Chief Economist & Fund Manager
One of the main characteristics of the current investment environment is the extreme concentration of a meg-cap stocks in ETFs and funds as a result of ETF investing.
While the Nasdaq 100 has lost a fraction of percentage points from its all-time highs, more than 30 components are down 25% or more, with high flaying names like Peleton down by over 70%, Baidu, Zoom, and Biogen by about 50%, Paypal holdings by 40%, and even names like Intel down by about 30% from its highs. In fact, just 8 components comprise over 50% of the Nasdaq 100 index. And this data is prior to December 1, when the ARKK ETF fell by about 6.5% in one day, followed by another 6% last Friday.
This over concentration has elevated the valuation of the top components to extreme levels, but companies which are not represented enough in most ETFs have an extreme low valuation.
And the question is, how vulnerable is the US market if stocks like Tesla and many of the top components of the S&P 500 and Nasdaq 100 Indexes start to fall? Will the money roll over to other unloved sectors and stocks, or will everything collapse, and cheap stocks will become even cheaper?
We don’t really know what might happen, but the recent correction in high flying technology names might force fund managers to be more selective. Fund managers for years now have been buying companies with a total disregard for valuation metrics. No valuation was too high as long as a stock had marginal improvement in adjusted EPS and revenue growth. That is, until the multiple was so far stretched, that no matter how much a company beat expectations, its stock went down. The 42% one day correction of DocuSign last Friday is probably a small indication of what might happen over the next several months.
The bottom line is passive ETF investing has created huge valuation disparities because of the extreme high concentration of money into specific stocks. However, the recent correction in high flying multiple stocks might be an excuse for selective stock picking one again. If confirmed, fund managers might actually pay attention to the valuation from now on, instead of focusing on marginal adjusted EPS improvements and revenue growth, but with a total disregards for valuations.
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