Ai, Fed Policy and Peak Apple: The Perfect Storm Hits Index Funds

The Money Runner hosted by David Nelson dives deep into the heated debate between index funds and active management. There's a "perfect storm" brewing on the horizon. Ai, the Fed and Apple are colliding creating an opportunity too good to pass up. 

00:00 Index Funds vs Active Management
00:33 Change is the True Constant
00:55 The Perfect Storm
01:36 Rise of Index Funds
02:36 Interest Rates, Quantitative Easing
03:47 Ai is the New Age of Compute
05:54 Peak Apple
06:45 Active Manager's Opportunity
08:56 Call to Action

Transcript

0:03

This is going to be the first in a series of podcasts regarding the role of index funds and Active Management in portfolio construction. There are fanatics on both sides of the debate. Put ten of them in a room and very quickly it turns into a shouting match rivaled only by Trump and Biden supporters trapped in a TV studio forced to debate each other. It doesn't take long before the governor is forced to call up the National Guard. When it comes to investing. The only true constant is change. The investment world is shifting under your feet, people. If you don't feel it, talk to someone who does. We could literally be right at the apex. A moment where at some point soon we look back and say, that was the beginning of the change. The perfect storm, perfect. Because no one believes there's anything that can take down an Index Empire. Three massive storms dead ahead. Ai, the Fed and yes, Apple or colliding. Creating an opportunity. Too good to pass up. Welcome to the Money Runner. I'm David Nelson. The late Jack Bogle invented the first index fund in December 1975 and Vanguard launched its first index product in August the following year. Much of the Street put down Jack's idea, with many calling it Bogle’s Folly. It took 30 years, but by 2015, index funds had captured 30% of the market. And in a recent article by Morningstar's John Rekenthaler today, index funds are over 50. Some believe that index funds are on a trajectory to take down 70% of the market. Let's look at the title of John's article. Index funds have officially won. Yeah, it's technically true. So I guess they get a trophy. But it's also a reminder of how investment sentiment swings to extremes. Remember this one? Like I said, when it comes to investing, change is the only true constant. The first is easy. Rates are normalizing and the world of quantitative easing is all but dead. Talk to any quant prior to the financial crisis. It was like shooting fish in a barrel. Those using multifactor, fundamental and technical models were, for the most part, outperforming. And if you were any good by a wide margin. The financial crisis and the era of zero interest rate policy ended that. For the next dozen years. The most dominant factor for investors was Fed policy. It leveled the playing field, sucking all the alpha out of the market. The Fed put went even further, rewarding reckless behavior and bailing out those who made bad decisions. Gamblers made a killing, and true. Investors brought up the rear. Portfolio managers who fought the age of indexing were at a disadvantage. The longer rates stay elevated, the more differentiation and dispersion you'll see in stock performance. A.I. is the new age of compute. From the early pioneers like Jim Simons of Renaissance Capital. Portfolio managers for decades have become ever dependent on compute power to get an edge. Increasingly, quant managers will turn to generative AI to better write programs that digest massive amounts of data to help in the security selection process. This is a massive leap forward for those who are not coders. Text to code will help better develop new quant models or refine existing ones. High frequency trading microseconds can be the dividing line between making the losing money. Compute power is the Holy Grail. Speed is of such importance that some firms locate their computers at available exchanges to reduce the time it takes electricity to move from their service to the point of execution. All in the world is changing. Index funds ushered in a new era nearly a half century ago. I'm here to tell you that artificial intelligence is already changing that world. Will index funds be able to keep up with active management? That's the question, not the other way around. In a recent article by Bloomberg, Jason Hsu of Rayliant Capital an Old School Quant, he used to use six criteria to assist in stock selection. Today, he uses some 200 signals in an AI algorithm to get to the right answers. Large language models are going to change the landscape, not just for professionals, but for those at home who decide to put their individual stamp on their portfolios. The question I have is, after all is said and done, we've taken A.I. to the max with access to all. Will we cancel each other out? It's not as big a storm as the other two, but we are likely in the early innings of peak Apple. Believe me, I've been wrong on this before. Writing several articles about the demise of Apple for both Bloomberg and Newsmax. This time. I'll be a little more nuanced in my call. Apple's influence over the investing public has peaked. Might take a decade, but I doubt it will ever retake the throne as the world's largest company. Apple is currently number two and at best flatlining. All it would take is another 14% move without any help from Apple and Nvidia will pass the Cupertino giant. I suspect we'll see that this year. For active managers. Apple's fall from grace is the best news ever. Think about it this way. Even as a manager, if you decide to own a half position in Apple for whatever reason today that would be about 3%. Every time Apple underperforms by 1% relative to the S&P 500, you are picking up three basis points of outperformance. And if you had the guts to own no apple since the start of this year, you've picked up 130 basis points. That's huge. Trust me, when it was the other way around, all of us, even those who owned Apple, felt the relative drag on our portfolios. At its peak, Apple was over 7% of the index, and few managers were comfortable putting that much money in any stock, even Apple. So if you had a 5% position, which is certainly respectable by portfolio standards, that left a 2% deficit. On a total return basis. Apple was up 49% last year. Your decision to own just 5% instead of a 7% position that cost you almost a full percentage point. And if you were a poor soul who didn't have any, it cost you 343 basis points. Sure, you could have bought something else that went up more, but trust me, when the index heavyweights are going in the right direction, it doesn't take long to feel like the train has left the station. So any tool, especially one with the promise Ai seems to offer, is going to get a hard look, even from skeptics who are still reading paper copies of The Wall Street Journal. If Apple continues to underperform the tape, active managers around the world should give a special thanks to Tim Cook, who seems to have missed the biggest technology undertaking in a generation. Tim's visit to China hat in hand to pay homage to the Chinese Death Star leader Darth Xi, isn’t going to keep the company from falling behind? If today's pod gave you anything you can use, do us both a favor. Hit subscribe. And don't forget to visit my sister site, DCNelson123@Substack.com Thanks for joining, I’m David Nelson. And this is The Money Runner.