1st Quarter 2018 Commentary

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The value of the entire stock market relative to GDP – perhaps the most fundamental valuation measure – is pretty much at an all-time high; interest rates aren’t much above their recent all-time lows; the Federal debt/GDP ratio, despite one of the lengthiest economic recoveries on record, is at a high exceeded only in the immediate aftermath of World War II. Yet, despite this traffic jam of systemic risks, and for whatever reason, investors feel sufficiently at ease that they don’t require a real interest rate above zero, or lower stock valuations, as if there financial markets rest in a comfortable equilibrium.
But one of the systemic risks to the stock market, the continued rapid expansion of large scale passive investing, rests on such a faulty – and unexamined – foundation that it might raise eyebrows upon a little reflection. A basic presumption of indexation – its use of the free-rider principle, of the price discovery function that active management provides – is that indexation’s share of float, of the shares not held by insiders, remains a minority of the available shares in the market. Not so. The definition is methodologically wrong, and in a way that can (and, we’ll suggest, has already done so) seriously distort major-company share prices.
The indexation community is likewise operating under a serious methodological error in their security weighting approach. And also in a way that can (and we’ll suggest has) seriously distort major-company share prices.
Also, a review of some additional inflation-beneficiary, non-correlated holdings in our portfolios.

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