The proliferation of the no-thought required approach to investing (index investment) along with other quantitative and algorithmic based strategies has created some disturbing cross-currents for the dwindling group of fundamental investors.
Here J.P. Morgan (via Zerohedge) estimates that only 10% of trading volume originates from fundamental discretionary investors.
That is a truly stunning statistic
If 90% of the volume in stocks is driven by value-agnostic investors, the obvious implication that we see is bigger booms and much bigger busts that are far removed from underlying fundamentals.
To avoid the emotionally draining roller coaster of a bigger boom and bust cycle, we would counsel a goals-based approach to investment, where future liabilities (retirement income, kids’ college, charitable goals) are the priority. Those who instead choose to chase an arbitrary benchmark with a handful of the market’s most expensive stocks in the driver’s seat better mentally prepare themselves now for the intense pain that a high-speed crash can bring.
First, some striking facts: to understand this market transformation, note that Passive and Quantitative investors now account for ~60% of equity assets (vs. less than 30% a decade ago). We estimate that only ~10% of trading volumes originates from fundamental discretionary traders. This means that while fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock-specific fundamentals.
The next, and perhaps just as important driver is, of course, central banks: “With ~$2T asset inflows per year central bank liquidity creates strong interest rate and policy sensitivity for sectors and styles. Low rates also invite investors to sell volatility.”
Discussing the recent shift in market correlations, which have become increasingly volatile, Kolanovic notes that their “interpretation has changed.” According to the JPM quant, historically, low correlation meant that stocks were driven by company-specific fundamentals – an environment in which fundamental investors thrive. Now, however, while correlations are low, it is for different reasons – large sector and style rotation driven by quant flows, monetary policy and political developments (e.g. growth-value, low volatility-high volatility, ‘Trump trade’ and its unwind), something we have repeatedly demonstrated over the past month courtesy of the work of RBC’s Charlie McElligott.
Jeremy Jones, CFA
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