Index Popularity Leading To 2000 2.0?
By Mark Yusko, CEO and CIO of Morgan Creek Capital Management and Portfolio Manager of the AdvisorShares Morgan Creek Global Tactical ETF (GTAA)
One of the most important indicators of the overly ebullient sentiment in the U.S. equity markets is the sudden acceleration of assets moving toward passive strategies like Index Funds and Smart Beta (which we contend is an oxymoron like jumbo shrimp…). To that point, Vanguard just set a new record for inflows in Q2. The last time they had this type of inflow activity was in the first quarter of 2000 and we know how that movie ended, with markets down 40% over the next three years.
We think the future is likely to look very similar to the past as slowing economic growth, falling earnings, high valuations and a potential U.S. Recession in 2017 conspire against further gains in the S&P 500. Mark Twain famously quipped that “history doesn’t repeat, but it rhymes”. One thing we know from history is that investors are amazingly consistent in buying what they wish they would have bought and they chase the strategies that have the best recent performance.
During periods of Central Bank largesse (like late 1990’s and early 2010’s) capitalization weighted indices outperform given their momentum bias (and value biased active strategies underperform) so investors invariably pour money into passive strategies right at the wrong time and suffer significant losses during the inevitable correction. This is one of the primary reasons that individual investors have dramatically underperformed over the past twenty years (achieving just 3.5% per year according to the latest Dalbar Study).
Another thing we know is that when the cacophony of negativity toward active management reaches a crescendo and everyone is predicting the death of active management (and hedge funds), historically that has been a great time to rotate away from passive investments and into active strategies. We expect this cycle to repeat over the coming three years and think 2016 to 2018 will look very similar to 2000 to 2002.
Welcome to #2000 2.0.