Why investing in benchmarks might not be a good idea
As the Bob Dylan song and album say: The Times They Are a-Changin’
In a recent commentary on the equity markets, Cathie Wood discusses what she sees coming in the not- too-distant future. You can find the entire post here.
Her thesis is that the companies represented in the major indices like the S&P 500 and DOW are for the most part backwards looking and many of them will be severely disrupted by the tsunami of change on the horizon. The combination of a high current earnings multiple (29.10X) and the fact that the companies in the S&P 500 are focused on short-term results and paying dividends, most of them will be left behind as the current business environment transitions to the new world order.
A new age is coming in the areas of “DNA sequencing, robotics, energy storage, artificial intelligence, and blockchain technology” says Cathie. These paradigm shifting segments and the companies in them will transform the way we and businesses interact. The entire value proposition in many areas will completely change.
These disruptive technologies might also change the balance of power away from the United States and China toward the distributed mass of humanity across the globe, but this is a much bigger topic and I won’t try to cover it here.
She goes on to say that: “even the FAANGs(1) could be in harm’s way as the convergence of blockchain technology and artificial intelligence in the so-called 'metaverse’ attempts to destroy the roles of centralized data aggregators, ceding economic power to creators and consumers.”
I know this all sounds very science fiction-like and way off in the future, but progress in these new areas is happening at a very rapid pace. More importantly, the rapid change in several of these areas will accelerate the change in some of the other areas – they will feed off one another. Most investors and consumers will be caught off-guard by how fast the transition to this new paradigm will take place.
To give you a sense of how large and transformative this change might be Cathie describes: “According to our research, the convergence between and among robotics, energy storage, and artificial intelligence will create autonomous taxis and significant growth potential: by 2030, autonomous taxi networks could scale from no revenue today to $9-$10 trillion globally, which when combined with the productivity uplift from time freed up from behind the wheel, could total more than $20 trillion. For perspective, [the] U.S. GDP today is roughly $21 trillion.” This is just one area of disruption and there will be many.
So why might this make investing in the S&P 500 a bad idea?
In a previous blog article I wrote (found here), I discussed how sector rotation caused underperformance in our InvestSmartTM and VigilantTM portfolios for a short period of time.
Now I’m talking about the opposite rotation where investors will shy away from the large cap “tried and true” companies in the S&P 500 and DOW as some implode and will rotate to the more innovative, higher growth companies causing the paradigm shift. This major type of disruption (rotation) in the S&P 500 and DOW will cause them to underperform – possibly for several years until new companies are inducted into the index to replace the old declining ones (remember indices are backward looking, not forward looking).
What Role will Clear Capital Management Play?
At Clear Capital Management we use a combination of technologies to manage the portfolios of our clients. First, these new innovative companies are already making their way into our Investment Pool(2).
Second, our Natural SelectionTM algorithms will weed out the declining companies and select the better performing companies from the Investment Pool. This will ensure our client portfolios are exposed to the most promising sectors and those companies who are benefiting from this rapid paradigm shift.
This is, and will be, an exciting time for investors if you are on the right side of this once-in-a-lifetime paradigm shift.
We will continue to stay vigilant, improve our Investment Pool, and apply our investment selection and risk management technologies so our clients can benefit no matter what the future brings.
Footnotes
1. FAANGs – Facebook (now Meta), Amazon, Apple, Netflix, and Google (now Alphabet).
2. Our Investment Pool of about 500 stocks is created by using fundamental and technical analysis to screen over 9,000 U.S. traded equities.
DISCLAIMER
This information is provided by Clear Capital Management LP (“Clear Capital” or the Firm”), a Registered Investment Advisor Firm with a principal office in the Commonwealth of Pennsylvania, for informational purposes only. No portion of the commentary included herein is to be construed as a solicitation to affect a transaction in securities or the provision of personalized investment or tax advice. The Firm’s market discussion and investment models are based on the Firm’s proprietary research and back-tested market data. This back-tested data has been prepared with the benefit of hindsight, and the market trends and economic conditions on which these statistics are based may not endure in the future. Past performance is no guarantee of future results, as there can be no assurance that any particular strategy or investment will prove profitable in the future. Composite account performance reflects the reinvestment of dividends and other related distributions, as well as the deduction of the Firm’s wealth management fee. Any reference to a market index or benchmark such as the S&P 500 or the Aggregate Bond Index is included for comparative purposes only, as an index is not a security in which investment can be made. Indices are unmanaged benchmarks that serve as broad market or sector indicators and do not account for management fees or transaction costs generally associated with investable products. Clear Capital may discuss and display, charts, graphs, formulas and specific stocks which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. This information offers limited information and should not be used on its own to make investment decisions. Investing involves risk, including the potential loss of principal, and investors should be guided accordingly.