New Era Economy and Financial Markets Explained—Part II

by the Curmudgeon with Victor Sperandeo




In part I of this two part series, Victor weighed in with his view on the root causes of the new era in financial markets and the economy.  Now it’s my turn.


Free Money Party Boosts Financial Assets & Created Bubbles:


“There aren’t any such things as a quantitative limit or anything, any numbers we can’t overcome,” BoJ Governor H. Kuroda said on March 30, 2016 during a parliamentary session in reference to his policy stance and the BOJ’s present easing measures.


“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough,” said ECB President Mario Draghi on July 26, 2012. 


Those quotes exemplify the extraordinary easy money policies the world’s central banks maintained from 2008 to boost the global economy.  The more direct effect was to create bubbles in financial assets, private equity unicorns and residential real estate.


Collusion and Global Central Banks Buying Equities:


The Swiss Bank made no secret out of creating money out of thin air to buy (mostly) U.S. stocks.  The BoJ overtly bought Japanese stocks via ETFs.  We believe that covertly, many global central banks bought U.S. stocks via S&P 500 futures and index ETFs, especially when there was a global stock market route (which was the case in early February 2016).


Furthermore, we strongly suggest that the Fed encouraged its dealer banks to buy U.S. equities (again via S&P 500 futures and index ETFs) whenever there was a 10% or more decline in the popular stock market averages.


Mega Tech Stocks – Must Own at Any Price + Increased Weight in S&P 500:


The five biggest companies by market value are U.S. tech stocks: Apple, Amazon, Alphabet [Google], Microsoft and Facebook. Between them they accounted for more than a third of the $2.7 trillion increase in value of the S&P 500 in the past 12 months.  These top five tech heavyweights now make up more than 15% of the S&P, the most for any top five since early 2000.


Shareholders have bought into the idea that these companies will dominate the market for many years to come, reaping the rewards of their heavy spending on research and development and expansion into new areas of business.  We believe that thinking is seriously flawed (see Q & A with Victor below).


It is also unusual that a small group of large companies should do so much better than everyone else. The scale of the out performance is extraordinary: An investor who put the same money into each of the big five tech stocks a year ago is up 38%, ignoring dividends, while the S&P is up 14%.


NY Times columnist Farhad Manjoo on June 12, 2018:


“Today, the internet is run by giants. A handful of American tech behemoths — Amazon, Apple, Facebook, Google and Microsoft — control the most important digital infrastructure…………...”


“As I’ve noted often in the last few years, big companies have been crushing small ones over and over again for much of the last decade."


Leuthold Group’s Assessment of the Tech Take-over:


In a June 8th research piece titled Dot-Com Déjà Vu?  (subscription required), Leuthold Group’s Chief Investment Strategist, James Paulsen, PhD wrote:


“Haven’t we seen this movie before? Technology takes over the stock market late in a recovery cycle, seemingly making the bull ageless, pushing portfolios toward a more concentrated new-era exposure, stimulating investor greed bolstered daily by watching a chosen few (FANGs) rise to new heights, and convincing many that tech is really a defensive investment against late-cycle pressures which trouble other investments.”


“On a price-return basis, technology has outpaced the S&P 500 ex-tech index by more than 2 to 1 during the last five years, more than 3 to 1 during the last two and three years, more than 4 to 1 in the last year, and so far, year-to-date, the S&P 500 is essentially flat without the 15% gain from technology stocks! Indeed, without tech stocks, this bull market has really only been ho-hum. During the last five years, without technology stocks, the S&P 500 (ex-tech) total annualized return at slightly more than +10% is essentially equal to the post-war average return from stocks.”


“At a minimum, investors should recognize that the stock market has taken on a bit of “back to the future” character. The longer participation continues to narrow within the S&P 500, although rewards may remain satisfying, risk is also increasing.


Victor:  The Nifty 50 Revisited              


The Nifty 50 stocks got their nickname in the early 1970’s because they were thought of as “Buy and Hold” or “One Decision” stocks.  It was (erroneously) believed their earnings would never stop growing -even during recessions.  That optimism was visible in a key measure of the stocks' value: the price-to-earnings ratio or P/E – the price-per-share divided by the company's annual earnings-per-share.


By 1972, when the S&P 500 Index's P/E stood at a then lofty 19, the Nifty Fifty's average P/E was more than twice that at 42.  Among the most inflated stocks were Polaroid (with a P/E of 91); McDonald's (P/E=86); Walt Disney (P/E=82); and Avon Products (P/E=65).


SOURCE: “Remember the Nifty 50”



Within the group of Nifty 50 stocks were a subgroup called “the Glamour Stocks,” which included: Avon, Polaroid, International Flavors & Fragrances, Texas Instruments, Xerox, Eastman Kodak, and others. There were also “long term growth stocks” in the Nifty 50, such as IBM and Johnson & Johnson.  


The Nifty 50 were the “Gold Standard” of equities!  Like tulip bulbs during the Dutch Tulip Mania, their stock prices went up on pure hype.  However, many are gone (i.e. bankrupt) or have done very poorly the last 10 years or more (e.g. Sears, Xerox, many others).


In January 1977, I sold my Options firm to Weeden &Co. (a 3rd Market Trading Firm) to be a Market Maker of the Glamour Stocks (22 stocks in the Nifty 50).  As an options expert, I was to make “tight markets, “but also to use options to hedge the stock positions.  IBM was $575 a share at that time, yet I was able to make a bid/offer spread of only $1.  Unfortunately, Weeden closed in February 1978 (due to over spending). I only lost money in 1 of the 12 months I traded.  The 10 block traders never lost money in any single month.


I traded mainly from the short side, as most institutions were always net buyers of the glamour stocks.  In 1977, the S&P 500 index was down a small amount (-7.16%) and I did quite well…


Those were the good old days with positive memories!


Today, the FANG stocks (Facebook, Amazon, Netflix, Google) + Apple (5 stocks) are a concentrated version of the Nifty 50. The key take away here is that a major decline in those 5 stocks will occur, just like the Nifty Fifty did.  When that will happen is unpredictable (due to Fed and government manipulation of markets), but inevitable.


Curmudgeon: Are the Fangs plus Apple worse (valuation/risk) than the Nifty Fifty?


Victor:  Yes.  The P/E's are much higher and most of the revenue comes from ads.  As soon as the U.S. goes into recession, advertising will be severely reduced (or eliminated) and the FANGs + Apple will be toast!


Conclusion and End Quote:


The "growth at any price" mentality that prevailed with the Nifty 50 resurfaced with a vengeance in the tech-stock bubble a quarter century later.  Apparently, no lessons were learned as that same mentality came back even stronger with the FANG + Apple “must have” stocks.                                      


"You can say the S&P 500 or the Nifty Fifty will make you rich, but they can also make you gray and die prematurely," said Charles Geisst, a Manhattan College finance professor and author of Wall Street: A History.

Good luck and till next time……


The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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