🎙️ Bear Market in Diversification

Cash is sorta king, right? Our friends over at The Wall Street Journal noted that investors parking cash in money-market funds last year “reaped around $300 billion in interest income — more than in the prior decade combined.”

According to the Federal Reserve, households now have over $4 trillion in checkable bank deposits — a staggering four times higher than pre-pandemic levels.

So, while Americans’ low-savings rates have made headlines, it’s worth a harder look. Maybe it ain’t necessarily a negative. “Elevated net worth supports a low saving rate,” Deutsche Bank’s Matthew Luzzetti wrote to investors.

As another analyst noted, “When you are ‘loaded,’ you have less reason to save. If my stock portfolio is rising and home prices are climbing, I don't feel like I need to be saving as much.”

— Matthew & Shawn

Here’s today’s rundown:

Today, we'll discuss the biggest stories in markets:

• Beneath the calm, stocks go haywire

• The great bear market in diversification

This, and more, in just 5 minutes to read.

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In The News

🎢 Beneath the Calm, Markets Go Haywire

The S&P 500 index keeps chugging higher, quite calmly. But underneath the surface, individual stocks are swaying rather drastically. 

The S&P 500 has had few large daily moves recently. There hasn't been a 2% move since February, and the VIX gauge of expected volatility is only slightly up from the post-pandemic low reached last month.

A smooth sea anomaly: Yet many individual stocks have experienced big swings of 10% in a day over the past three months. As The Wall Street Journal reports, only once in the past 25 years have stocks swung about like this while the overall market stayed so calm.

• For example, Salesforce fell 20% and HP soared 17% on the same day at the end of last month, and Hewlett Packard Enterprise, a spinout from HP, jumped 11% last week."

The longest stretch this year without a 1% move in the S&P was 15 trading days. Why?

For starters, investors are trying to pick winners and losers amid higher interest rates and AI euphoria, and they (evidently) see little risk out there. However, as WSJ warns, "the bigger risk is that “ investors get too comfortable with the idea that there are no imminent threats."

Reasons for the divergence: The "two-speed economy" and excitement about AI are causing investors to rotate heavily into and out of certain stocks based on their perceived winners and losers.

• As one managing partner observed, "There are enough stocks that do well or badly from interest rates to move share prices around a lot, but they largely cancel out at the index level. This shows up in stock options that are priced for very low correlation between them—the lowest for the year ahead since at least 2006.”
  

• Another noted, "As for AI, the bet is about who the winners will be, with little evidence yet of who will lose. But hopes for AI have led to huge gains for the AI leaders, especially chip maker Nvidia."
  

Why it matters:

Investor enthusiasm has stayed strong this year. There’s a consensus among investors that major risks are limited, at least for now.

The Wall Street Journal reports that “investors widely agree that the big bout of inflation is over, that the economy will be neither so hot nor so cold that the Federal Reserve will have to make major changes, and that wars in the Middle East and Ukraine are contained."

Try and fail: According to similar markets in the past, the current environment of big single-stock moves with a calm index should benefit skilled stock pickers. 

• On the flip side, many stock pickers will fail and underperform, revealing the primary flaw in stock picking: Half those who try will fail and—in this market—underperform even more than usual.

Final word: The author's main warning is against investor complacency, given the perceived lack of big market risks.

Read more

More Headlines

⛽ Berkshire Hathaway purchases more shares in Occidental Petroleum

💻 Everything Apple announced at WWDC, including Siri with ChatGPT

💰 U.S. millionaire population grew by 600,000 last year

💼 Lazy work, good work by Morgan Housel

🤩 Microsoft’s Satya Nadella is the most admired CEO in Fortune 500

🤔 The hidden costs of living in every U.S. state

👻 Great ‘Bear Market in Diversification’ Haunts Pros

In case you hadn’t noticed, American stocks have been on a great run since the 2008 financial crisis, outpacing almost everything else. 

The S&P 500's 14% annual gain is double that of emerging markets and triple that of investment-grade bonds. Cash is more attractive nowadays, but its long-term performance vs. U.S. equities isn’t even a discussion. 

Homegrown: The exceptional performance of U.S. equities is partly due to the Fed's market rescue during the financial crisis, leading to an (almost) uninterrupted rally with subdued volatility. The S&P 500 has scored a much higher risk-adjusted return (Sharpe ratio) than diversified portfolios since 2008.

As Bloomberg reports, money managers who did what they were taught — spread investments across geographies — are underperforming investors who simply bought the S&P 500 and did nothing, a strategy Warren Buffett and Charlie Munger long endorsed. 

Consider: Out of roughly 370 asset-allocation funds tracked by Morningstar., only one has beaten the index since 2009. One! 

• Bloomberg reports that diversified portfolios have trailed the US large-cap stock index in 13 of the last 15 years—a stretch seen only once before in almost a century of data. 

Big get bigger: Now, betting heavily on only U.S. stocks poses a concentration risk, with tech mega caps like Nvidia dominating the market. Elevated Treasury yields offer a potential buffer against a stock crash, but diversification advocates remain doubtful. And now, some advisors and academics suggest retirees would be better off eschewing bonds entirely. 

• As Bloomberg reports, “The data has emboldened those who say diversification — however sound in theory — is costing investors over the long run, by holding underperforming investments.”
  

• Advisors say clients are growing skeptical about investing in small-caps and non-U.S. stocks as "the big gets bigger."

Even fixed income's haven status is questioned after the asset class sank with stocks during 2022's inflation-induced selloff.

Why it matters:

Interest in stock investing has swelled amid zero-fee trading, mobile trading apps, and a pandemic-era rise in market interest. 

Meanwhile, U.S. stocks keep surging. Relatively brief market declines in 2018, 2020, and 2022 have proven to be nothing but “buy the dip” opportunities for long-term-oriented investors. 

Best friend: Diversification backers point out that diversified portfolios won out from 2000 to 2008 and that the tides could soon turn again. 

• “Diversification is your best friend on your worst day,” said the chief global strategist at J.P. Morgan Asset Management. “The right asset allocation is a little bit like home insurance. You never know when you’re going to need it, but you should never feel comfortable not having it.”

Home bias: While it's tempting to call an end to the equity rally, the S&P 500 has maintained its leadership in 2024. As investors adapt, some are deepening their home bias, while institutions lean into private equity as "the savior" to juice up performance. 

• “If your neighbor has all their money in the S&P, then you look like a moron,” one portfolio theory expert said, calling the last 15 years a “bear market in diversification.”

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Quick Poll

On Monday, we asked: The SEC is expected to scrutinize trading around Gill's involvement. Do you think Gill's social media activity and livestreams constitute market manipulation?

— Results were exactly 50/50. Among responses were: “The guy is a phenomenon, not a market genius or manipulator,” and “He’s not directly associated with the company and as long as he isn’t communicating false facts he’s just providing his opinion. ”

— Others said, “It's manipulation for certain. Whether is is illegal manipulation will be up to the SEC and other authorities to decide. It definitely deserves a hard look.”

See you next time!

That's it for today on We Study Markets!

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