For observers of the financial markets, the history of past events only demonstrates what can happen; it does not lend probability to what will happen. We are reminded of this kernel of wisdom each time a sustained rise in stock market prices prompts some to engage in facile thinking to justify predictions of more gains to come. In response to U.S. stocks rising 30% in five months, one market analyst pointed to the longevity of bull markets in the 1950s and 1980s as evidence that today’s upward trend (which he claims began in 2013) is “middle aged,” and could continue until 2033. Given that the target date is nearly ten years away, and that most ten-year periods do produce positive equity returns, this opinion is not worth very much. It also glibly overlooks the possibility (present in the historical data as well) that dramatic reversals could occur in the meantime.
Rosy future or not, the world’s stock markets have returned to robust health over the past year, leaving the uncertainty of the disruptive and confusing pandemic period behind. The strongest first quarter for stocks since 2019 led to a string of index records, or near-records, led by the U.S. market’s S&P 500, that itself reached new peaks on twenty-two occasions. Towards quarter-end, markets in Europe and Japan outpaced the U.S. While technology shares continued to dominate action in the U.S., there was some broadening of interest among investors, and in Europe, banking and other more sedate sectors did unusually well. Given all this bullishness, it is not surprising that “momentum”—the ultimate bull market strategy in which securities are purchased because their prices have already risen rapidly—has seen a revival, scoring its best quarter since 2002.
Increasing market optimism has produced some truly astounding statistics, notably in the more speculative regions. While the outsized influence of the so-called “Magnificent Seven” technology companies has waned somewhat due to declines in a few of its members, one of them, Nvidia, a company at the center of the current hype surrounding artificial intelligence, saw its market value rocket by $277 billion in one day in January, an amount equal to the entire market value of the Philippine stock market. In the first quarter, the company’s value rose by $1 trillion, or 20% of total global equity market gains in the period. A tech company in the social media sphere rose to a $14 billion market valuation after going public, supported by $3 million in revenues and a host of individual punters. The experience of Pets.com seems to be lost to history at this point.
Speculative action spread beyond the stock market to other tradable assets as well. Bolstered by the relaxing of regulations on the creation of retail funds that “invest” in the vehicles, bullishness gave a boost to cryptocurrencies (purely speculative constructs, in our view), which had slumped heavily in 2022. Chief among them, Bitcoin rose 60% during the quarter, and its total value now exceeds the GDP of 150 countries. One enthusiast at a hedge fund says Bitcoin’s price could rise to $150,000 this year, from about $70,000 now. Such breathless hype puts paid to the notion that Bitcoin is a “currency,”—a ludicrous idea in our estimation. A financial instrument whose price has fluctuated between $20,000 and $70,000 in the last twelve months is hardly a store of value, one of the chief attributes of a true currency.
Commodities also participated in the general optimism and experienced a booming quarter across a broad swath of materials and foodstuffs. Cocoa prices tripled, setting new record highs. Gold achieved records, silver attained recent highs, and crude oil markets rose 14-18%. Fundamental supply and demand factors usually underly market enthusiasm in the commodity-trading community; shortages, crop failures, inflation fears, and geopolitical tensions provided sufficient grounds for concern with the supply of many materials. But commodity trading is more akin to gambling than investing, and the recent market activity in goods is an even less reliable indicator of future prices than are past price trends in stocks.
Despite the bullishness, there remains a good deal of skepticism regarding the recent advances, much of it based solely on the enthusiasm evident among market participants. Enthusiasm comes at a high price, and rampant speculation in certain sectors, stretched valuations, and concentration of interest in narrow groups of industries are hallmarks of markets getting beyond themselves. Other concerns, such as the direction of interest rates, also suggest caution. However, we are sanguine about the current market situation. There are always skeptics in bull markets. Many stocks are overvalued, and the concentration phenomenon is certainly of interest, but at the same time some sectors and individual situations are not excessively valued or subject to hype. The key as investors is to be bullish about the latter when enthusiasm is focused on the former.
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From time to time, we have written about how the concentration of interest in a small group of securities—recently the “Magnificent Seven”—can distort readings from market indexes that are designed to give investors insights into the direction of market prices, and valuation. At times indexes can actually present a picture that is the opposite of reality. In the late 1990s there were times when someone looking at the S&P 500 or NASDAQ indexes in the U.S. might have thought that American stocks were rising sharply, when in fact most suffered price declines. This was a lucky state of affairs for index fund owners, but not so much for those who chose to act differently, a group that included some well-known and highly successful investors. (The latter group was vindicated after the dotcom collapse beginning in 2000.)
A recent piece in the Financial Times brought to our attention another form of concentration among global stock markets in the aggregate. The U.S. equity market comprises over 60% of global stock market value—far above its 29% share in 1989—close to the levels of the 1950s and 1960s, when the U.S. was the world’s dominant economic power. Much of the increase in U.S. relative share has been fueled by record flows of funds into ETFs (Exchange Traded Funds) representing the S&P 500 index, which totaled $137 billion in 2023. The big U.S. fund sucked in money from investors worldwide, accounting for 27% of all equity ETF inflows.
Much of the Financial Times article was devoted to some technical factors that impacted fund flows, as well as a description of how the aura surrounding the MAG7 piqued speculative interest far beyond American shores. What piqued our interest, however, was a chart depicting individual country market allocations within the global equity markets since 1900. Except for the early years of the 1900s, the U.S. has been the single largest market during the time span, accounting for roughly 50% of global market capitalization, on average, since the early 1920s—with ebbs and flows.
It is the ebbs and flows that we find particularly interesting. Curiously, whenever U.S. market dominance approached or exceeded about 60%, sooner or later a significant downturn ensued. The most notable peaks came in the late 1920s, the late 1960s, the mid 1980s, and the late 1990s, all of which preceded market breaks of sizable magnitude. Although history does not lend probability, it will be interesting to see if and when global buying interest in U.S. stocks eventually exhausts itself, as has always happened in the past.
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Readers of our recent letters know that we have long had a bee in our bonnet about the developing crises in water usage and insurance. The two are connected in some respects (a regional dearth of water may impact insurance availability, for example), and the root cause of both lies in humans unwisely setting up shop in places where they have no business doing so.
The insurance problem is becoming acute. In February, the Financial Times ran a piece titled “The uninsurable world: what climate change is costing homeowners,” which outlined how the rising frequency and spread of destructive weather to normally less damage-prone areas are raising costs, forcing insurers to lift premiums and sometimes abandon markets altogether. For insurers themselves, insurers’ insurance, or “re-insurance,” has become very expensive and more limited in coverage, making primary coverage for many homeowners and businesses affordable (or available) only with government involvement in the form of subsidies or policy directives requiring companies to provide insurance.
Some insurance executives are beginning to realize that their industry is in some ways at the coalface of climate change, where real problems must be dealt with in real time, not just discussed in a future tense. Rising premiums serve a carbon tax-like function, beginning to change behavior, or at least forcing parties to grapple with long-ignored issues. The issue of insurance affordability affects property markets and valuation and “has society-wide impacts, from where people choose to live to where they decide to retire.” No longer is retiring to Florida to enjoy nice weather in one’s old age a “no-brainer” decision.
In some ways, insurance is capitalism’s “collective action”: the many contribute to benefit the group by protecting against catastrophic loss by any one member. Insurance is a critical financial mechanism that reaches into many aspects of our lives. To operate properly, it must live up to its “proposition to society,” as the Times put it, and not put off grappling with trends such as climate change that impact insurability, as some executives quietly admit doing. When large areas become uninsurable from the industry’s standpoint, its role as society’s “financial shock absorber,” and its independence, are called into question.
Dennis Butler, MBA, CFA
Commentary