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This guest commentary was written by Mike O'Rourke of JonesTrading

The Most Crowded Trade in Market History? - z 3 zaz11

It may finally be safe to say that the S&P 500 is officially the most crowded trade in the history of financial markets. 

Bloomberg reported today that according to data compiled by Morningstar, passive assets under management rose to $4.27 Trillion moving ahead of the $4.246 Trillion managed by active managers.  While we were likely destined to reach this point eventually, there is little doubt in our mind that a decade of ultra-accommodative monetary policy accelerated the trend. 

As we noted a couple of weeks ago, the S&P 500 has compounded at nearly 18% per annum since the March 2009 lows. 

The price appreciation ex-dividends, has been more than 12%, well ahead of the long term average of 6.3% dating back to 1928.

The Most Crowded Trade in Market History? - 9 12 2019 10 11 25 AM

Admittedly we are measuring versus a historic low, but most other times long term returns achieved such lofty levels, they were measured against key troughs.  For example, the 1997-1998 peaks were measured again the aftermath of the 1987 crash, the 1991 peak measured against the 1981-1982 double dip recession, etc.  Regardless, with such remarkable broad market returns over the past decade, passive strategies became magnets for flows.

Why would investors even bother with active managers?  Historically, the financial markets had some connection to economies and business.  Active managers offered different alternatives for investors to position for different parts of the cycle. 

Active managers also represented the opportunity to find hidden gems whose values would eventually be recognized by markets.  Over the past decade, central banks have made it their mission to use asset purchases to buttress financial markets, especially equities.  Although most central banks did not purchase equities, equity weakness elicited a policy response. 

We are living in such an era right now.  The S&P 500’s 6.2% decline last year prompted the FOMC to reverse policy and start easing in an economy with 5 decades low Unemployment and GDP growing 60 basis points faster than the FOMC’s own foretasted long run potential. 

Needless to say, if the central bank is continually responding to any weakness in the S&P 500, owning the S&P 500 has a large probability of becoming the most crowded trade in history.   

If there is any doubt that this is the most crowded trade, just look at the S&P 500’s annual cumulative advance decline for this year. 

The Most Crowded Trade in Market History? - 9 12 2019 10 11 56 AM 

The trade war escalated to new heights and earnings have disappointed since Q3 of last year.  These headwinds should impact stocks, instead, the cumulative advance decline this year is stronger than any year since 1997. While it has served investors well (as it grew to essentially be the largest position in the market), one must recognize it is a flow driven trade. 

Investors need to recognize a flow driven trade cannot be the largest position in the market without significantly dislocating the market pricing mechanism. This is yet another example of central banks being ignorant of the unintended consequences of their activist policies.

EDITOR'S NOTE

This is a Hedgeye Guest Contributor research note written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.