. Every
month Bank of America does their hedge fund or their
fund manager survey, and one of the questions they ask
is what do you perceive as the most crowded trade?
And basically, like almost every month for years now, it's
(32:33):
been some it's some version of big tech. And you know,
like you're like, typically you think, oh, this is a
crowded trade, it can't go on. But the move has
been to play the crowded trade.
Speaker 1 (32:45):
Yeah. Absolutely, and you're right to some extent that's been
justified by earnings. But I think I think there is
like this reflexivity that I mentioned at play in the market,
where you know, the big attract more inflows, they get
more capital, they get bigger, maybe they get more pricing power,
and then that leads to more earnings. So you have
this sort of cycle going on.
Speaker 3 (33:07):
I mean, well, for whatever reason, we're in an era
and I would say there is a winner take all
this across the economy. Yeah, that you see for sure,
And how much of that is financial flows, how much
of it is real economic outcomes. I guess my inclination
is still to look and say, you know, the earnings
(33:29):
growth of these names are unbelievable, but whatever the reason,
everyone is now all in on the same bet. And
Kevin made the point about career risk, which is really key,
which is that even if you think you've identified something
else or maybe a better way to diversify, et cetera,
do you really want to be the one person who like, oh,
(33:49):
I'm gonna like shave down my Nvidia exposure or do
you just want to ride with everyone else at the
same time.
Speaker 1 (33:55):
You know, one of my favorite benchmark controversies is there's
actually a lot of if you think about, you know,
like including Chinese bonds, including Chinese shares and things like that.
But there there was this big kerfuffle among frontier and
em investors.
Speaker 4 (34:11):
About Kuwait huh.
Speaker 1 (34:13):
Kuwait was included in the MSCI Frontier Index for the
longest time, and a lot of people didn't like that
because Kuwait is this like fairly small country with only
four million people and like a pretty small GDP, and
everyone was like, why can't we have more Vietnam or
something like that. So eventually they kicked Kuwait out of
(34:36):
the Frontier Index and sent it to em and everyone
was happy, that's a good story starting Kuwait. Presumably it's
a good story. Yeah, thanks. Shall we leave it there?
Speaker 3 (34:47):
Let's leave it there, all right.
Speaker 1 (34:48):
This has been another episode of the Odd Lots podcast.
I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 3 (34:54):
And I'm Jill Wisenthal. You can follow me at the
Stalwart Follow or guest Kevin Muir. He's at Kevin Follow.
Our producers Kerman Rodriguez at Kerman ermann Dashel Bennett at
dashbot and kill Brooks at Kilbrooks. For more Oddlots content,
go to Bloomberg dot com slash odd Lots. We have
transcripts a blog in the newsletter, and you can shout
about all of these topics, including index concentration and markets
(35:17):
and investing in our discord discord dot gg slash odlog.
Speaker 1 (35:21):
And if you enjoy all lots, if you like it
when we talk about benchmark index providers, then please leave
us a positive review on your favorite podcast platform. And remember,
if you are a Bloomberg subscriber, you can listen to
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Hosts And Creators
Joe Weisenthal
Tracy Alloway
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