According to Harvard lecturer and renowned writer Vikram Mansharamani, the explosive growth in passive trading, a fear of missing out, and blind faith in “celebrity CEOs” have all contributed to the froth in high growth tech names.
Now, the author who made a name for himself spotting market bubbles in his book “Boombustology: Spotting Financial Bubbles Before They Burst” predicts that another one is on the way.
“I believe a passive investing bubble has been brewing and may, in fact, be cracking and bursting here,” Mansharamani said on Editorials99 Finance’s Future of Finance. “In many sectors, flows have driven prices more than fundamentals.” And a large part of that is due to the massive amounts of money flowing into some of these indexes.”
According to Bloomberg Intelligence, passive investing, which tracks a market-weighted index or portfolio, now accounts for more than half of all publicly traded equity index funds in the United States. Because of the way they are managed, the funds have seen explosive growth, in part because they charge much lower fees. However, Mansharamani, a Harvard University lecturer, contends that the outsized influence of passive investing has resulted in price distortions in stocks, with the market increasingly driven by capital flows and momentum-driven algorithms.
He cites the rise in funds devoted to environmental, social, and governance (ESG) issues as an example. According to Refinitiv Lipper data, nearly $650 billion was poured into ESG-focused indexes through the end of November last year, resulting in a record 2021. However, Mansharamani contends that market demand has not always matched market supply.
As a result, capital inflows from ESG-mandated funds have largely concentrated in a few stocks, resulting in inflated valuations of firms deemed sustainably investible, he claims.
“Those funds didn’t have a lot of places to park as much money as they were receiving.” And so those flows drove stocks to levels that they might not have had if there hadn’t been this ESG style mania bubble brewing on the side,” he explained.
Mansharamani stated that valuations have been exacerbated by a fear of missing out, as well as the “power of storytelling” by celebrity CEOs, citing Tesla (TSLA) as an example. Elon Musk’s disproportionate influence in the company, as well as his ability to sell potential investors on a “fantastic new world,” has fueled the stock’s rise, creating a gap between the firm’s fundamentals and the price at which investors value the company, he claims.
That has only grown as a result of social media.
“There’s this visionary logic to it all, which is that it’s all in the future.” It’s all going to happen. We have full self-driving cars, robo taxis, solar zones, batteries… and we’re going to Mars and sending a car there. Whatever it is, those who want to believe in the hill will find it credible. “You can see sentiment shift quickly the minute sentiment shifts,” he said. “I believe that if some of these pressures that have been supporting the stock were removed, the stock would not be where it is.”
Recent movements in Tesla’s stock may indicate that a shift in sentiment is already underway. Despite the company posting a record profit in the most recent quarter, shares have dropped more than 25% from their highs last fall.
Other high-tech growth stocks have fallen alongside the electric vehicle maker on concerns about rising interest rates, bringing valuations back down to earth, according to Mansharamani.
“You get a self-fulfilling cycle going up with higher prices equaling more demand,” he explained. “By the way, that’s also going to happen going down.” Lower prices, lower demand, lower prices, lower demand, lower prices, lower demand.”