Murray Stahl (Trades, Portfolio) of Horizon Kinetics just came out with another market commentary and calls a momentum bubble. It is the second in his series: Under The Hood. I have also discussed the first one on GuruFocus.
I follow Stahl's writing like a hawk as it is always extremely interesting, often actionable and incredibly concise and clear. It doesn’t appear as if he is talking about his own book, but that could be because his holdings are quite differentiated. In this "Under The Hood" series, Stahl takes aim at the ETF industry. This is a great example of his integrity as Horizon Kinetics, which is critical to his wealth, actually manages several ETFs. Stahl has refused to jump on the bandwagon of selling every ETF that can be sold based on back tested positive results, but instead exploits a number of niche ETFs built around interesting and sustainable ideas, like the wealth indexes.
Because he is actually an industry insider, he is extremely knowledgeable about this industry and over the past few years has talked about its systemic flaws at almost every opportunity. If there is a ETF crash, he should definitely be celebrated as an expert who saw it coming. I highly recommend reading the entire commentary, but I’ll highlight what stands out to me.
In this particular issue, Stahl talks about how the S&P 500’s performance is entirely driven by a few stocks. After doing the math, only 10 stocks are responsible for the positive performance of the S&P 500, while their total weight in the index is just 13%.
Stahl suggests in his commentary that this phenomenon is tied to the advent of momentum ETFs. At the core of his argument sits this paragraph (emphasis mine):
So, it is now possible to raise substantial sums for almost any index if the performance is sufficiently high. It is nearly impossible to raise money for any index if the return is insufficiently high, let alone if it happens to be negative. If diversification, efficiently provided, were really the objective of the indexation industry, a period of negative performance would simply mean that the investment in question would have a lower weight. If asset allocation is the objective, the rebalancing process would ensure some degree of equilibration: underperforming assets would experience inflows in order to restore previously established weightings; dramatically outperforming assets would likewise be rebalanced for the same reason. This was the historical practice. The current environment is precisely the opposite.
Although, I do not buy the argument the market is dislocated because of momentum ETFs, these appear to be just a symptom of this trend, and this general trend does explain the difficulties experienced by the value investor community at large. Many gurus have been complaining about dislocated markets and having to endure difficult periods for the value style. Usually this is chalked up to the market being “irrational” and the investor reiterates how he is going to persevere in the end. Einhorn has a short basket of overvalued momentum stocks. Many others also have the track records to make that a credible argument, but Stahl’s commentary adds something else: an explanation of why value is lagging growth over the past few years.
Indexation leads to money flowing to the strategies that have been performing well in the recent past, which in turn leads to better performance as the ETFs bid up these shares and the virtuous cycle continues with additional investors converting to ETF investing. Stahl ends with an eery paragraph (emphasis mine):
One would do well to remember that this state of affairs is not a new phenomenon in investing. In prior eras, it was known as go-go investing, or trend following. Now it takes the guise of index-based asset allocation. All such phenomena have ended unpleasantly. The index universe has become, simply, a big momentum trade. It is the most crowded trade in the history of investing. And crowded trades eventually attract short sellers.
