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FAANG Is Now a Textbook Example of an Overheated, Unsustainable Market

Stock-Markets / Stock Market 2017 Jun 22, 2017 - 07:08 PM GMT

By: John_Mauldin

Stock-Markets

Technology stocks suffered from a little anxiety attack in the markets last week.

It didn’t last long and really wasn’t all that serious. (Yet.) It was nothing worse than what everyone called “normal volatility” 10 years ago.

But the lack of concern it generated this time is not bullish. More than a few investors seem to think that “nowhere but up” is somehow normal.


The Famous 10 Rules of Investing—Which Most Investors Don’t Follow

Doug Kass had similar thoughts and reminded me of Bob Farrell’s famous 10 Rules of Investing. I’ll just list them quickly, then apply some of them to our current situation. (Emphasis mine.)

1. Markets tend to return to the mean over time.

2. Excesses in one direction will lead to an opposite excess in the other direction.

3. There are no new eras—excesses are never permanent.

4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.

5. The public buys most at the top and the least at the bottom.

6. Fear and greed are stronger than long-term resolve.

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. (Sound familiar? Can you say FAANGs?)

8. Bear markets have three stages: sharp down, reflexive rebound, and a drawn-out fundamental downtrend.

9. When all the experts and forecasts agree, something else is going to happen.

10. Bull markets are more fun than bear markets.

I think most of these rules are obvious to investors who experienced the 2008 mess, the dot-com crash, and (if you’re of a certain age) the 1987 Black Monday. Some of us can remember 1980 and ’82. ’82 was especially ugly.

Maybe we mostly forget these experiences, but we pick up a little wisdom along the way.

The problem is that now a new generation of investors lacks this perspective. They had little or no stock exposure in 2008 and experienced the Great Recession as more of a job-loss or housing crisis than a stock market crisis.

The previous crises are no secret. People know about them, and on some level they know the bear will come prowling around again. But knowing history isn’t the same as living through it.

Newer investors may not notice the signs of a top as readily as do investors who have seen those signs before—and who maybe got punished for ignoring them at the time.

FAANG’s Current Rally Is a Textbook Example of Rule 7

Doug Kass notices. Here’s a bit from an e-mail conversation we had last week.

During the dot-com boom in 1997 to early 2000 there was the promise (and dream) of a new paradigm and concentration of performance in a select universe of stocks. The Nasdaq subsequently dropped by about 85% over the next few years.

I got to thinking how many conditions that existed back then exist today – most importantly, like in 1999, when there emerged the untimely notion of “The Long Boom” in Wired magazine. It was a new paradigm of a likely extended period of uninterrupted economic prosperity and became an accepted investment feature and concept in support of higher stock prices!

[JM note: Here’s the Wired article Doug mentions: “The Long Boom: A History of the Future, 1980-2020.”]

And in 2007 new-fangled financial weapons of mass destruction—such as subprime mortgages that were sliced and diced during a worldwide stretch for yield—were seen as safe by all but a few.

And, just like during those previous periods of speculative excesses, many of the same strategists, commentators, and money managers who failed to warn us then are now ignoring/dismissing (their favorite phrase is that the “macroeconomic backdrop is benign”) the large systemic risks that arguably have contributed to an overvalued and over-loved US stock market.

Doug points especially to Farrell’s Rule 7, on market breadth. A rally led by a few intensely popular, must-own stocks is much less sustainable than one that lifts all boats.

We see it right now in the swelling interest in FAANG (Facebook, Apple, Amazon, Netflix, Google). Tesla comes to mind, too. Their influence on the cap-weighted indexes is undeniably distorting the market.

These situations rarely end well.

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