Tech Dominance Is Breaking the Market Cycle

During their recent episode, Taylor, Carlisle, and Michael Gayed discussed Tech Dominance Is Breaking the Market Cycle. Here’s an excerpt from the episode:

Michael: No, no, that’s good, actually. So, let’s play with this.

Jake: Confirm my priors, please.

[laughter]

Michael: Right. Misery loves company, especially in podcasts. Okay, let’s play with that. Let’s talk through the fundamentally broken argument. Yeah. Broadly speaking, why is it that growth has outperformed value? Why is it that US has outperformed international? Why is it that large has outperformed small? The answer is the same across all three. It’s tech.

Tobias: Yeah.

Michael: It’s not a factor dynamic. It’s a sector dynamic, right?

Tobias: Yeah.

Michael: Large cap is dominated by tech companies, small caps are not. US is tech dominant, international is not. Growth is tech, value is not. Value is financials, industrial’s tech. So, the argument that’s fundamentally broken is that we’re in an era where tech is everything, that this is the world that we’re in that the exponential nature of technology makes it impossible for other companies to possibly catch up. It’s beyond winner take all within tech, it’s going to take all across the entire system. I think there is actually a legitimate argument for that,-

Tobias: Yeah.

Michael: -which scares the ever-living crap out of me.

Tobias: Yeah.

Jake: Yeah.

Michael: Because what’s the implication of that? Then, what are we doing?

Tobias: Marc Andreessen says, “Software eats the world.” Marc Andreessen seems to be right so far.

Michael: Yeah. Okay. Now, the other side of it is so far. If it’s not fundamentally broken, then it’s a cycle. Okay. So, if it’s a cycle, what becomes the catalyst for the cycle to break? Because you need something. Time doesn’t seem to be enough, because it’s already been a long time. We don’t know what that would be. But I would submit to you that the only way you get that big catch up is if you shake the money that’s playing the momentum in tech. And if you shake that momentum in tech on a sustained basis, then that money will eventually rotate international into value into small. [crosstalk]

Tobias: Traditionally, it’s been a crash that has created that transition. 2020 looked like a crash, but in retrospect, it’s probably more like a flash crash. It was more–

Michael: Yeah, I agree. Yeah.

Tobias: It didn’t really cause anybody to change anything. And if anything, what it showed was that you really needed more tech, because tech was the thing that bounced hardest out of the bottom then. What do you think about Michael Green’s thesis that it’s basically flows from passive that have just gone to winners, and so the winners just keep on winning. The biggest market capitalizations attract the bulk of the flows, and so therefore it doesn’t turn around.

Michael: Yeah, I’ve called that structural insanity, [Tobias laughs] because it’s structural. Because literally, that’s the default option is to go into equities, which are basically market cap, weighted vehicles and 401(k)s. So, you have this auto bid, which is basically the Michael Green argument around passive. It’s structural, because it’s the default option. People are not even realizing that they’re putting a portion of the income automatically into basically the largest companies in terms of the allocations. Again, it’s worked, but it also creates distortions.

So, take it to the logical conclusion. If we’re in a world where everything is broken, it’s purely passive. The true value of anything that’s active is what, that it’s fundamentally rewarding companies that are doing the right thing, in terms of profitability, in terms of earnings, in terms everything.

Market prices are a signal to a company that they’re doing something right or wrong also. And you need active management for that to play out, for that signal to mean something. If everything has gone passive, then there’s no signal for individual companies, which means that companies end up floating to the top, maybe not because they’re actually good companies, but just because of their relative weighted position in the index everybody’s buying automatically.

Take that to the further logical conclusion. We’ve seen this incredible concentration keep on building. I looked at the NASDAQ-100 in 2010, the top 10 holdings were, I think 49%, now they’re 60%. I think maybe even be more than that. All right, so then at what point does the passive auto bid, which is causing more and more of that concentration risk at the top? At what point then is it not a market anymore? At what point is it, are these tech companies now the too big to fail dynamic, which means that anytime you have a market crash, the Fed is not stepping in to save the economy. They’re stepping to save five companies or six companies or seven, whatever it is, because it’s such an outsized contributor total return.

I find that to be very disturbing. I really do. Listen, I spent my youth studying markets, reading old books on markets and really getting into the historical terms on technical analysis. This is not the way investing is supposed to be, but it’s the way that people think of this.

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