Billy Wilder was a writer, director and producer of a number of motion pictures, 7 of which won Academy Awards. In one of his last interviews, addressing statements by others that he was past his prime said, “People say Billy Wilder is out of touch with the times. Who wants to be in touch with these times?”
What makes this quotation pertinent is how matters like valuation and growth have been replaced with fund flows and momentum. The ETF industry has been front and center in this transition. Starting with the idea that index investing would reduce risk by providing diversification, it is now exponentially increasing risk due to their inability to distinguish good investments from bad and concentrating portfolios in the same manner as the associated index.
Previously, I wrote about how ten companies make up 40 percent of the Standard and Poor’s 500 Index. Investing in such an index is hardly diversification when 2 percent of the stocks make up 40 percent of the value of the index. Passive investing in indexes tends to reinforce such concentration. As more money flows into index funds, the stocks are bid up accordingly. When the time comes to reverse the trend when investors pull money out of index funds, the spiral will work in reverse. Since the average investor has no idea of how an index is invested it is assumed they will have no compunction selling the same.
Seeking Alpha columnist Lance Roberts points out that there are approximately 4,000 ETFs available, including sector ETFs and actively managed funds.1 Almost 20 percent own Apple. Even if you diversify to, say, an S&P 500 fund, a NASDAQ fund and a tech index, you will own Apple in all three. The investor, thinking he or she is getting diversification, is getting concentration instead.
What this trend has done is promote momentum investing. When a given stock goes up more than the market, computer algorithms flag it and investors buy more of it, taking the price higher still. When it goes up less than the market (or down more) the same computers duly note and investors bail. No investment analysis is involved. This type of speculation is less investing and more of a game of chicken.
Some are promoting “alternative investing” as a tonic to the market’s concentration. The problem is that alternatives are usually expensive, illiquid and thus almost impossible to manage, and are often outside the purview of the SEC. The last part is significant; some companies are trying to issue stock in cryptocurrency to evade SEC oversight.
Liz Ann Sonders, market strategist for Charles Schwab, has noted the different trajectory of stocks earning a profit from those who are not.2 Using the broader Russell 2000 Index, it has been established that 57 percent of the stocks are profitable. While 41 percent are unprofitable, two percent of the stocks did not have earnings information at this time.
Since the last market correction in early April, stocks that have earnings are up 22 percent. However, stocks that do not have earnings are up 53 percent. This is indicative of a frothy market, where people invest for gains without studying the specifics of the investment. Earnings are secondary to momentum and a good story.
How long can this go on? Longer than you think. John Maynard Keynes, who was both an economist and market investor, once said that markets can be irrational for a lot longer than you can be solvent. This was his way of saying not to bet against the crowd when things are a mania, as they are now.
At present, the best advice is to be independent of the heard. Know your investments and the rationale for them or trust someone who does. In a volatile market, income can be the difference between positive and negative returns. Do not follow those who have no idea what they are doing but profess great confidence in their ignorance. He who follows the leader must pay the piper.
A recent story by Mark Hulbert ranks the current market in the aggregate to be the most overvalued in history. This is not to say that all the market is overvalued, but with large firms taking up so much of the valuation it would seem that the index funds in particular are in for a bit of turbulence. No one can say when, but then it wasn’t raining when Noah built the Ark.
The Economy
Economic activity is distorted by the ongoing shutdown of the Federal Government. With no end in sight it would seem the adverse impact will be felt for some time. Data to calculate the economy is not being collected except by the private sector. The reasons for the shutdown do not seem to be totally economic but rather political. For this reason, it will require a political solution.
Outside of the government, it would appear that the trend for those with assets to benefit while those who do not continue. The exception is the pattern of layoffs. With AI targeting white collar employment while emigration opens jobs for blue collar workers, we may see for the first time professional workers having more job losses than laborers.
Inflation
Inflation data is bottoming out with the core rate around 3 percent. This is about 1 percent above the Federal Reserve’s goal of 2 percent inflation.
Inflation rates are expected to continue upwards next year. In talking about the tariffs being a one-time adjustment to inflation, investors overlook the fact that the imposition of tariffs is currently ongoing and subject to change. Efforts to reduce inflation by, say, bringing beef into this country from Argentina are not being well received by America’s ranchers or farmers, who are dependent on disappearing migrant labor to harvest crops. The government is already spending over $1 Trillion on interest on the debt.
Interest Rates
Interest rates are forecast to decline with the reduction in rates presumably being dictated by the Federal Reserve. It is felt that most forecasts are wrong for several reasons.
First, there is no assurance, given the trend of gradually rising inflation, that interest rates will decline across the board. Indeed, the usual trend would be for interest rates to rise on the long end of the yield curve even as they decline short-term given the inflation forecast.
Second, the demand for borrowing is set to accelerate as the deficits by the government exceeds $2 Trillion a year and the cost to build out AI continues to accelerate. There was an estimate some time ago that congress would have to raise the borrowing limit before the end of the year. If congress remains out of session, the government will run out of cash.
The Stock Market
There is an old Wall Street adage: when market hits the high, fate does not ring a bell. By this it is meant that highs (or lows) can only be discerned in retrospect after the markets changes course. At this time there are all manner of pundits pointing to the extreme valuations of the current market. Yet the market continues to grind higher, fueled by algorithm computer programs and the public’s fear of missing out.
The Wall Street Journal recently wrote an article about the funding of start-ups4. A secondary trading platform called Forge Global based in San Francisco follows firms that attain start-up funding in their area. Of the firms that attained funding in 2021, the average price per share has fallen 62 percent from the prior funding round. Start-ups that were funded in 2022 have seen a 59 percent price drop. Wall Street has fads and fashions which get discounted quickly and severely when the fad moves on to something else.
Warren M. Barnett, CFA
October 28, 2025
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