Is the Total US Stock Market too concentrated?

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simplesauce
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Is the Total US Stock Market too concentrated?

Post by simplesauce » Sat Jul 15, 2017 10:45 pm

I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies.

This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.

Has John Bogle commented on this phenomenon? Has it changed his views? This might be a good reason to increase our allocations to international stocks.

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Re: Is the Total US Stock Market too concentrated?

Post by PFInterest » Sat Jul 15, 2017 10:48 pm

Most Bogleheads invest internationally.

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Re: Is the Total US Stock Market too concentrated?

Post by Angelus359 » Sat Jul 15, 2017 11:10 pm

If you just nab a target date fund, you'll be very diversified
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Re: Is the Total US Stock Market too concentrated?

Post by Nate79 » Sun Jul 16, 2017 12:33 am

Vanguard's TSM holds over 3500 different stocks. How many different stocks would be good enough for you?

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Re: Is the Total US Stock Market too concentrated?

Post by acanthurus » Sun Jul 16, 2017 12:39 am

Nate79 wrote:Vanguard's TSM holds over 3500 different stocks. How many different stocks would be good enough for you?
The absolute number of stocks is a bad metric for diversification in a cap weighted index.

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Re: Is the Total US Stock Market too concentrated?

Post by FrugalInvestor » Sun Jul 16, 2017 12:46 am

There is little agreement among Bogleheads on the need for international stocks even though Jack has said many times that international investing is unnecessary for U.S. investors. He adds that if you must invest internationally go no higher than 20% of equities.

Here's a recent article on the subject in which Jack clearly lays out his reasoning....

http://www.investmentnews.com/article/2 ... nal-stocks

From article:
"Everyone tells me I'm wrong," Mr. Bogle said. "In my book, 'Bogle on Investing,' I said, for a lot of reasons, you don't need to own international stock." His argument: International investing involves extra risk, ranging from currency risk and economic risk to societal instability risk.
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Re: Is the Total US Stock Market too concentrated?

Post by celia » Sun Jul 16, 2017 12:46 am

Some companies disappear because they were merged/ bought out by another company. In that case, the "deleted" company is still there but as a subsidiary or other corporate structure. If you were to hold several individual stocks, you would see that the shares of the "deleted" company were either cashed out or turned into shares of the bigger company.

Conversely, sometimes a company spins off a division, then the price of the parent company shares drops while you also get shares of the spin-off company (or of the company who bought the spin-off).

Of course, a company can go bankrupt and its shares then become worthless.

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Re: Is the Total US Stock Market too concentrated?

Post by alex_686 » Sun Jul 16, 2017 2:33 am

simplesauce wrote:This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.
Could you explain this a bit more? What sectors do you think are being under weighted?

Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.

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Re: Is the Total US Stock Market too concentrated?

Post by Valuethinker » Sun Jul 16, 2017 3:07 am

alex_686 wrote:
simplesauce wrote:This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.
Could you explain this a bit more? What sectors do you think are being under weighted?

Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.
e


Except that, of course, If you diversify internationally you are In more of Those companies.

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Re: Is the Total US Stock Market too concentrated?

Post by iamlucky13 » Sun Jul 16, 2017 3:54 am

alex_686 wrote:
simplesauce wrote:This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.
Could you explain this a bit more? What sectors do you think are being under weighted?

Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.
I suppose a large cap bias in the US could be interpreted as one form of diminished diversification (as in concentrating ~75% of your investment in about 15% of the US publicly held companies), but it's not one I'm seeing a reason to be concerned about.

But that's size diversification, where as simplesauce mentioned sector diversification, and I'm a little more intrigued by his point there: as labor costs in the US have increased and other nations have developed, resources and manufacturing industries have tended to shift to other countries, while the US market has seen (I presume, but have not checked) increasing weights of financial services, health care, and technology companies.

But again, international diversification seems to address that.

Furthermore, it's not like those industries are absent from the US stock market, especially since many of those activities are conducted internationally by US-based companies. I think Mr. Bogle has been one of those who has pointed out that for that reason, there is some degree of international diversification present in the US market.

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 5:41 am

alex_686 wrote:Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.
If you are trying to track market dominance you should be revenue weighting not cap weighting. If you are looking for market dominance margin adjusted you should be earnings weighting or a mix of the two. I'm not seeing how cap weighting achieves what you are claiming it does.

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Re: Is the Total US Stock Market too concentrated?

Post by tennisplyr » Sun Jul 16, 2017 7:04 am

Generally speaking, diversification is good on many levels.
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Re: Is the Total US Stock Market too concentrated?

Post by Simplegift » Sun Jul 16, 2017 8:24 am

simplesauce wrote:I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies...snip...This might be a good reason to increase our allocations to international stocks.
The decline in the number of listed companies in recent decades indeed appears to have been a U.S.-only phenomenon, not an international one. According to a recent Credit Suisse report, with the consolidation of the U.S. stock market into fewer, larger, older companies, international investing may now expose investors to more smaller, newer, faster-growing companies (my bold in quote below).

The Incredible Shrinking Universe of Stocks
Credit Suisse wrote:Exhibit 2 shows the rise and fall in listed companies in the U.S. from 1976 to 2016. Because new lists heavily outnumbered delists, especially in the late 1980s and 1990s, more than 2,500 companies were added from 1976 through 1996. The pattern reverses after 1996, as delists outstrip new lists and the population of listed companies falls by 3,650 companies.

This trend is more pronounced in the U.S. than in any other developed economy. For example, while the number of listings fell by roughly 50 percent in the U.S. from 1996 through 2016, it rose about 50 percent in 13 developed countries that have complete data. Over the same period, listings rose 30 percent for a larger population of 71 non-U.S. countries.

As a result, listed U.S. companies today are on average larger, older, and more profitable than they were 20 years ago. Further, they operate in industries that are generally more concentrated. The overall size and maturity of listed companies means they are more likely to pay out cash to shareholders in the form of dividends and share buybacks than companies were in the past.

We speculate that the maturation of listed companies has also contributed to informational efficiency in the stock market. Gaining edge in older and well established businesses is likely more difficult than it is in young businesses with uncertain outlooks. In turn, the greater efficiency may be one of the catalysts for the shift that investors are making from active to indexed or rule-based strategies.
Cordially, Todd

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Re: Is the Total US Stock Market too concentrated?

Post by lostdog » Sun Jul 16, 2017 8:56 am

Go with Vanguard Total World Index. Simplicity and diversification all in one. I don't have to think about sectors at all. It's all there.

OR

Go with a Life Strategy or Target Date Fund.
"Our life is frittered away by detail. Simplify, simplify." -Thoreau | Vanguard Total World Index

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Re: Is the Total US Stock Market too concentrated?

Post by simplesauce » Sun Jul 16, 2017 9:09 am

lostdog wrote:Go with Vanguard Total World Index. Simplicity and diversification all in one. I don't have to think about sectors at all. It's all there.

OR

Go with a Life Strategy or Target Date Fund.
Yes, but I prefer to overweight the US stocks for many reasons brought forth by Jack Bogle. I just wanted to know if the diminishing number of stocks in the US is of any concern.

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Re: Is the Total US Stock Market too concentrated?

Post by tibbitts » Sun Jul 16, 2017 9:20 am

alex_686 wrote:
simplesauce wrote:This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.
Could you explain this a bit more? What sectors do you think are being under weighted?

Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.
I think there is near-universal agreement that in the U.S. real estate is under-represented in the public equity markets. How to respond to that is more in dispute.

I also think it's always been a winner-take-all environment, but that process may be somewhat more efficient today than it was in the past.

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Re: Is the Total US Stock Market too concentrated?

Post by lostdog » Sun Jul 16, 2017 9:24 am

simplesauce wrote:
lostdog wrote:Go with Vanguard Total World Index. Simplicity and diversification all in one. I don't have to think about sectors at all. It's all there.

OR

Go with a Life Strategy or Target Date Fund.
Yes, but I prefer to overweight the US stocks for many reasons brought forth by Jack Bogle. I just wanted to know if the diminishing number of stocks in the US is of any concern.
I was in the same boat as you. Based on your past posts it seems like this is constantly on your mind? At one point I decided to go with Jack Bogle's opinion about international and I still didn't have peace of mind. Diversification and simplicity gave me the peace of mind.
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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 9:55 am

simplesauce wrote:I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies.

This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.

Has John Bogle commented on this phenomenon? Has it changed his views? This might be a good reason to increase our allocations to international stocks.
Simplesauce in reading this thread I think you are conflating two very different issues. Control investors would rather take on debt than sell equity all things being equal. They become willing to sell equity only when they can't take on enough debt at their current equity levels to fuel obvious growth prospects. Companies, and investors, have become much more conservative in their desire for growth since the 1990s and especially since 2008. So there simply is less demand for financing of any kind coming from corporate America. At the same time the world right now has cheap debt prices and not super cheap equity except for the SP500 high P/E stocks, i.e. the stock market while highish isn't crazy high. SP500 high P/E stocks do have access to cheap equity financing from index funds by manipulating their float, but those wouldn't be "new stocks" so irrelevant for now. So given less demand for investment capital and a much greater percentage of that investment capital coming from the bond market than the stock market you would expect to see less equity sales including IPOs.

Then there is somewhat different question about whether the market cap weighting of the stock market is a good weighting of sectors and industries to be holding for diversification. And the answer is there are spot problems. For example real estate is a huge percentage of the USA economy but under 3% of TSM. Conversely technology is 25% of TSM. The technology index has some overvalued stocks but isn't totally crazy. However from a diversification perspective with TSM your technology holdings are as large as the entire consumer staples economy, energy, telecommunications, materials, industrials and utility combined. I think it is reasonable to ask whether your portfolio would be better diversified and thus safer by holding those other sectors in something other than their market weight. But the problem isn't mostly being created by a lack of stocks.

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Re: Is the Total US Stock Market too concentrated?

Post by Simplegift » Sun Jul 16, 2017 10:29 am

jbolden1517 wrote:However from a diversification perspective with TSM your technology holdings are as large as the entire consumer staples economy, energy, telecommunications, materials, industrials and utility combined. I think it is reasonable to ask whether your portfolio would be better diversified and thus safer by holding those other sectors in something other than their market weight.
More to the OP’s question, instead of looking beyond market-cap weighting in U.S. stocks, one could just add an index of cap-weighted international stocks — or simply choose a total world stock market fund. The “overweighted” sectors in the U.S. index (tech and health care) are balanced by “underweighting” in these sectors internationally — and vice versa (table below).
In practical portfolio terms, though, any choice — all U.S., an international mix, or total world — is probably diversified "enough."
Cordially, Todd

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Re: Is the Total US Stock Market too concentrated?

Post by nisiprius » Sun Jul 16, 2017 10:41 am

Simplesauce, I think you need to back up a second and go back to the root reasons for investing in a total U.S. stock market fund.

For obvious reasons, the 70% of the mutual fund market which consists of actively managed funds--and is losing ground to index funds has a marketing imperative to find plausible-sounding reasons why there's something wrong with cap-weighted total stock market indexing, so keep in mind that the messages that come your way are going to include spin and bias. A common sales technique in all industries is to say something about the competitor's product that is true, while implying that it's a problem. We once had a roofing contractor tell us--I'm not make this up--that we shouldn't buy the competitor's shingles because "you won't believe the stuff they put into them, they even use ground-up oyster shells." So, it's become popular to point to the composition of total market index funds, observe (what is true, just as it's true that shingle manufacturers put oyster shells into shingles) that most of the money in the stock market is in large-caps, and imply--or say outright--that it is "concentrated" in the biggest companies. Similarly, people point out that the stock market itself, and thus in a total stock market index fund, are about 20% in financials and only about 6% in basic materials, and suggest that it is "concentrated" in financials.

If you dip a bucket off a ship in the middle of the ocean and pull up a bucket of seawater, you will find that the contents of the bucket is 96.5% water. It is overwhelmingly water. Would you say that your bucket of seawater is "too concentrated" in water?

So, let's back up. In financial economics, the "market portfolio" is the total of all assets held in a market. In the case of the U.S. stock market that's some $25 trillion or so in stocks. "All models are wrong, but some are useful." In a simplified textbook model, the market portfolio has--let me quote Jeremy Siegel, in his book, Stocks for the Long Run:
These portfolios, under the assumptions of an efficient market, give investors the "best" trade-off between risk and return. That means for any given risk level, these capitalization-weighted portfolios give the highest returns; and for any given return, these portfolios give the lowest risk. This property is called mean-variance efficiency.*
The second interesting thing about holding the market portfolio, or a replica of it, is that it cancels out the effects of speculative trading in the market, and it's the only portfolio that does this. Any other portfolio is "taking sides" on every speculative transaction and will benefit if you're on the winning side and suffer if you're the losing side.

The point is, the market portfolio--and cap-weighted total market index funds, which copy it--is not just one of many ways to allocate money. It is special. It is different. The surface of the ocean and the Leaning Tower of Pisa are not just two equally opinions about what is level.

That doesn't mean you necessarily should stick with a cap-weighted total stock market index fund, but you do need to go into it understanding that it's not just some random way to weight a portfolio, it's special and backed by a fundamental model which may or may not be a good approximation of reality. And you need to be prepared to accept the true statement--most of the money in the stock market is in large-caps, 80% is in the S&P 500, about 20% is in the Dow Jones companies alone--and be prepared to ask "but is that bad, and if so, why?"

*In earlier editions of the book, that's all he said; in later versions, he sets it up to knock it down, saying that in real life the market is not efficient and that certain departures from cap-weighting are better.
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Re: Is the Total US Stock Market too concentrated?

Post by nisiprius » Sun Jul 16, 2017 10:54 am

There's a terrible logical problem in all weighting systems that try to give arbitrary equal weight to all stocks, or all sectors. The problem is that then your portfolio becomes dependent on an imperfect classification scheme that changes if someone changes their mind.

For example, up until last year, there were ten top-level headline sectors in the GICS: Energy, Materials, Industrials, Consumer Discretionary, Consumer Staples, Health Care, Financials, Information Technology, Telecom Services, and Utilities. If you decided for some reason--and I have to say personally I do not understand what that reason would be[/i]--that you wanted to equal-weight them, you'd put 10% in each.

And in 2016, MSCI changed its mind, and decided to split off REITs into their own sector, making eleven.

So, if you were equal-weighted on August 31, 2016, a day later you were underweighted in REITs. The day before, you had 3.5% in REITs (within your 10% allocation to "financials.") A day later, you needed to buy 7.6% REITS, and sell a bit of everything else. Which is crazy, because nothing changed in the economy itself, and probably not much in the market (unless the reclassification triggered enough activity to move the market).

Meanwhile, this reclassification had no effect at all on cap-weighted total stock index and index funds... or on the S&P 500 and S&P 500 index funds. The total stock market still had the same amount of every stock as it did before.
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Re: Is the Total US Stock Market too concentrated?

Post by pkcrafter » Sun Jul 16, 2017 11:17 am

simplesauce wrote:I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies.

This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.

Has John Bogle commented on this phenomenon? Has it changed his views? This might be a good reason to increase our allocations to international stocks.
No, you cannot be underdiversified in U.S, stocks if you hold a total market index. The total stock market reflects the whole U.S market, and the U.S. market is constantly changing. Think about how much was in the tech sector 30 years ago. I've also seen a few recent articles claiming that U.S, start-ups are on the rise.

Mr. Bogle has not changed his view on international. If you want to consider international as a different market, then if you don't hold any, you would be underdiversified. Many posters on the board think holding some international diversifies a portfolio a bit better than just holding U.S. The all eggs in one basket concern. Lots of investors who are not holding international are basing that decision on recent performance, which is a mistake.

Total world is 55% U.S, and 45% international, so if you are 20% international you are getting significant exposure without overdoing it. I'm holding 30% international and I have no plans to change it.

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Re: Is the Total US Stock Market too concentrated?

Post by spdoublebass » Sun Jul 16, 2017 11:36 am

simplesauce wrote:I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies.

This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.

Has John Bogle commented on this phenomenon? Has it changed his views? This might be a good reason to increase our allocations to international stocks.
Please do give my response a lot of weight, I am a new investor.
That being said I am amazed at which quote's of Mr. Bogle BH's feel the need to follow and which they are ok breaking. I have no problem with people choosing only to invest in the US market. I think you will be just fine, but....I honestly think that Mr. Bogle might have a different opinion if he were 21 and had 60+ years of investing ahead of him. Many people here on this forum can relate to his timeframe of investing and I have no issue with that decision. I would say if that's how you started then stay the course. For younger investors, I wouldn't fault them for not following this Bogle rule 100%.

What I don't understand is that some people on this forum choose to follow Mr. Bogle's US only rule, but then go ahead and Tilt REIT's. When Bogle was asks about REIT's he said, "People should invest in total market stock and bond funds for the long term. Total market indexing is the gold standard. Anything else, like sector investing, is a dilution of that standard." I only bring this up because as I said before, I find it funny when people pick and choose which statements to follow. Note: I am NOT accusing the OP of this, only tossing this out there.
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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 11:55 am

Simplegift wrote: More to the OP’s question, instead of looking beyond market-cap weighting in U.S. stocks, one could just add an index of cap-weighted international stocks — or simply choose a total world stock market fund. The “overweighted” sectors in the U.S. index (tech and health care) are balanced by “underweighting” in these sectors internationally — and vice versa (table below). In practical portfolio terms, though, any choice — all U.S., an international mix, or total world — is probably diversified "enough."
Glad we are agreeing on the facts. I do agree that International helps a lot, I still don't like Vanguard Total World Stock index but its much much better than just TSM as the core or a portfolio. This sort of cap weighting can have problems, for example you can see how heavily it is overweighting financials and underweighting real estate. I don't like how large and growthy it is, especially on international you can have large companies that act like quasi-governmental agencies and don't put their profits high up on their objectives. But using Vanguard Total World probably solves about 80% of the problems with TSM while introducing only about 20% new ones. A definite improvement.

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Re: Is the Total US Stock Market too concentrated?

Post by alex_686 » Sun Jul 16, 2017 12:06 pm

jbolden1517 wrote:If you are trying to track market dominance you should be revenue weighting not cap weighting. If you are looking for market dominance margin adjusted you should be earnings weighting or a mix of the two. I'm not seeing how cap weighting achieves what you are claiming it does.
I think we are talking past each other. The OP wants to know what to do with the fact that there are fewer companies out there. I am telling him why there are fewer companies out there.

Free float market cap is the market's neutral position. I can't think of any obvious way to lean against this or if one even should. IT has dramatically increased scales of efficiency. More on this below.
tibbitts wrote:I think there is near-universal agreement that in the U.S. real estate is under-represented in the public equity markets. How to respond to that is more in dispute.

I also think it's always been a winner-take-all environment, but that process may be somewhat more efficient today than it was in the past.
Lets talk about scale for a moment.

First, real estate has always be underrepresented. Real estate is a local business. There is not a huge advantage in scale. FYI, I overweight REITs in my personal portfolio. The point here is that market structure has not changed.

Second, it has not always been a winner take all. Go back 30 years. GM was able to achieve a 33% market share but it could never crush it rivals. O.K., maybe Chrysler, that was more of the fault of foreign completion. Go industry by industry and rarely would you find a single company getting more than 50%. Partly it was a question of scale, partly one of anti-trust. Today is different. The idea is to create a industry standard and ecosystem, and then ride the network effect. Who are the direct competitors to Google or Facebook?

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Re: Is the Total US Stock Market too concentrated?

Post by Valuethinker » Sun Jul 16, 2017 12:21 pm

spdoublebass wrote:
What I don't understand is that some people on this forum choose to follow Mr. Bogle's US only rule, but then go ahead and Tilt REIT's. When Bogle was asks about REIT's he said, "People should invest in total market stock and bond funds for the long term. Total market indexing is the gold standard. Anything else, like sector investing, is a dilution of that standard." I only bring this up because as I said before, I find it funny when people pick and choose which statements to follow. Note: I am NOT accusing the OP of this, only tossing this out there.
The case for REITs is one made by David Swensen & Burton Malkiel among others closely followed here.

There's considerable empirical data that REITs have a higher correlation with the underlying asset (commercial Real Estate) than they do with the stock market-- or at least a less than perfect correlation with the latter.

The unique tax/ legal structure of REITs and the way they produce returns for investors is the underlying logic for this.

I have argued (and I could well be wrong) that the events of 2008-09 highlight the risks of a large weighting in REITs, that that volatility makes the undoubted attractions just a lot less attractive. Plus tax issues, etc. However even I concede that if inflation exceeds expectations, REITs will show a higher correlation with it (and are thus a better diversifier) than stocks or bonds as a whole (except TIPS bonds).

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 12:26 pm

nisiprius wrote:let me quote Jeremy Siegel, in his book, Stocks for the Long Run:
These portfolios, under the assumptions of an efficient market, give investors the "best" trade-off between risk and return.
*In earlier editions of the book, that's all he said; in later versions, he sets it up to knock it down, saying that in real life the market is not efficient and that certain departures from cap-weighting are better.
I thank you for adding the disclaimer at the end. Jeremey Siegel is getting better over the years. But let me just point out how circular the original form of that argument is by dropping out the middle steps. It essentially amounts to: If I assume CAPM constructs the ideal portfolio then CAPM constructs the ideal portfolio. At the time he was making that argument it amounted to urging everyone to run around with buckets of water so as to be able to put out the fire during a flood. Stocks for the Long Run was an incredibly damaging book at the time.

I would agree with you that TSM is a special portfolio. Deviations from TSM do need to be justified. The burden of proof is on the people doing the justifying. I think they have easily met that burden, what they argued 20 years ago proved true (though a bit mistimed). And of course those people had made the same arguments during bulls and bears for many decades before. Today's market is nowhere near as unbalanced as the market of 20 years ago, and the dominance of FA I like to think is somewhat responsible for the fact that we have spot problems in the stock market and not overall insanity. Now we just need to have that same revolution towards rational pricing in the bond market.

I think your analogy regarding active mutual funds and sales strategies is extremely uncharitable. There is an active vs. passive debate, that is over. And then there is a there is a CAPM vs. fundamentals debate which is the point in question. Conflating the two doesn't advance the argument. There are plenty of fundamentally weighted passive vehicles.

Today active is successful mostly in niches that no one is quite sure how to passively index. That's not to say there aren't successful active managers but on average they are having trouble justifying their costs especially for core components. That being said if I had to lock someone into one fund for 30 years I'd pick Oakmark Global because I trust Oakmark to keep the investor out of bad ideas. Bad ideas do more damage than an extra 1% of ER. Passive indexes now have a history of failing to evolve as their strategies become obviously stupid. Since this is a Vanguard forum: VPACX and VTIBX are excellent examples of passive going from an investing strategy to a religion to the detriment of shareholders.

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Re: Is the Total US Stock Market too concentrated?

Post by Kevin M » Sun Jul 16, 2017 12:30 pm

simplesauce wrote: Yes, but I prefer to overweight the US stocks for many reasons brought forth by Jack Bogle. I just wanted to know if the diminishing number of stocks in the US is of any concern.
No, the number of stocks in the total US stock market is way more than enough to diversify away company specific risk.

As others have pointed out, if you compare sector weights for 100% US stocks to global sector weights, you are underweight in some sectors and overweight in others. If you compare to publicly traded US companies only, then you have market weight in all sectors, pretty much by definition.

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Re: Is the Total US Stock Market too concentrated?

Post by Valuethinker » Sun Jul 16, 2017 12:32 pm

alex_686 wrote:
jbolden1517 wrote:If you are trying to track market dominance you should be revenue weighting not cap weighting. If you are looking for market dominance margin adjusted you should be earnings weighting or a mix of the two. I'm not seeing how cap weighting achieves what you are claiming it does.
I think we are talking past each other. The OP wants to know what to do with the fact that there are fewer companies out there. I am telling him why there are fewer companies out there.

Free float market cap is the market's neutral position. I can't think of any obvious way to lean against this or if one even should. IT has dramatically increased scales of efficiency. More on this below.
tibbitts wrote:I think there is near-universal agreement that in the U.S. real estate is under-represented in the public equity markets. How to respond to that is more in dispute.

I also think it's always been a winner-take-all environment, but that process may be somewhat more efficient today than it was in the past.
Lets talk about scale for a moment.

First, real estate has always be underrepresented. Real estate is a local business. There is not a huge advantage in scale. FYI, I overweight REITs in my personal portfolio. The point here is that market structure has not changed.

Second, it has not always been a winner take all. Go back 30 years. GM was able to achieve a 33% market share but it could never crush it rivals. O.K., maybe Chrysler, that was more of the fault of foreign completion. Go industry by industry and rarely would you find a single company getting more than 50%. Partly it was a question of scale, partly one of anti-trust. Today is different. The idea is to create a industry standard and ecosystem, and then ride the network effect. Who are the direct competitors to Google or Facebook?
Google and Facebook are the direct competitors to Facebook and Google ;-). And there's Amazon & Apple, which are also competitors with them (and co-opitors)-- particularly Apple.

We are getting into that world described so memorably in The Space Merchants (Cyril M. Kornbluth & Frederick Pohl) about a future world controlled by advertising agencies. Except it was a satire, and it's lost something of the humour of it as the world has evolved in that direction. But one of the great works of 1950s Science Fiction.

https://www.fantasticfiction.com/k/c-m- ... chants.htm

Kornbluth had been a GI in the Ardennes Forest (Battle of the Bulge) hauling a Browning 0.50 calibre machine gun (big and heavy, not really a man portable weapon) in freezing cold weather. It damaged his heart. He died, tragically aged only 39, of a heart attack. A great talent snuffed out far too soon -- see novels like The Syndic and Not this August (the description of the battle in winter in the New York forest between American guerillas and a Russian MVD (KGB) division could only have been written by someone who had fought in a battle like that, I still feel a chill rereading it)-- or many fantastic short stories.

On the paper between the carbons on the typewriter he worked on, he scrolled ideas for new stories, including one "Ghosts in a Martian Department Store"-- we shall never get to read that story.

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Re: Is the Total US Stock Market too concentrated?

Post by nisiprius » Sun Jul 16, 2017 12:55 pm

jbolden1517 wrote:...I would agree with you that TSM is a special portfolio. Deviations from TSM do need to be justified. The burden of proof is on the people doing the justifying. I think they have easily met that burden, what they argued 20 years ago proved true (though a bit mistimed)...
Good. We are in agreement about how to frame the question.

That's exactly the mental framework simplesauce needs to have.

And while I agree that there are rational arguments for departing from Total Stock Market, being "too concentrated" isn't one of them.
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Re: Is the Total US Stock Market too concentrated?

Post by Boogieknight » Sun Jul 16, 2017 1:05 pm

Funny to see this thread. I read it last night and will catch up with the recent posts in a minute. But I wanted to first say, late last week and early the week just ending. I sold 20% of the VTI in 3-4 of my portfolios and used it to buy RSP. RSP is an ETF that is equal-weighted in the S&P 500. 1/500th for Facebook, 1/500th for Cliffs, etc. I even shot off an email to my brothers recommending they do likewise. I really felt a little nervous about having 10% of my equity devoted to App, Facebook, etc., the FANGS. Similar IPOs like SNAP are faltering badly, which seems like the proverbial canary in a coalmine. RSP has a .4% ER which I wish was smaller. Does anyone know of a cheaper, equal weighted ETF?

Now I'm gonna backtrack 18 hours and read the posts. I'm really glad this topic came up.

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Total World or Total Stock plus Total International?

Post by Taylor Larimore » Sun Jul 16, 2017 1:08 pm

I still don't like Vanguard Total World Stock index but its much much better than just TSM as the core or a portfolio.
Bogleheads:

When I designed The Three-Fund portfolio I carefully considered using Vanguard Total World Stock Index fund thereby eliminating one fund. I decided it was better to separate U.S. stocks and U.S. international stocks into two funds. This reply I posted on the first page of The Three-Fund Portfolio explains:
I have considered simplifying The Three Fund Portfolio to a Two Fund Portfolio (Total World + Total Bond Market). However, keeping Total U.S. Stock Market and Total International Stock Market separate has several advantages (edited 4-21-2017)

Usually lower Fund/ETF Expense Ratios: Total Stock Market (VTSAX & VT) = .05%; Total International (VTIAX & VXUS) = .11%; Total World (VTWSX = .21%; VT = 0.11%).

Lower Turnover (hidden cost): Total Stock Market = 4.0%; Total International = 3.1%; Total World = 14.8%

Tax Efficiency (5 years): Total Stock Market =.56; Total International = 1.09; Total World = .82

Better diversification (lower risk): Total U.S. Stock Market and Total International (combined) hold 9,773 stocks. Total World holds 7,774.

More U.S. stocks: Total World contains approximately 53% U.S. stocks. Many authorities, including Mr. Bogle, believe this is inadequate for U.S. investors.

Flexibility: The ratio between U.S. Total Stock Market and Total International is flexible for investors wherever they live in the world or whatever their desire.

Admiral Shares: Unlike Total Stock Market and Total International, Total World has no Admiral shares.
Best wishes.
Taylor
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Re: Is the Total US Stock Market too concentrated?

Post by BuyAndHoldOn » Sun Jul 16, 2017 1:11 pm

alex_686 wrote:
simplesauce wrote:This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.
Could you explain this a bit more? What sectors do you think are being under weighted?

Here is my take. For the past 20 to 30 years the market has undergone a structural change. It favors large companies over smaller companies. A winner takes all. Work you way down the list of companies held and you will find companies that dominate their respective market, or are transnational companies that benefit from scale, or both. It is a winner takes all environment.

That is the market we live in today. Going international is not going to help you that much since the same trend is happening in both developed and emerging markets.

(this is more of an aside than a response to anything above)

Karl Marx predicted as much. His analysis is not perfect (Far from it), but he did get many things right about Capitalism.

However, Xerox was once a really big company. So was Kodak. Disruption due to technology is not something easily forecasted, although now with the Big Technology companies being disruptors, maybe large companies are are still going to dominate every industry (even the future industries we don't know exist yet).

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Re: Is the Total US Stock Market too concentrated?

Post by beardsworth » Sun Jul 16, 2017 1:29 pm

This is a Larry Swedroe column, published last month, about "What Fewer Stocks Mean."

http://www.etf.com/sections/index-inves ... tocks-mean

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Re: Is the Total US Stock Market too concentrated?

Post by celia » Sun Jul 16, 2017 1:30 pm

The paper referenced near the beginning has a good analysis of what the OP is observing. I think this statement sums it up:
Mergers and acquisitions (M&A) are the leading reason for delisting, and initial public offerings (IPOs) are the primary source of new listings. In the last decade, M&A has flourished while IPOs have floundered.
http://www.cmgwealth.com/wp-content/upl ... 753661.pdf

New companies are waiting longer before they IPO than in the past. There is some SEC requirement that once (tbd) individuals hold shares of the company, then it must go public. So the tech companies who gave their employees early shares in the company, can only do that for so many years.

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 1:32 pm

alex_686 wrote:
jbolden1517 wrote:If you are trying to track market dominance you should be revenue weighting not cap weighting. If you are looking for market dominance margin adjusted you should be earnings weighting or a mix of the two. I'm not seeing how cap weighting achieves what you are claiming it does.
Free float market cap is the market's neutral position. I can't think of any obvious way to lean against this or if one even should. IT has dramatically increased scales of efficiency. More on this below.
I gave you 3 ways to do this. Revenue weighting (Oppenheimer, Schwab ETFs have this) or Earnings weighting (WisdomTree has ETFs that do this) or some mix. In terms of why you should, your entire argument is phrased in terms of the volume of sales and profits not the available float. Using cap weighting you are implementing a float based algorithm: sell X if my share of the float for X is above Y+, buy if my share of the float of X is below Y-. If for example your concern were purely revenue then your algorithm would be: buy stock X if my share of X's revenue is below Y-, sell stock X if my share of X's revenue is above Y+. That's a buy sell algorithm much more in keeping with your theory.

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Re: Is the Total US Stock Market too concentrated?

Post by Simplegift » Sun Jul 16, 2017 1:57 pm

jbolden1517 wrote:If you are trying to track market dominance you should be revenue weighting not cap weighting.
This is an interesting point. Although, I'm fairly sure that many U.S. equity investors would be shocked to see how little exposure to the U.S. they have when considering the revenue breakdown of the global portfolio — and how much exposure to emerging markets.
  • Image
    Source: MSCI, as of 6/30/14.
We had a good Forum discussion on this topic a few years ago: International Stock Diversification: A New Look
Cordially, Todd

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Re: Is the Total US Stock Market too concentrated?

Post by Phineas J. Whoopee » Sun Jul 16, 2017 9:57 pm

If, in terms of stocks, the US Total Stock Market is too concentrated and bad, setting aside international stocks because that wasn't your original question, then there must be some other US stock allocation that's less concentrated and better.

US stock market participants, wherever they're located, in aggregate own the US stock market in its cap-weighted sense. It's impossible for it to be otherwise. There's nobody else to own US stocks, and US stocks all must be owned by market participants. That's it.

What external-to-the-market allocation represents the proper weighting of US stocks if the market allocation doesn't? Answer that question telling us why and maybe we'll be able to to have a rational conversation about it.

PJW

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 10:33 pm

Phineas J. Whoopee wrote:US stock market participants, wherever they're located, in aggregate own the US stock market in its cap-weighted sense. It's impossible for it to be otherwise.
That's both false and not impossible at all. For example shorting is getting quite popular now because of the prevalence of options. Which means for many stocks the broad market participants own something like 105-120% for many individual stocks making up the market. That is unless you want to count puts as diluting ownership in which case TSM isn't tracking the market because it isn't tracking the cap weighting of various options. This of course would also require frequent trading for the index as the percentage of a stock an option counts as varies with the price of the stock.

More importantly in the context of indexing, control investors both create and destroy float. The company itself can hold its own shares, create them and destroy them. That stock can be held by genuine participants (individual stock investors, pension funds, mutual funds) arbitrage investors who are using the stock as a component of a market neutral device (and thus not "holding the stock" in the CAPM sense) or synthetic investors that exist to allow the company to declare floats at variance with market holdings (parent companies, child companies, investment banks...).

I get where you are coming from. Its like the joke about a spherical horse on a frictionless planet. When indexing played a small role in the market it was fine to remove the complexities of arbitrage and control investors. For the SP500 at this point index style buys and arbitrage are 6/7ths of the market activity. There isn't much non-index (including quasi indexing) non-control non-arbitrage float left. You gotta start dealing with the reality that the horse ain't spherical and earth has an atmosphere. The players that effect index returns now are not active mutual funds.

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Re: Is the Total US Stock Market too concentrated?

Post by patrick » Sun Jul 16, 2017 11:32 pm

jbolden1517 wrote:
Phineas J. Whoopee wrote:US stock market participants, wherever they're located, in aggregate own the US stock market in its cap-weighted sense. It's impossible for it to be otherwise.
That's both false and not impossible at all. For example shorting is getting quite popular now because of the prevalence of options. Which means for many stocks the broad market participants own something like 105-120% for many individual stocks making up the market. That is unless you want to count puts as diluting ownership in which case TSM isn't tracking the market because it isn't tracking the cap weighting of various options. This of course would also require frequent trading for the index as the percentage of a stock an option counts as varies with the price of the stock.


Each option has two sides. If those who use options to go long in the underlying stock count as owning 5% to 20% of it, then those on the other side of those options should count as owning -5% to -20% of it. In the aggregate the options add up to zero.

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Sun Jul 16, 2017 11:52 pm

patrick wrote: Each option has two sides. If those who use options to go long in the underlying stock count as owning 5% to 20% of it, then those on the other side of those options should count as owning -5% to -20% of it. In the aggregate the options add up to zero.
Counting the options as 0 is fine. But then you have a bunch of arbitrage people trading stocks so frequently as to be over 40% of all trades while not trying to achieve an optimal risk adjusted return on their stock sales. A huge collection of irrational actors contradicts efficient market and CAPM. If you count the options as having weight the arbitrage stock trades make sense to increase risk adjusted return but then the floats for stocks vary wildly with the price changes in the stock because the weight of the options changes. You get a contradiction whether you pick heads or tails.

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Re: Is the Total US Stock Market too concentrated?

Post by patrick » Mon Jul 17, 2017 12:12 am

jbolden1517 wrote:
patrick wrote: Each option has two sides. If those who use options to go long in the underlying stock count as owning 5% to 20% of it, then those on the other side of those options should count as owning -5% to -20% of it. In the aggregate the options add up to zero.
Counting the options as 0 is fine. But then you have a bunch of arbitrage people trading stocks so frequently as to be over 40% of all trades while not trying to achieve an optimal risk adjusted return on their stock sales. A huge collection of irrational actors contradicts efficient market and CAPM. If you count the options as having weight the arbitrage stock trades make sense to increase risk adjusted return but then the floats for stocks vary wildly with the price changes in the stock because the weight of the options changes. You get a contradiction whether you pick heads or tails.
Certainly one side of an option, by itself, doesn't count as 0 and it shouldn't be ignored if you are trying to add up the total position of an options trader. Certainly the options traders are trying to achieve something with their trades.

The 0 comes in when all the option positions are aggregated together. Suppose I write a call option which puts me at -0.00005% of the stock. If you buy the call option then you are at 0.00005% of the stock. Neither of us is at 0 individually, but together we add up to 0 in terms of this option. Including the option has no impact on the total float unless you decide to include only one side of the option in the calculation.

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Mon Jul 17, 2017 12:19 am

patrick wrote:
jbolden1517 wrote:
patrick wrote: Each option has two sides. If those who use options to go long in the underlying stock count as owning 5% to 20% of it, then those on the other side of those options should count as owning -5% to -20% of it. In the aggregate the options add up to zero.
Counting the options as 0 is fine. But then you have a bunch of arbitrage people trading stocks so frequently as to be over 40% of all trades while not trying to achieve an optimal risk adjusted return on their stock sales. A huge collection of irrational actors contradicts efficient market and CAPM. If you count the options as having weight the arbitrage stock trades make sense to increase risk adjusted return but then the floats for stocks vary wildly with the price changes in the stock because the weight of the options changes. You get a contradiction whether you pick heads or tails.
Certainly one side of an option, by itself, doesn't count as 0 and it shouldn't be ignored if you are trying to add up the total position of an options trader. Certainly the options traders are trying to achieve something with their trades.

The 0 comes in when all the option positions are aggregated together. Suppose I write a call option which puts me at -0.00005% of the stock. If you buy the call option then you are at 0.00005% of the stock. Neither of us is at 0 individually, but together we add up to 0 in terms of this option. Including the option has no impact on the total float unless you decide to include only one side of the option in the calculation.
OK now the guys short the option are dynamically selling or buying to keep their delta under control. From a CAPM perspective how do you describe their trades?

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Re: Is the Total US Stock Market too concentrated?

Post by patrick » Mon Jul 17, 2017 1:21 am

jbolden1517 wrote:
patrick wrote:
jbolden1517 wrote:
patrick wrote: Each option has two sides. If those who use options to go long in the underlying stock count as owning 5% to 20% of it, then those on the other side of those options should count as owning -5% to -20% of it. In the aggregate the options add up to zero.
Counting the options as 0 is fine. But then you have a bunch of arbitrage people trading stocks so frequently as to be over 40% of all trades while not trying to achieve an optimal risk adjusted return on their stock sales. A huge collection of irrational actors contradicts efficient market and CAPM. If you count the options as having weight the arbitrage stock trades make sense to increase risk adjusted return but then the floats for stocks vary wildly with the price changes in the stock because the weight of the options changes. You get a contradiction whether you pick heads or tails.
Certainly one side of an option, by itself, doesn't count as 0 and it shouldn't be ignored if you are trying to add up the total position of an options trader. Certainly the options traders are trying to achieve something with their trades.

The 0 comes in when all the option positions are aggregated together. Suppose I write a call option which puts me at -0.00005% of the stock. If you buy the call option then you are at 0.00005% of the stock. Neither of us is at 0 individually, but together we add up to 0 in terms of this option. Including the option has no impact on the total float unless you decide to include only one side of the option in the calculation.
OK now the guys short the option are dynamically selling or buying to keep their delta under control. From a CAPM perspective how do you describe their trades?
I'm not quite sure I'd call this the CAPM perspective, but here is what happens generally when someone has both an options position and a plain position in the same stock:

Before:

The guys short the option have A shares in the stock
The guys short the option have -B contracts in the option which have the same amount of exposure as -C shares in the stock
The guys on the other side of the option have B contracts in the option which have the same amount of exposure as C shares in the stock
Aggregate: A shares in the stock, zero in the option

After:

The guys short the option have F shares in the stock
The guys short the option have -D contracts in the option which have the same amount of exposure as -E shares in the stock
The guys on the other side of the option have D contracts in the option which have the same amount of exposure as E shares in the stock
The guys on the other side of the stock trade have A-F shares in the stock
Aggregate: A shares in the stock, zero in the option

The details of course matter for an individual trader. You'd have to figure out the equivalent stock exposure for the options to determine how well hedged they are. But it's not needed for the aggregate. A plain stock trade transfers shares without changing the total number. An options trade adds to the exposure on one side but subtracts the same amount on the other side, for a net change of zero. Changes in delta would mean a change in the exposure from an individual option, but it would have the opposite impact on the two sides of the option trade, for a net impact of zero on the aggregate position.

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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Mon Jul 17, 2017 6:49 am

patrick wrote: I'm not quite sure I'd call this the CAPM perspective, but here is what happens generally when someone has both an options position and a plain position in the same stock:

Before:

The guys short the option have A shares in the stock
The guys short the option have -B contracts in the option which have the same amount of exposure as -C shares in the stock
The guys on the other side of the option have B contracts in the option which have the same amount of exposure as C shares in the stock
Aggregate: A shares in the stock, zero in the option

After:

The guys short the option have F shares in the stock
The guys short the option have -D contracts in the option which have the same amount of exposure as -E shares in the stock
The guys on the other side of the option have D contracts in the option which have the same amount of exposure as E shares in the stock
The guys on the other side of the stock trade have A-F shares in the stock
Aggregate: A shares in the stock, zero in the option

The details of course matter for an individual trader. You'd have to figure out the equivalent stock exposure for the options to determine how well hedged they are. But it's not needed for the aggregate. A plain stock trade transfers shares without changing the total number. An options trade adds to the exposure on one side but subtracts the same amount on the other side, for a net change of zero. Changes in delta would mean a change in the exposure from an individual option, but it would have the opposite impact on the two sides of the option trade, for a net impact of zero on the aggregate position.
OK I think I see where we are disagreeing and it is a bit subtle. I'm going to make two half arguments in this post. Both of which are IMHO close analogies and I'll wait for your response to those analogies.

My opening question to you is this: Twenty years ago did Vanguard mutual funds own any stocks at all? Did their SP500 index fund trade stocks at all?

With that in mind let's start with an analogy. Alan has a $100 bill. He deposits that $100 bill at Ben's Bank. Ben takes the $100 and lends it Charlie. Charlie buys stuff from Dan. Dan puts the $100 bill in his pocket. Here is the accounting in terms of derivatives.

Alan is long $100 in a derivative called check deposits
Ben is short $100 in check deposits and long $100 in loan
Charlie is short $100 in loan
Dan has the $100 bill.

In the aggregate all the derivatives net out to 0 and the only thing that matters is the actual physical currency. Dan is the only person holding any money, Alan is just holding a derivative.

Now if we apply to Vanguard 20 years ago. Vanguard and Vanguard mutual funds were not a bank or stock holding company. Vanguard funds couldn't legally hold any stocks (stock certificates) at all. All they could hold were derivatives issued by banks, a derivative called "registered beneficial owner". The bank/holding company actually owned the stock. In such a model stock transactions aren't what was happening on the New York Stock exchange every day, they are just trading derivatives. The actual stock transactions were when the large holding companies and banks cleaned up their physical holdings by moving physical shares between them.

So yes you can 0 out derivatives like you are doing. But it fundamentally violates the concept of CAPM (especially 20 years ago) because the people who own stock and the people who care about their price and dividends are almost never the same.

I'll let you respond to this analogy. Because there are a couple different ways you could go.

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Re: Is the Total US Stock Market too concentrated?

Post by mptfan » Mon Jul 17, 2017 7:15 am

jbolden1517 wrote:Its like the joke about a spherical horse on a frictionless planet.
That's a classic!
:confused
I eat risk for breakfast. :)

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Re: Is the Total US Stock Market too concentrated?

Post by rkhusky » Mon Jul 17, 2017 10:26 am

simplesauce wrote:I've been learning more about how in the past 20 years, the US stock market has diminished in regards to the amount of publicly traded companies.

This might leave an investor who invests in 100% US stocks exposed to certain sectors and not adequately diversified.

Has John Bogle commented on this phenomenon? Has it changed his views? This might be a good reason to increase our allocations to international stocks.
Rather than look at the number of companies in a Total Stock fund to determine diversity, you should look at the percent of investable market cap that the fund contains. I see no reason not to invest in a Total International fund.

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Re: Is the Total US Stock Market too concentrated?

Post by patrick » Mon Jul 17, 2017 5:36 pm

jbolden1517 wrote:
patrick wrote: I'm not quite sure I'd call this the CAPM perspective, but here is what happens generally when someone has both an options position and a plain position in the same stock:

Before:

The guys short the option have A shares in the stock
The guys short the option have -B contracts in the option which have the same amount of exposure as -C shares in the stock
The guys on the other side of the option have B contracts in the option which have the same amount of exposure as C shares in the stock
Aggregate: A shares in the stock, zero in the option

After:

The guys short the option have F shares in the stock
The guys short the option have -D contracts in the option which have the same amount of exposure as -E shares in the stock
The guys on the other side of the option have D contracts in the option which have the same amount of exposure as E shares in the stock
The guys on the other side of the stock trade have A-F shares in the stock
Aggregate: A shares in the stock, zero in the option

The details of course matter for an individual trader. You'd have to figure out the equivalent stock exposure for the options to determine how well hedged they are. But it's not needed for the aggregate. A plain stock trade transfers shares without changing the total number. An options trade adds to the exposure on one side but subtracts the same amount on the other side, for a net change of zero. Changes in delta would mean a change in the exposure from an individual option, but it would have the opposite impact on the two sides of the option trade, for a net impact of zero on the aggregate position.
OK I think I see where we are disagreeing and it is a bit subtle. I'm going to make two half arguments in this post. Both of which are IMHO close analogies and I'll wait for your response to those analogies.

My opening question to you is this: Twenty years ago did Vanguard mutual funds own any stocks at all? Did their SP500 index fund trade stocks at all?

With that in mind let's start with an analogy. Alan has a $100 bill. He deposits that $100 bill at Ben's Bank. Ben takes the $100 and lends it Charlie. Charlie buys stuff from Dan. Dan puts the $100 bill in his pocket. Here is the accounting in terms of derivatives.

Alan is long $100 in a derivative called check deposits
Ben is short $100 in check deposits and long $100 in loan
Charlie is short $100 in loan
Dan has the $100 bill.

In the aggregate all the derivatives net out to 0 and the only thing that matters is the actual physical currency. Dan is the only person holding any money, Alan is just holding a derivative.

Now if we apply to Vanguard 20 years ago. Vanguard and Vanguard mutual funds were not a bank or stock holding company. Vanguard funds couldn't legally hold any stocks (stock certificates) at all. All they could hold were derivatives issued by banks, a derivative called "registered beneficial owner". The bank/holding company actually owned the stock. In such a model stock transactions aren't what was happening on the New York Stock exchange every day, they are just trading derivatives. The actual stock transactions were when the large holding companies and banks cleaned up their physical holdings by moving physical shares between them.

So yes you can 0 out derivatives like you are doing. But it fundamentally violates the concept of CAPM (especially 20 years ago) because the people who own stock and the people who care about their price and dividends are almost never the same.

I'll let you respond to this analogy. Because there are a couple different ways you could go.
I don't see anything subtle here. One side of the option is X. The other side is -X. Both sides care about the price (unless they''re hedged). The zero is the aggregate. It seems plain to me.

Regarding your question on Vanguard holdings, I would normally say that for all practical purposes they do hold the stock and the inner workings of the registration system are obscure technical details I don't need to worry about. I would not use the term "derivative" to describe the situation.

If you really want to label this as a derivative and list everyone's position, it actually does work out, and it doesn't lead to any difficult inconsistencies. If Vanguard buys 1000 shares, that would mean (with respect to those shares) the following 3 positions exist in this sort of analysis:

Nominal owner has a +1000 position by virtue of being the owner of record of the shares
Nominal owner has a -1000 position by virtue of the ownership arrangement requiring all the benefits of ownership to be given to Vanguard
Vanguard has a +1000 position by virtue of the ownership arrangement which entitles them to receive all the benefits of ownership

If you aggregate them all, the total number of shares coming from this is 1000, the same as if this arrangement did not exist. If you look at the net position of each participant, then you would see that the nominal owner has a net position of 0 while Vanguard has a net position of +1000. And since Vanguard (or more accurately the Vanguard fund) is the one with the nonzero net position, it is the Vanguard fund whose value depends on the price of the stock.

jbolden1517
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Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Mon Jul 17, 2017 5:52 pm

mptfan wrote:
jbolden1517 wrote:Its like the joke about a spherical horse on a frictionless planet.
That's a classic!
:confused


Quite true. Not sure what you are confused about. Unless you don't know the joke: https://en.wikipedia.org/wiki/Spherical_cow

jbolden1517
Posts: 868
Joined: Sun Jul 09, 2017 2:53 pm

Re: Is the Total US Stock Market too concentrated?

Post by jbolden1517 » Mon Jul 17, 2017 6:07 pm

patrick wrote: I don't see anything subtle here. One side of the option is X. The other side is -X. Both sides care about the price (unless they''re hedged). The zero is the aggregate. It seems plain to me.
So just to clarify you are saying that Alan isn't holding "money" in some generic sense. He's holding a derivative of currency and only currency matters. In other words you are disagreeing with the monetary theory. Do you at least agree that a large expansion of checkable deposits even without an expansion in currency can cause prices to rise (i.e. the price of currency to decline)?
patrick wrote: If you really want to label this as a derivative and list everyone's position, it actually does work out, and it doesn't lead to any difficult inconsistencies. If Vanguard buys 1000 shares, that would mean (with respect to those shares) the following 3 positions exist in this sort of analysis:

Nominal owner has a +1000 position by virtue of being the owner of record of the shares
Nominal owner has a -1000 position by virtue of the ownership arrangement requiring all the benefits of ownership to be given to Vanguard
Vanguard has a +1000 position by virtue of the ownership arrangement which entitles them to receive all the benefits of ownership
Vanguard (again of 20 years ago) doesn't own any shares. They own a derivative. The above should be:
Nominal owner has +1000 shares of stock X
Nominal owner has -1000 registrations on X
Vanguard has +1000 registrations on X.

Registrations on X happen to have the same return as the dividends of X (minus a very small ER). People on the NYSE are willing to trade registrations. As the clients trade registrations the banks/holding companies buy and sell stocks from one another to remain close to market neutral. The banks/holding companies are holding a pair of assets that together generate a tiny return and whose only expense is some administration. You are balking at thinking this way and that's good. You are balking for all the right reasons. But these analogies get to the heart of the problem of treating derivatives like they didn't exist.

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