New market thoughts from Raymond James’ Jeff Saut: “Active vs. Passive?” 05/11/17

“The S&P 500 has 500 stocks in it. Every new dollar placed into an index fund pushes these 500 stocks up. Investors watch the performance rise and add even more money to the ‘chosen 500’.” . . . Paul Siluch, Portfolio Manager, Raymond James Ltd.
While traveling in Michigan seeing some institutional accounts, and speaking at events for our advisors and their clients, I got the chance to reread some emails that have gotten lost in the over 2500 emails that populate my inbox. One such email was from the sagacious Paul Siluch on passive versus active investment management. He scribed this excerpt (as paraphrased):
In large part, this [passive investment trend] is due to the fee advantage low-cost index funds have over active managers. Another factor, though, is just due to money flows. A huge amount of money is now chasing the indexes, which sends them even higher. According to The Wall Street Journal, $429 billion was invested in index funds in 2016 while $285 billion was removed from actively managed mutual funds. . . [However] This is just 9% of all listed stocks. There are over 5,300 publicly listed stocks on U.S. exchanges (source: Financial Post). This means we are pumping most of our money into just a handful of all available stocks and ignoring the rest.
Andrew and I have written extensively on this point suggesting when stocks are undervalued, and the indices are going up, you want to own “Cheap Beta” (passive investment is just fine), but when stocks are neutrally valued you want to have “active management.” We think that is the case here! Intuitively, one has to know that when EVERYONE is “leaning left” you want to “lean right” and clearly everyone is leaning toward “passively investing” currently. In fact, sparked by Paul’s cogent comments, I went back and reviewed my notes from the late-1960s, and early-1970s, regarding the then “Nifty Fifty” (Nifty Fifty). Those of us that are old enough to remember that era know it did not turn out very well; not that we are predicting a similar event here.
Speaking of not turning out right, the Comey firing should not have come as a great surprise. The Republicans will argue Comey was out of control and was violating protocol. The Democrats will claim Comey was getting too close to President Trump’s relationship with Russia. The truth is likely somewhere in the middle. What to watch for now is: 1) Who will the president nominate to run the FBI? 2) Will Rosenstein appoint a special prosecutor? And 3) will Republicans flee from the president over the firing? Whatever the answers to those questions, our models still appear to be on track since they telegraphed this week and next week as probably “quiet weeks” for the equity markets, which should lead to a big “up” move from there. As Andrew said to me yesterday, “Everybody is expecting the stock market to go down, except you and me!” We think the equity markets are setting up for a rally. And that’s the way it is as the Comey caper comes a cropper. Look for some more attempts to pull stocks down into next week, which doesn’t get much traction, and then a slingshot rally should develop. This morning the world is flat once again at 5:00 a.m. here on Lake Michigan . . .

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