25 July 2023
The Dow Jones Industrial Average (DJIA), S&P 500, and Nasdaq Composite Index have experienced a decline over the past 18-20 months, with a steeper dip when adjusted for inflation. The DJIA, for instance, is down 6.42% inflation-adjusted from its all-time high in January 2022. Despite certain stocks like Apple and Nvidia performing well, investors are often blind to the overall market downturn due to the influence of these giant companies.
Market indexes, such as the S&P 500 and Nasdaq, being cap-weighted can exaggerate the performance of mega-cap stocks. Hence, even when most stocks in an index may not perform well, a few key players can mask this underperformance. The extreme concentration on a few companies adds vulnerability to market reverses.
Automated trading dominates over 80% of the market, pushing traditional active investing to the sidelines. This automation, based on flawed assumptions like the inevitability of matching market performance and the future resembling the past, can lead to disastrous consequences in the face of a large market crash.
Such an environment of feedback loops, market concentration, and tagalong asset management cultivates a bubble, or in this case, a super-bubble. Despite being easy to spot, such bubbles’ bursting time is challenging to predict, making preparation the best course of action. Over-reliance on index mania may lead to significant losses when the bubble bursts. A diversified strategy involving cash, gold, private equity, land, Treasury notes, and selected stocks may offer a better shield against the looming downturn.