A New Year Message from Horizon Kinetics (LINK)
In 2015, we continued to observe evidence of the impact of indexation as the primary investment modality. At the risk of sounding like a broken record, we can’t help but share yet another data point illustrating the valuation dichotomy created by the ETF divide, which to our knowledge is unprecedented, at least in our three-plus decades of investing experience. The largest 15 companies in the S&P 500 Index have an aggregate market capitalization of $4.7 trillion dollars. That is also the total market capitalization of the smallest 346 companies in the S&P 500. Looked at in another way, the 15 highest-contributing stocks, with an average aggregate weight of 13%, produced about 280% of the S&P’s return. That’s the extent of bifurcation which investors face. Mindboggling as it is, this is reality.
Hussman Weekly Market Comment: Complex Systems, Feedback Loops, and the Bubble-Crash Cycle (LINK)Of course, our ongoing study on the subject of indexation begs the question: how does it all end? Fee competition continues to trend toward a dead end: the iShares Total Market ETF (ITOT), which purports to include every possible subset that is buyable in the stock market, just lowered its expense ratio to three basis points, which is three 100ths of 1%. We believe that this is a seminal moment in indexation mass-investing. As the profitability is squeezed out of it, so too will be the incentive of the manufacturers and promoters to practice it. This change will have completely unpredictable consequences for equities at large, because ETF asset flows have been dominating valuations with no regard whatsoever for the fundamental properties of the underlying securities they comprise.
In any complex system, there are typically two types of feedback loops at work. Some feedback loops are balancing, so that deviations from some desired target are followed by actions to push the system back to that target. Your body has lots of these, which keep your temperature, blood sugar, and other vital processes in check. Other feedback loops are self-reinforcing, so that deviations from some starting point are followed by changes that push the system even further from that point. Cancer and viral replication are among those self-reinforcing feedback loops, and can be fatal if left unchecked by a balancing loop.
Any system that rewards the winner of one competition with the means to win the next competition also contains a self-reinforcing feedback loop. Many internet and social media companies benefit from this dynamic, because new users tend to gravitate toward the platforms chosen by existing users. Even if these companies operate with little profit, speculative financial markets may provide them with a war chest of cash through overvalued public offerings, which can then be used to acquire other businesses. The U.S. income distribution has featured a similar feedback loop in recent decades because repeated cycles of capital misallocation have resulted in a scarcity of productive investment. The irony is that as productive capital becomes scarce, the pie becomes smaller, but a larger share goes to the owners of existing capital. Fed policymakers then respond to economic weakness with actions that amplify the misallocation of capital. Instead of continuing these monetary distortions, the best way to improve the distribution of income in the U.S. would be to encourage productive investment at every level - government (productive infrastructure, clean energy), industry (investment and R&D incentives), and individuals (education, job training). This would contribute both to a larger pie and a more equitable income distribution.
BRIEF HISTORY & INTRODUCTION OF RUBBER (LINK)Most complex systems contain both balancing and self-reinforcing feedback loops, and the behavior of the overall system can change dramatically depending on which loop becomes dominant at any point in time
Book of the day: Cod: A Biography of the Fish that Changed the World
While I've had the book Cod on my list for a while, it was brought back to my attention from this paragraph in the book Capital Returns:
Thoughtful investment managers probably packed Capital: The Story of Long-Term Investment Excellence by Charles Ellis for their beach reading this year. Instead, our pick of the holiday reading this year is Cod by Mark Kurlansky. In this wonderful book, Kurlansky describes the rise and fall of the cod fishing and processing industry from the perspective of a social historian and gastronome, and the book takes the form of a culinary travelogue peppered with recipes. The recipes look appealing, but our advice is to read the book from the perspective of the capital cycle; then the industry’s rise and fall becomes even more interesting.