Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 246

Unwinding is warning of late stages of boom

Last year in Cuffelinks, I wrote an article entitled ‘Fear of missing out trumping fear of loss’ in which I highlighted the overwhelming demand for Argentina’s 100 year bond issue, despite the country’s litany of defaults, military coups, and bouts of hyperinflation over the last 90 years. The demand for Argentina’s bond issue was the tip of an iceberg representing investors’ insatiable appetite for returns above cash.

'Fear of missing out' driving markets

From post-80s American art, to low-digit number plates, stamps, coins, wine, and collectible motor vehicles, 2017 saw auction records smashed just as the appetite for Bitcoin, KodakCoin, and any company that added Blockchain or Nodechain to their name, fuelled a fear of missing out that usurped the fear of loss.

Then last month I wrote; “I do not know with any useful accuracy when the US market will turn down more meaningfully than it did last week …”, and I listed many problems facing markets.

The recent enthusiasm for higher return and higher risk alternatives, which always defines the late stages of a boom, has begun unwinding. And the unwinding will have serious implications for equities, especially those companies whose earnings multiples can only be supported by an uninterrupted period of high growth rarely achieved in the business world.

One useful signpost, following a period of unbridled optimism, that an unwinding has begun, is investors in credit markets pulling back, even while equity investors continue to party.

First, let's look at equities

In late January and early February, volatility spiked but investor bullishness and complacency were largely unwavering, especially when it came to tech stocks – enthusiasm for which was reflected in new March highs in the Nasdaq.

One of the most crowded trades has been US technology stocks. Today the Nasdaq 100 is dominated by a few names as investors have piled into index funds that care little about future prospects or value. Apple (NASDAQ: APPL) alone accounts for 12% of the Nasdaq 100 index. Alphabet (NASDAQ: GOOGL) at 9.4%, Microsoft (NASDAQ: MSFT) at 8.2%, Amazon (NASDAQ: AMZN) at 6.9% and Facebook (NASDAQ: FB) at 5.5% are the next four largest companies. A significant part of the gain in both the Nasdaq 100 and the S&P 500 indices over the last year can be attributed to an extremely narrow band of tech stocks.

Immovable bullish sentiment toward a narrow band of similar companies is reminiscent of the heavily-crowded positioning that has marked important market tops of the past.

In the week ending 23 March 2018, investors poured $3.3 billion into the PowerShares QQQ Trust Series 1, the biggest exchange-traded fund tracking the Nasdaq 100 index. It was a cash injection into technology shares not seen since the peak of the tech bubble. J.P. Morgan also reported the biggest weekly inflow ever into equity ETFs in the week ending 16 March of US$34 billion.

Now to credit markets

Meanwhile, US corporate bonds are sending investors a warning. Investment grade bond spreads now sit near their widest level in six months and yields have risen to their highest level in six years. Corporate bond investors are pushing yields higher, signalling the greater risk associated with investing, while their equity counterparts continue to accept a high P/E and prices that imply ultra-long-term growth rates that few businesses have ever achieved.

Elsewhere, current forecasts for US federal government borrowing needs, expected to exceed 100% of GDP by 2028, are brushed aside. By contrast, we have been reminded of the 1980s, when federal publicly-held debt hitting nearly 40% triggered fears of an apocalypse. According to some analysts the demographics were more favourable in the 1980s, and tailwinds existed in the form of productivity growth, financial-sector deregulation, and benign inflation. Today, these could now be headwinds and yet complacency over rising debt and deficits persists.

We agree with analysts who suggest the jump in the TIPS (Treasury Inflation-Protected Securities) market and in Libor spreads to levels last seen in the GFC should be setting off alarm bells because it is a sign that monetary policy has tightened considerably.

LIBOR rates since 2008

Quantitative Easing has been inflationary for property and financial assets including equities, bonds and bond proxies. Quantitative Tapering will at least generate heightened volatility in the same markets. And as volatility increases, cost-of-capital assumptions increase, opportunity costs rise, price-earnings multiples contract and credit stress or merely fears of credit stress become more frequent.

The 12-month annualised Sharpe Ratio for the S&P 500 reveals that the combination of very high returns and very low volatility in recent times is an anomaly last observed in the 1950s. The combination of higher volatility and lower returns is likely to return.

12-month annualised S&P 500 Sharpe Ratio to Dec.31, 2017

Source: Gestaltu, ReSolve Asset Management

The figure below shows that when volatility (risk) as measured by the VIX index, picks up, P/Es (price to earnings multiples) contract. Investors are simply less willing to make optimistic assumptions about a company’s prospects, and therefore less willing to pay higher multiples, when a fear of loss replaces the fear of missing out.

Volatility as measured by the VIX Index versus P/E ratios for S&P 500

Source: Bloomberg, ETF Daily News

There are of course many arguments that suggest portfolios should be fully invested. We agree that in the long run, being fully invested is preferred. But it is also true that the higher the price you pay the lower your return, and holding long-term just means locking in a low return on a long-duration asset.

Prices today are factoring in all of the bullish arguments with little room for setbacks, hiccups, or speed bumps. In the bond market, some investors are already leaving. Those who are patient will be well rewarded for making additional investments only when there is blood in the streets.

 

Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is general information and does not consider the circumstances of any individual. 


 

Leave a Comment:

RELATED ARTICLES

Feel the fear and buy anyway

Should you be a value or growth investor?

To zig or to zag?

banner

Most viewed in recent weeks

Finding the best income-yielding assets

With fixed term deposit rates declining and bank hybrids being phased out, what are the best options for investors seeking income? This goes through the choices, and the opportunities and risks involved.

What history reveals about market corrections and crashes

The S&P 500's recent correction raises concerns about a bear market. History shows corrections are driven by high rates, unemployment, or global shocks, and that there's reason for optimism for nervous investors today. 

Howard Marks: the investing game has changed

The famed investor says the rapid switch from globalisation to trade wars is the biggest upheaval in the investing environment since World War Two. And a new world requires a different investment approach.

Welcome to Firstlinks Edition 605 with weekend update

Trump's tariffs and China's retaliatory strike have sent the Nasdaq into a bear market with the S&P 500 not far behind. What are the implications for the economy and markets, and what should investors do now? 

  • 3 April 2025

Designing a life, with money to spare

Are you living your life by default or by design? It strikes me that many people are doing the former and living according to others’ expectations of them, leading to poor choices including with their finances.

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Latest Updates

Investment strategies

An enlightened dividend path

While many chase high yields, true investment power lies in companies that steadily grow dividends. This strategy, rooted in patience and discipline, quietly compounds wealth and anchors investors through market turbulence.

Investment strategies

Don't let Trump derail your wealth creation plans

If you want to build wealth over the long-term, trying to guess the stock market's next move is generally a bad idea. In a month where this might be more tempting than ever, here is what you should focus on instead.

Economics

Pros and cons of Labor's home batteries scheme

Labor has announced a $2.3 billion Cheaper Home Batteries Program, aimed at slashing the cost of home batteries. The goal is to turbocharge battery uptake, though practical difficulties may prevent that happening.

Investment strategies

Will China's EV boom end in tears?

China's EV dominance is reshaping global auto markets - but with soaring tariffs, overcapacity, and rising scrutiny, the industry’s meteoric rise may face a turbulent road ahead. Can China maintain its lead - or will it stall?

Investment strategies

REITs: a haven in a Trumpian world?

Equity markets have been lashed by Trump's tariff policies, yet REITs have outperformed. Not only are they largely unaffected by tariffs, but they offer a unique combination of growth, sound fundamentals, and value.

Shares

Why Europe is back on the global investor map

European equities are surging ahead of the U.S this year, driven by strong earnings, undervaluation, and fiscal stimulus. With quality founder-led firms and a strengthening Euro, Europe may be the next global investment hotspot.

Chalmers' disingenuous budget claims

The Treasurer often touts a $207 billion improvement in Australia's financial position. A deeper look at the numbers reveals something less impressive, caused far more by commodity price surprises than policy.

Fixed interest

Duration: Friend or foe in a defensive allocation?

Duration is back. After years in the doghouse, shifting markets and higher yields are restoring its role as a reliable diversifier and income source - offering defensive strength in today’s uncertain environment.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.