Unconventional wisdom: What if the market never goes down?
More market resiliency after another quick rebound.
Mentioned: Diageo PLC ADR (DEO)
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. The more different you are from the person that defined a rule the less you should follow the rule. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: What if the market never goes down?
“The trend is your friend.”
- Martin Zweig
What if the share market never goes down? I’m being serious. There might be some bad days and months. A negative year thrown in there. But what if we never have a multi-year, soul crushing bear market? What if we don’t have terrible decades like the 2000s or 1970s?
What other conclusion can you draw from recent market history?
We had a global pandemic that shut down at least parts of the global economy for years. The market dropped for a couple months.
We experienced a surge of inflation not seen in decades and the fastest interest rate rise in history. There was a short bear market in the US. Barely a blip in Australia.
We are going through the start of the Trump presidency which I will generously describe as chaotic and threatening to the existing global economic order. The market is up for the year on May 16th.
Ever since the global financial crisis the market has shown a surprising level of resiliency. Why? I think there are several reasons:
- The rise of passive
- Slim pickings
- Big bad super
- HODL
- Crony capitalism
The rise of passive
The rise of passive means that investors have trimmed the branches of the investing decision tree. Once somebody decides to invest there is no need to agonise over which investment to buy. Just dump money into the ‘market’.
Passive investing doesn’t make the market go up. Passive investors can just as easily sell. Yet the combination of passive and market capitalisation weighted indexes funnels more money into the largest companies.
Passive can reinforce other trends that benefit the largest companies. When the big companies do well passive investors do well. That encourages more people to invest because when you cut through the hyperbole about markets people chase returns.
Slim pickings
In major share markets around the world the number of publicly listed shares is dropping. According to the AFR the total listed ASX shares and funds is at the lowest level since 2006.
In 1996 the US had 7,000 publicly traded companies. By 2020 there were less than 4,000.
The reasons for this drop are well documented. Given the robust funding available to private companies there is less of a need to list. Couple that with more stringent regulations for publicly traded companies and you get an IPO drought.
Private Equity buyouts have thinned the herd of listed companies and mergers and acquisitions have swallowed up smaller companies as markets are increasingly dominated by global giants.
Less supply is good for shares as the remaining listed companies get a larger proportion of each dollar flowing into the market. Buyouts also put money in investor’s pockets which is often ploughed back in. I’ve experienced that myself in the past few years as two of my former holdings in InvoCare and Bingo were acquired.
Big bad super
The super system in Australia is currently the 4th largest in the world. Not bad for a county with under 27 million people. Even more impressive the Super Members Council is projecting Australia will overtake the UK and Canada by 2031 to rise to second place behind the US.
The giant super funds are allocating more to private assets and have largely outgrown local markets. However, super is still growing and more money flows into the Australian market every year. That supports share prices.
The poster child for this phenomenon Is CBA. Almost every investment professional I hear from thinks CBA is wildly overvalued. It is the most expensive bank in the world. Our own analyst Nathan Zaia thinks it is 70% overvalued. Yet the shares keep going up. Big super is often cited as the catalyst.
HODL
The acronym HODL stands for hold on for dear life. It entered the wider vernacular thanks to Keth Gill, a.k.a ‘Roaring Kitty’ who captivated markets during the GameStop saga in 2021.
The abbreviated story is that Gill and his legion of online followers executed a short squeeze on GameStop shares and forced several hedge fund and institutional investors to cover their shorts. The shares skyrocketed.
The merits of GameStop as an investment aside the episode demonstrates the simple notion that if nobody sells share prices won’t go down. Gill was posting in the subreddit WallStreetBets. That is one of the many social media channels where investors gather.
I follow several of these channels and after every drop in the market the posts come pouring in exhorting people to buy. Is this a collective act of delusion? An online support system encouraging good behaviour? Probably a little bit of both. But it seems to be working.
The AFR reported record trading volume of retail investors buying shares and ETFs on April 3rd, 4th and 7th as markets plunged in the face of the tariff announcement. Many retail investors have embraced this mentality of meeting each drop with more buying. And retail investors are more important than ever.
According to Science Direct retail trade volume in the US increased from 10% in 2010 to 23% in 2021. There are many reasons for this. Barriers have dropped with brokerage costs dropping and the advent of fractional share trading. There was the surge of interest in investing during the tedium of the pandemic. There is the strong performance of markets and investor’s penchant for recency bias.
The influence of retail investors still trails professionals significantly. But in any market the changes along the margin drive performance. Retail investors just may be the force that is stemming any prolonged fall.
Crony capitalism
Globally there are many signs that the level of competitiveness in the economy is dropping. There is greater concentration in many industries globally and signs of lower business formation. Australia is the perfect example with duopolies in almost every major industry.
The reasons for declining competition are complicated. Decades ago there was a reinterpretation of anti-trust law that has led to lax enforcement. It is easier to scale businesses in the asset light modern economy.
There is the mutually reinforcing cycle of increasing corporate power leading to more political influence which leads to more power. There is the current occupant of the White House who gleefully favours companies and industries that kowtow to him.
Competition is at the heart of free market capitalism. Companies compete for business by developing better products and services and by lowering prices. Neither of those things are good for investors. They mean lower margins and lower returns on invested capital.
While we should be concerned about the declining dynamism of the global economy there is little doubt this is beneficial to concentrated markets. Profit margins are up as demonstrated by the following chart that shows the profit margin for the S&P 500 since the mid-1960s. There are dips during recessions but the trend is clear.
Source DQYDJ
Returns have been strongest in the US and they have been driven by the largest companies. Things have not gone as well for the average company.
The following chart shows the performance (in AUD) of the iShares S&P 500 ETF (ASX: IVV) which tracks the market capitalisation weighted index and the BetaShares S&P 500 Equal Weighted ETF (ASX: QUS) since the start of 2015. It isn’t even close.
Source Morningstar Investor
What is good for the largest companies is good for markets. And things have been good for the largest companies.
Final thoughts
As the market keeps going up I feel like an obsolete curmudgeon shouting into the wind. Valuations matter! This time is not different! It doesn’t matter. People can see my mouth moving. But nobody is listening.
Do I think I will experience another crushing bear market in my life? Absolutely. Would I mind if I didn’t? Of course not.
There are several factors bolstering the resilience of the market. Each is interrelated and symbiotically pushing the market higher. It isn’t hard to connect the pieces.
What should you do if you agree with my drivers of market resilience? For now, just enjoy the mind. But also keep an eye out for changes that might disrupt the pattern of quick and painless rebounds. One domino falling may bring them all down. History shows that often happens even if the first crack isn’t readily apparent.
I would love to hear your thoughts. Have I missed anything? Email me at mark.lamonica1@morningstar.com
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It is hard to beat Mimi’s in Coogee on a beautiful day. And it is hard to beat caviar on any day. The Greeks were the first to eat caviar but Byzantine traders brought it to Russia where the industry took off. At Mimi’s they make a caviar pie with scallop mousseline and citrus butter. It is incredible.
