Friday Afternoon Musings, Thoughts Into the Weekend

Been a tumultuous week. I think we learned a lesson about crowded investment spaces and herd mentality working the OPPOSITE of how it worked during the bull market of previous years.

When everyone owns the same stuff, or over owns may be a better term, and sellers emerge, everyone sells the excess. In this case, big tech. Sure tech/growth investors own it. But guess what, so do ESG funds. Top 5 holdings in Blackrock’s and Vanguard’s ESG flagships have a top 5 holdings that mirror QQQ. On the week QQQ fell 6.5% and those ESG flagships fell around 5.9% while the SPY fell 5.7%.

If everyone owns the same stuff, returns will look the same. Correlations go to 1, it all moves together. Contrarily, the ESG Orphans fell 3.6% on the week. That’s nothing to write home about, but it is relatively better. Why? Because comparatively, nobody owns these stocks.

The ESG Orphans are value idea, fundamentally sound, produce real goods, and pay decent dividends. This week MO recorded a $0.94 dividend, as a $42 stock. It carries a 3.22% weight in the ESG Orphans Index. Most importantly, they are so under owned that there are fewer excess sellers in these stocks.

As we look out to the end of Q3 and beginning of Q4, everyone should consider tax-loss selling season. A majority of mutual funds have October 31 as year-end. What stocks will be sold to realize tax-losses? It seems reasonably to think that lead candidates will be widely held stocks exhibiting the biggest losses for maximum harvesting. This points to big tech. We would add that the likelihood that the large quant funds own these tech names is quite high. Furthermore, the possibility of more rate hikes means growth revaluation and a repricing of these tech stocks could still have a ways to go.

AAPL is a 7.1% weight in the SPX and carries a forward P/E multiple of 25x. Compare that to the forward P/E of the SPX at 15.73x and the ESG Orphans at 13.1x. That is a massive divergence to consider.

To us, positioning and who owns what, and what kind reactive selling pressure between now and year-end may be the greatest risk in the market going forward. Of course, the Fed’s actions will dictate a fair bit too, but our feeling is they have lost control of the narrative that many may end up acting first based on their own P&L and the asking questions second.

Options’ expiration impacted the action on the open today. Seems some dealers were surprised that the expiration print was below 3900 this AM. That may have upset the apple cart a bit more than planned.

Next week we have the Fed and the indication is at least a 75bp hike with about an 18% chance of 100bps. Traders must always be wary of the “Fed Drift” into the meeting on Wednesday where markets tend to catch a bid, possibly short cover, into JPow’s big day. The thought is usually around, “Who knows what rabbit he pulls out of a hat.” But lately correlations have broken down, so past history says nothing of future behavior.

If the view is that the market always wants to test Jay’s mettle, then further selling ahead of the meeting could be the path. It’s a crap shoot. Just pointing out some factors at play to consider over the weekend and into next week.

I am available to talk about the content here, the markets, and the ESG Orphans. Have a great weekend.

Mark Neuman