Once again, passive investors are dominating the market. Index investing, by definition, overweights whatever is most overvalued and underweights whatever is most undervalued. Passive investors don’t care about valuations. This is resulting once again in a bifurcated market, where the big money flow is not smart money, but big passive investors. Oscar Wild once said, “a cynic is a man who knows the price of everything, and the value of nothing.” The quote fits perfectly todays biggest passive investors. The capital that is trading in the market are passive flows, index flows, ETF flows. On top of that, there are the algorithms, which are trying to find out what the big money trades, reinforcing the passive trade, neglecting valuations as well. This is resulting in a massively overvalued technology sector, leading to a concentrated index portfolio, where seven stocks make up 50% of the Nasdaq index, and 10 stocks make up more than 30% of the S&P500 index. Both do not represent well diversified portfolios anymore - still the flow into passive strategies seems relentless. While most investors truly enjoy the ongoing party, there is a geopolitical development unfolding, which will affect financial markets in the coming years, but currently gets ignored by most. The isolation of Russia from the global economy has resulted in a commodity trade outside of the US-Dollar. What started with China and India buying commodities from Russia in their own currencies, seems to spread across the emerging markets space. The BHP Group is now trading iron ore in Remimbi and other big commodity producers will have to follow suit. The Chinese have prepared for this a long time ago. The Shanghai Gold Exchange is trading Gold against the Chinese currency since 2002. Emerging Markets used to have the inconvenience, that they had to buy commodities in US-Dollars, hence having the obligation to hoard or buy US-Dollars to trade commodities. Those days will soon be numbered. Brazil is the latest country that has improved its trade relations with China, especially in the grain sector, and the odds are high, that they will not trade in US-Dollars as well. The privilege, the United States enjoyed for over 80 years, owning the world reserve currency will be harmed. This will have implications not only for the currency, but also for the US Treasury Bond Market. The US could lose a big privilege, it never handled with humility. If the global demand for US-Dollars and US Treasury Bonds drop simultaneously, it will have far-reaching consequences. As the mountain of debt is skyrocketing, fueled by the coming election, the US will need creditors more than ever before. To finish on a more positive note, the US economy is doing much better than economists have predicted. The pre-election cycle should remain supportive. In Europe, things look a bit different. Uncommonly, Germany could become the achilles heel of the European Community. The pent-up demand is keeping most large companies in a pretty good shape, the question is for how long.
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