Malkiel on stock market concentration

[asset_chaos]

Given the several recent threads on stock market concentration, I had not seen discussion of this recent opinion piece in the wall street journal by Burton Malkiel, Indexing Is Still the Best Bet for Investors that addresses these concerns of stock market concentration. Selected quotes from the article:

Many [active fund managers] have lately argued that simple indexing is a bad strategy in today’s environment because the stock market is dangerously “narrow.” Seven stocks—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla—constitute close to 20% of the S&P 500’s value and have been responsible for almost 90% of the index’s gains this year. ... The simple index investor, the active managers warn, will soon be overly concentrated in a small number of stocks that are overpriced ...

This argument is wrong. Indexing a stock portfolio through a low-cost fund remains the best way to participate in the stock market.

Malkiel explores similarities of today's valuations and concentration with those of the late 1990s and it's aftermath, the tech wreck,

Index investors got banged up. Tech stocks got crushed.

But did indexing really fail? The evidence suggests it didn’t. From 1990 to 2009, ..., a broad U.S. stock market index fund outperformed the average actively managed equity fund by almost 1% a year.

Certainly there are some similarities today to the economic environment of the dot-com era of the late 1990s. Technological innovation promises to transform our economy. ... There is no doubt that U.S. equities are richly valued in part because of the promise of AI. ... It may be that hype over the promise of AI has inflated these multiples to unwarranted heights. But it is also possible that they simply reflect the enormous potential of AI to transform the way the world’s work is done.

Malkiel asks if rich valuations means the market is no longer efficient.

The basic idea of efficient markets isn’t that prices are always correct. In fact, they are always wrong. What efficiency implies is that information is reflected in prices without delay. And the current tableau of market prices reflects the combined judgment of hundreds of thousands of investors, including those of the research departments of the most influential firms on Wall Street—as well as the galaxy of active managers who run mutual funds and institutional portfolios.

He concludes,

It isn’t impossible to beat the market. But if you go active, chances are you’ll underperform. Years of evidence in a variety of market environments confirms the wisdom of indexing. And if you do decide to alter your portfolio from market weightings, you can do so with much less risk if your active bets are made around a core portfolio that is broadly indexed.

Malkiel didn't use the phrase, stay the course, but I think he means pretty much just that.

[chassis]

Given the several recent threads on stock market concentration, I had not seen discussion of this recent opinion piece in the wall street journal by Burton Malkiel, Indexing Is Still the Best Bet for Investors that addresses these concerns of stock market concentration. Selected quotes from the article:

Many [active fund managers] have lately argued that simple indexing is a bad strategy in today’s environment because the stock market is dangerously “narrow.” Seven stocks—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla—constitute close to 20% of the S&P 500’s value and have been responsible for almost 90% of the index’s gains this year. ... The simple index investor, the active managers warn, will soon be overly concentrated in a small number of stocks that are overpriced ...

This argument is wrong. Indexing a stock portfolio through a low-cost fund remains the best way to participate in the stock market.

Malkiel explores similarities of today's valuations and concentration with those of the late 1990s and it's aftermath, the tech wreck,

Index investors got banged up. Tech stocks got crushed.

But did indexing really fail? The evidence suggests it didn’t. From 1990 to 2009, ..., a broad U.S. stock market index fund outperformed the average actively managed equity fund by almost 1% a year.

Certainly there are some similarities today to the economic environment of the dot-com era of the late 1990s. Technological innovation promises to transform our economy. ... There is no doubt that U.S. equities are richly valued in part because of the promise of AI. ... It may be that hype over the promise of AI has inflated these multiples to unwarranted heights. But it is also possible that they simply reflect the enormous potential of AI to transform the way the world’s work is done.

Malkiel asks if rich valuations means the market is no longer efficient.

The basic idea of efficient markets isn’t that prices are always correct. In fact, they are always wrong. What efficiency implies is that information is reflected in prices without delay. And the current tableau of market prices reflects the combined judgment of hundreds of thousands of investors, including those of the research departments of the most influential firms on Wall Street—as well as the galaxy of active managers who run mutual funds and institutional portfolios.

He concludes,

It isn’t impossible to beat the market. But if you go active, chances are you’ll underperform. Years of evidence in a variety of market environments confirms the wisdom of indexing. And if you do decide to alter your portfolio from market weightings, you can do so with much less risk if your active bets are made around a core portfolio that is broadly indexed.

Malkiel didn't use the phrase, stay the course, but I think he means pretty much just that.

And your take is…?

[Gaston]

The basic idea of efficient markets isn’t that prices are always correct. In fact, they are always wrong. What efficiency implies is that information is reflected in prices without delay.

I have a lot of respect for Dr. Malkiel’s interpretation of the Efficient Market Hypothesis which, as reflected in the above quote, suggests that markets quickly absorb all new information. Some academics contend that this phenomenon tends to drive correct pricing, but even when it does, there’s no way to know which prices are correct and which are incorrect.

Will there be another sharp, dot.com-like market decline one day? Of course there will. Markets periodically crash for various reasons and will do so again. Will active managers navigate those crashes better than an index fund? There’s no evidence to suggest they will.

[Mr. Buzzkill]

I’m convinced indexing works and it’s the best chance (not 100 percent guarantee) of the average investor to do no worse than the index followed.

That’s what’s it’s designed to do. Not fund comfortable retirement, not make one rich.

Market concentration is a fact of life for every successful diversified portfolio of equities. Not every stock in an index goes up or down by the same percentage.

But the goal is a successful portfolio, not a successful stock, mutual fund, or ETF. That’s why rebalancing is good, to reduce concentration of a portfolio, rather than just that of an index.

[calmaniac]

Certainly there are some similarities today to the economic environment of the dot-com era of the late 1990s. Technological innovation promises to transform our economy. ... There is no doubt that U.S. equities are richly valued in part because of the promise of AI. ... It may be that hype over the promise of AI has inflated these multiples to unwarranted heights. But it is also possible that they simply reflect the enormous potential of AI to transform the way the world’s work is done.

asset_chaos, thanks for these highlights. Great quote on efficient markets.

This market does not "feel" like the dot com bubble. Back then, I remember many casual conversations discussing the amazing returns of the market. That doesn't mean there is not some overvaluation, but doesn't seem as crazy as 1999.

[burritoLover]

The real question is how concentrated are you? If you only invest in the S&P 500, then you are already taking on a high amount of risk regardless, even if the stocks at the top happened to be the least concentrated in history.

[RationalWalk]

Rebalancing actually isn't "good," because it actually represents contrarian investing; i.e., that you know more than the market when the market has re-priced stocks. It might be "good" because you're aligning your asset allocation with your investment policy but not because you have some idea you'll make more money because of it. Bogle showed us a long time ago that rebalancing doesn't actually accomplish that over the long run.

[Valuethinker]

Certainly there are some similarities today to the economic environment of the dot-com era of the late 1990s. Technological innovation promises to transform our economy. ... There is no doubt that U.S. equities are richly valued in part because of the promise of AI. ... It may be that hype over the promise of AI has inflated these multiples to unwarranted heights. But it is also possible that they simply reflect the enormous potential of AI to transform the way the world’s work is done.

asset_chaos, thanks for these highlights. Great quote on efficient markets.

This market does not "feel" like the dot com bubble. Back then, I remember many casual conversations discussing the amazing returns of the market. That doesn't mean there is not some overvaluation, but doesn't seem as crazy as 1999.

More like the Nifty Fifty? Early 1970s?

Lots of macroeconomic and political-economic uncertainty. "Flight to safety".

"One decision" stocks that always grew their earnings. Selling for very high PEs. Except then the market revalued them downwards - they weren't quite so foolproof as we thought.

We have seen, with Meta, what happens when they disappoint. Both the earnings expectations are downgraded, *and* the PE ratio (the market's valuation of those future earnings) falls. (OTOH Meta has now recovered quite a lot of that lost ground?).

That is where we are with the big 6-7 tech stocks (including Tesla) I think. They have to not disappoint on earnings expectations to keep their share prices where they are. Digital advertising has to keep growing, their market dominance has to be retained or grow. Those stocks are priced for perfection.

(Counterpoint, I saw some good analysis that much of US corporate is really struggling, but a layer of companies is golden - manageable debt to equity ratios, good margins, profits rising. The Big 6/7 will be in that latter category. Meanwhile the sharp rise in interest rates is feeding through to general corporate earnings).

And my sense there is a "wall of money" that is in stocks because it doesn't have anywhere else to go. Which means it is not sticky.

[RationalWalk]

Certainly there are some similarities today to the economic environment of the dot-com era of the late 1990s. Technological innovation promises to transform our economy. ... There is no doubt that U.S. equities are richly valued in part because of the promise of AI. ... It may be that hype over the promise of AI has inflated these multiples to unwarranted heights. But it is also possible that they simply reflect the enormous potential of AI to transform the way the world’s work is done.

asset_chaos, thanks for these highlights. Great quote on efficient markets.

This market does not "feel" like the dot com bubble. Back then, I remember many casual conversations discussing the amazing returns of the market. That doesn't mean there is not some overvaluation, but doesn't seem as crazy as 1999.

More like the Nifty Fifty? Early 1970s?

Lots of macroeconomic and political-economic uncertainty. "Flight to safety".

"One decision" stocks that always grew their earnings. Selling for very high PEs. Except then the market revalued them downwards - they weren't quite so foolproof as we thought.

We have seen, with Meta, what happens when they disappoint. Both the earnings expectations are downgraded, *and* the PE ratio (the market's valuation of those future earnings) falls. (OTOH Meta has now recovered quite a lot of that lost ground?).

That is where we are with the big 6-7 tech stocks (including Tesla) I think. They have to not disappoint on earnings expectations to keep their share prices where they are. Digital advertising has to keep growing, their market dominance has to be retained or grow. Those stocks are priced for perfection.

(Counterpoint, I saw some good analysis that much of US corporate is really struggling, but a layer of companies is golden - manageable debt to equity ratios, good margins, profits rising. The Big 6/7 will be in that latter category. Meanwhile the sharp rise in interest rates is feeding through to general corporate earnings).

And my sense there is a "wall of money" that is in stocks because it doesn't have anywhere else to go. Which means it is not sticky.

So, where does this "wall of money" go when it unsticks? I want to get there first.