Everyone gets it. QE, the price-insensitive bid from SWFs, debt-funded buybacks, and passive investing are all the same damn thing. It’s all one trade. It’s “Heisenberg’s Wave Paradox.”
No one can distinguish between making a good decision and a decision turning out good by virtue of your having made it. When everyone falls into that trap, it’s no longer possible to distinguish between riding the proverbial wave and creating the wave you’re riding.
This is a self-fulfilling prophecy – a perpetual motion machine. And the longer it goes on, the more people it captures until finally, everyone is (unwittingly) in on it.
We – and plenty of others – have noted that active management has begun to throw in the towel when it comes to besting passive. How do you outperform a benchmark that’s being driven by a perpetual motion machine? You can’t. And especially not when you’re playing from behind by virtue of the fact that the people replicating that benchmark are paying as little as 5bps in fees to participate.
And so, what do active managers do? Well, they just stop trading. They become passive investing vehicles themselves.
In what is one of the clearest explanations of this dynamic to date, Wells Fargo is out with a note aptly entitled “Passive Is The New QE: The Buy-Side Is On A Seller’s Strike.” Not to put too fine a point on it, but this note is hilariously blunt. Consider the executive summary:
It would be difficult to put it any more concisely than that. But it actually gets better.
“Clients have said repeatedly that any time they’ve sold or tried to reposition in the last 3, 6, or 12 months, they’ve come to regret it,” Wells goes on to write. So guess what active has decided to do? They’ve gone on a “seller’s strike.” To wit:
So if they sell, they underperform. So they simply stop selling. But by not selling, they join the perpetual motion machine. That only makes that machine stronger and thereby makes it even more impossible for any one active manager to go against the grain and sell. The result: selling has become anathema. It’s a logical impossibility.