This is a difficult cycle to understand.
The shares of Facebook, Amazon, Apple, Netflix, Microsoft and Google have all boasted strong returns over the past year, together accounting for almost half of the total return of the S&P 500, despite making up only 15 per cent of market capitalisation. Is this a bull market or a bubble?
In the current market, it is investors’ fear of losses – against their desire not to miss out on gains – that is fuelling price distortions. And new investment vehicles are amplifying the effect.
The saying goes that history doesn’t repeat, but it rhymes.
Today’s exceptional growth in US technology stocks is quite different from the late 1990s bubble, when media and telecommunications companies took the lead amid a flurry of highly priced IPOs.
Whereas most bull markets and bubbles are driven by investors’ focus on capital gains, and their subsequent fear of missing out, this market is driven by a powerful desire to avoid capital loss, with investors still bearing the scars of the financial crisis.
Confidence has also been dented by the highly uncertain economic outlook – a perception amplified by a political landscape of unprecedented instability.
As a result, securities that offer certainty of yield (irrespective of the underlying assets) or certainty of growth (the tech mega-caps) have attracted the largest flows.
Yet collectively, this risk-averse behaviour has driven asset prices to alarming levels. So prices of apparently safe, stable assets have soared, meaning long term asset owners face a remarkably challenging market.
It’s common for asset price booms to eventually draw in investors who were initially sceptical. This was certainly true of the original tech boom, when the sceptics on the sidelines were forced to join the party.
But this time, it is not just sceptics joining the fray and pushing prices ever higher. More important is the boom in vehicles, such as passive funds and quant strategies, which represent a desire for low-cost access to the markets and nothing more.
The cautious investor mindset is also reflected in the growth of low-volatility strategies. They aim to achieve modest absolute returns through investing in low-volatility assets, reducing the risk of a loss of capital.
Yet the volatility of certain assets is low because investors are persistently flocking towards them.
What appears to be happening now is that the sustained inflows into tech mega-cap stocks in the US are fuelling a self-perpetuating cycle.
Remarkably, these stocks are currently less volatile than consumer staples or utilities, prompting increased exposure within minimum-volatility strategies.
Understanding this helps to explain the performance of the tech mega-caps in the US.
There is little doubt that investors would do well to heed warnings about many asset prices.
It may be that the alarm is being sounded early, but there are certainly enough examples of allocations shifting to riskier assets – and of riskier assets becoming mainstream – to give us pause.
It is also important to consider the dominant investor psychology, because by looking at the motives of significant actors, we can assess the gains made in recent years.
In contrast to the previous tech boom it is a broad-based flight to safety and capital loss aversion that is fuelling the rise in US tech giants’ shares.
If this is the case, and we are approaching the end of the post-financial crisis bull market, it could well be that stocks which are unattractive to those with a strong aversion to capital loss may paradoxically prove to be the most resilient.
In other words, if the price of avoiding volatility is elevated, investors could actually benefit from taking on the volatility that others reject.