The Dow saw another week of record highs, as Wall Street continues buying in anticipation of the pro-growth Trump agenda.
Politics is the biggest driver in the markets right now. But there may be another, more “robotic” reason why stocks continue to push to new highs.
In the Wall Street Journal column, The Intelligent Investor, writer Jason Zweig posed the following question, “How Dangerous Is a Stock Market of Mindless Robots?”
Now, Zweig isn’t talking here about the kind of robots we wrote about in Thursday’s Afternoon Edition. Those are the super-intelligent, A.I. robots of the sort with a 10,000 IQ.
The robots Zweig refers to are automated investments of all varieties. These include so-called “robo-advisers,” computer programs designed to recommend investors buy stocks on an automated, even autopilot, basis.
Zweig also lumps in the category of automated investment vehicles things such as indexed mutual funds and ETFs that allow investors to buy the market in one single bundle. Then there are target-date portfolios designed to hold a predetermined mix of assets, and hence own stocks no matter the market conditions.
As Zweig asks, “Could all these millions of people investing on autopilot be pushing an already expensive market even higher?”
To put the issue in context, Zweig offered up the following facts:
Four leading robo-advisers — Betterment, Schwab Intelligent Portfolios, Vanguard Portfolio Advisory Services and Wealthfront — have roughly doubled their assets in the past year, to $77 billion.
In 2016, 82% of new retail investments coming through financial advisers (more than $400 billion) went into index funds and ETFs, according to Broadridge Financial Solutions, which helps process such trading.
All told, U.S.-based exchange-traded portfolios have amassed $2.6 trillion, says ETFGI, a research group in London. Target-date funds hold $915 billion, according to Morningstar, the investment-research firm.
That’s a lot of support for the thesis that these automated-style investments are keeping a bid in stocks.
Yet the mere existence of these funds fails to tell the whole story, and Zweig knows it.
Here, he offers a counter to the automated bid thesis:
…the evidence that automated investing has driven up stock prices is tenuous at best.
Over the past decade, stocks in the U.S. — where the automated investor is much more dominant — have significantly outperformed shares from the rest of the world. U.S. stocks are trading at 29.5 times their long-term average earnings, adjusted for inflation. That’s only a whisker below their levels in July 1929, shortly before the Great Crash.
But correlation isn’t causation. Market valuations were at their modern highs in 1999, when index funds held less than 10% of all stock, points out Fran Kinniry, an investment strategist at the Vanguard Group, the giant of autopilot investing. Since then, index funds have roughly tripled their share, but stock valuations have fallen by almost half.
My intuition here is that the answer to the question of whether automated-style investing is pushing markets higher is both yes, and no.
Certainly, if you are buying stocks via index funds or ETFs, then you are buying most of the market with one click. That will have the effect of pushing that index higher.
Related story: The ROBO ETF Can Help You ‘Future-Proof’ Your Portfolio
Conversely, if you get nervous and want to sell, then there is usually a massive rush for the exits. That selling amplifies the downside much the same way buyers amplify the upside.
The net result is probably a market that’s going to do what it’s going to do based on factors such as economic growth expectations, Fed expectations, corporate earnings, cash flow, etc.
The macro and the micro still very much matter … although I grant that the rapid rate of change in either direction (bull or bear) could be amplified by the automatons.
Good luck and happy investing,
Uncommon Wisdom Daily