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Market Concentration Signals Need for Caution

Wed, Sep 12, 2018 - 7:40am

sheep herd

We’re currently in the longest bull market in history. Where do we go from here? This time on Financial Sense Newshour's Big Picture, Jim Puplava discusses the forces that are holding this market up, and what issues might develop under these conditions as a recession takes hold.

For related podcast, see What's Different This Time or subscribe on iTunes here.

Fiscal Stimulus Is Making the Difference

Every cycle has its own unique character, and this one is no different. The defining standout this time around, Puplava stated, is Donald Trump. He initiated a large tax cut, and Congress authorized more than $300 billion in additional spending over the next 2 years.

With fiscal stimulus at the end of what is already a long business cycle, we’re unlikely to see a turn down quite yet. The tax cuts have driven corporate profits and increased corporate cash flow. We’ve also seen record-breaking corporate merger and acquisition activity.

It’s important to remember, however, that this fiscal stimulus is coming at a time when the Federal Reserve is removing stimulus. We just don’t know what will come of that conflict in policy at this point.

“Congress came in and added $300 billion of additional spending. So it's no wonder that the economy's growing at 4 percent. Eventually, however, there's going to be a high probability that the Fed rate hikes will bring an end to this business cycle, as they always do. Stimulus has allowed — and this is just my personal opinion — the Fed to raise and hike rates more often. … Without the stimulus, in my opinion, there's no way the Fed would have gotten this far.”

Three Unique Characteristics that Threaten this Bull

Because of this substantial stimulus, Puplava noted, we aren’t likely to see a recession this year, or even possibly until the end of next year. But a recession will come. And when it does, he added, there are three things we need to keep in mind about this market.

First, we have a bubble in passive indexing. Second, we’re seeing some of the most profound financial concentration we’ve ever observed. Third, this is likely to lead to a liquidity crisis (see podcast: The Big Risk Nobody Is Talking About).

In the equity markets, Puplava noted, there are about $3.5 trillion of index mutual funds that are managed passively. In addition, a massive amount of money has gone into ETFs, most of which are passively managed. This trend toward passive investing by itself is distorting valuations and reducing overall liquidity.

There are fewer humans involved in the decision-making process, AI is taking over in many instances, Puplava stated, and the end result is, herd-like behavior is becoming more pronounced (see AI Powering Worldwide Tech Bubble and Technician John Roque: Machines Are Now in Control of the Markets).

“If you want to know where the bubble is in this bull market, it is in passive index funds,” Puplava said. “Money is going in. It is a pure example of money chasing an asset without regard to its price. Worse, it is money that thinks it is diversified, when in fact it is highly concentrated in a handful of stocks.”

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