Over the past five years, a key driver of S&P 500 Index®3 performance (and hence, many passive management4 strategies that seek to track the S&P) has been increased liquidity from global quantitative easing; the injection of capital into the financial system by central banks worldwide. Price appreciation is typically associated with improvement in other areas, such as wage growth, increased productivity, and earnings growth. While earnings growth in the US has been relatively robust in recent quarters, wage and productivity growth rates were muted .
As a result, the continued balance sheet expansion of central banks and the ease of access to low-cost credit have helped boost stock price valuations. As central banks tighten liquidity programs – raising interest rates and withdrawing money from the system – these liquidity supports for stock prices are slowly removed.
Recent stock index performance has also likely benefited from equity investments by retirement investing programs. In recent decades, savers have outnumbered withdrawers in these programs. However, as the aging Baby Boomer generation retires, the number of withdrawers will likely begin to outnumber savers.
In April 2017, the first of the Baby Boomers reached age 70½ and began taking the 5% required minimum distribution from their retirement accounts. By 2020, when the number of Boomers receiving distributions exceeds those contributing to plans, that ratio should shift to $3 of selling for every $1 of buying. At that point, the subsequent generations that are paying into plans will likely be unable to keep pace with Baby Boomers’ withdrawals. We believe this will result in indiscriminate selling, with sellers outnumbering buyers.
How might active managers benefit?
We believe active managers stand poised to benefit from these trends. Active strategies will likely have higher fees than passive strategies. However, because passive investments derive value from liquidity rather than price discovery, active managers are likely placed to benefit from a normalization5 in the credit markets. With the reversal of quantitative easing – enhanced by Baby Boomer required retirement withdrawals – a substantial portion of stocks will likely resume responding to pricing pressures related to fundamentals and valuation.
With keen insight into prevailing macro and policy shifts and business fundamentals, skilled stock pickers have the potential to benefit as liquidity seeps out of the market. Concentrated flexible portfolios that buy securities based on fundamentals, calculated merit, and future business expectations could therefore be well-positioned for near-term shifts in the investment landscape.
1 Active management (also called active investing) refers to a portfolio management strategy where the manager makes specific investments with the goal of outperforming an investment benchmark index.
2 A market cycle is a trend or pattern that may exist in a given market environment.
3 S&P 500® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market.
4 Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio.
5 Normalization refers to policies being considered or enacted by central banks worldwide aimed at returning interest rates to a level somewhere above the near zero rate levels authorized in response to the global financial crisis.
All investing involves risk, including the risk of loss.
Unlike passive investment strategies, there are no indexes that an active investment strategy attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the portfolio manager.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.