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Markets are back to rational investment

Markets / May 28, 2022 / DRPhillF / 0

Even with the massive declines in tech stocks, the pain is far from over for most appraisers.

It is known that the S&P 500, the most popular indicator of passive strategies, is dominated by a few tech giants such as Alphabet, Amazon and Facebook, all of which have fallen significantly. But a deep dive by research and data science firm Syntax shows that technology risks are still 42 percent of the norm. This is just below the 47 percent technology represented in March 2000 – the height of the dotcom bubble.

Investors generally use more common and less accurate metrics, which now show technology exposure in the S&P 500 hovering at about 22 percent, half the figure that Syntax came up with. Syntax’s alternative methodology calculates exposure to technology using more detailed information on individual product lines and other services provided by companies. The company warned investors that they were being exposed to the technology more than expected late last year.

Investors can blame their embrace of market-weighted index funds for leaving them more exposed to technology and even less diversified than they think — all at a time when the market is going through an important turning point.

Simon Witten, product strategist at Syntax, said investors should keep the 42 percent in mind when they feel tempted to buy in the current market weakness, believing it’s only a temporary pullback. He said he will fall more.

Witten added that it is not surprising that public pension funds and other large investors are buying index-weighted because this approach is the cheapest way to get exposure to large parts of the market. In contrast to equal-weight or stratified indices, reference cap measurement does not require much work to maintain a standard-compliant portfolio.

The syntax strategist said that to see what happens next, investors need to pay attention to what he believes is a shift in the system — a return to rational investing where valuation matters. Given that technology plays a large role in growth, he noted the performance of the Russell 1000 Growth Index, which has been twice the returns of value strategies over the past five years. While he can’t predict how low growth will go, he said, “This current market environment makes me feel back to rational investing.” When rationality takes hold, evaluations become important again. “Investors haven’t paid attention to valuations for five years,” he said.

Whitten said markets are fundamentally different from what they were in March 2020, when the massive drop that month alarmed all investors and prompted the Federal Reserve to intervene. “This is a market correction that was left to markets,” Witten said, acknowledging that it has been a long time since markets were left to their own devices. But the Fed does not intervene this time and continues with its intention to raise interest rates and tame inflation based on economic signals and its own schedule.

This is a consensus correction. No one is going to look at it and say, “That’s kind of crazy what’s going on in the markets. It’s a rational feeling.”

With the Fed rates normalizing, tech stocks are becoming riskier. When rates are rising faster than the market expects, long-term profits – growth, in other words – must be curtailed. This is because they get a much harder discount than valuable stocks.

“[The] “The danger is that you think you are diverse, but you are not,” Witten said.

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