Market Failure - JAck Bogle's "Chaos and Catastrophe"
“The true investor... will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies" - Jack Bogle
“Over the short run, however, the fundamentals are often overwhelmed by the deafening noise of speculation -
the price at which the stock market values each dollar of earnings” - Jack Bogle
“Buying funds based purely on their past performance is one of the stupidest things an investor can do” - Jack Bogle
The big three - Vanguard, State Street, and BlackRock - control 30% of the US stock market, which Bogle believes gives them effective control:
“Public policy cannot ignore this growing dominance, and consider its impact on the financial markets, corporate governance, and regulation.... I do not believe that such a concentration would serve the national interest. That might leave a power vacuum, leaving corporate chieftains unacccountable" - interview with Jack Bogle - Money, Sergei Klebnikov - November 30, 2018.
"If everybody indexed, the only word you could use is chaos and catastrophe, the markets would fail" - Jack Bogle 5/6/17
"Chaos and catastrophe."
Passive and quantitative investment vehicles (80%+ of the market) have no idea that there IS a "real economy" and that "real lives" are being impacted. They have no idea that we are in a bubble and depression simultaneously. They see price movement and money flows.
Without active managers setting prices, the market ecosystem has lost a vital predator required for it's survival.
We are living in an ecosystem out of equilibrium, where failing companies that consistently dilute shareholders have been rewarded with higher stock prices. Why? Without a critical mass of active managers to adjust valuations for dilution, share issuance has had the perverse effect of actually increasing the market capitalization of issuing companies in a feed-back loop. The inflated market cap attracts trend-following quantitative funds, passive indexes allocate a larger share of investment to companies, and momentum ensues. Active managers, who are overwhelmed by these flows, have not been rewarded for taking idiosyncratic security risk and have clung to the index in fear.
Jack Bogle was an investment icon. He was a leader who dared to be different. Index investing revolutionized the investment industry. He deserves our thanks and respect. But the market runs in long cycles, and we believe this cycle has run its course. Passive indexing, combined with Fed manipulation of the market mechanism, have gone too far. We believe the Fed is abusing it's power and using indexing (a great idea) as a policy tool to provide cheap, unaccountable, financing to US companies. The end result is a misallocation of resources and slower growth in the "real economy."
The Fed is now trapped at the lower bound (0% interest rate).
The current monetary system (US > 60% of global reserves), requires a credible kingpin. The coronavirus and excessive money printing by the Fed are dampening this credibility. Foreigners have become net sellers of U.S. bonds. The Fed needs to print money to avoid an unsustainable spike in interest rates. We believe that the Fed de facto nationalized the REPO market, now they are buying corporate bonds to avoid price discovery in the bond market and maintain control of the market mechanism. They are in a battle with basic economics, finance, and math.
Irrational behavior is being rewarded. Fed policy has structurally altered our capital markets and is directly responsible for a decade of no growth in the"real economy". Our markets are failing.
"The World Turned Upside Down." - Fellow Wesleyan Alum, Lin-Manuel Miranda - Hamilton
Each time we find ourselves defaulting to the conventional wisdom that markets are smart and efficient, we need to stop and remind ourselves exactly who controls the market: a large concentration of passive indexes and trend following quantitative funds. In order to start growing the "real economy" again, we need asset allocators to allocate capital based on fundamentals again, and not past price movements from an irrational market.
Here are the recent numbers of a well-known online consumer discretionary company.
Market Cap - $31 Billion (8/19/20)
Debt - $2.5 Billion.
(in $billions) 2019 2018 2017 2016 2015
- Revenue $9.1 $6.7 $4.7 $3.4 $2.3
- Pre-tax loss -$.981 -$.502 -$.244 -$.194 -$.077
- Share count 92.2 89.5 87.0 85.0 83.7
- Share equity -$.944 -$.330 -$.048 $.079 $242
This company has generated accelerating losses. Without cheap financing, the company would be insolvent. The chart on the right shows insiders selling, which appears as the long list of red on the bottom.
Notice the growth in share count: most recent Q2 '20: 94.8 million shares.
There are no analysts at a passive investment firm, therefore no one adjusts for dilution. So dilution actually increases the market capitalization. The increased market cap, attracts Quants, momentum ensues. It's a simple market failure and a misallocation of resources.
