Hannibal the Carthaginian general was one of the greatest military strategists of all times. The city of Carthage in ancient Roman times was in the spot of modern-day Tunis, in Tunisia. Hannibal was so feared by the Romans that a common Latin expression to express anxiety about an impending calamity was “Hannibal ante portas!,” which means “Hannibal is at the gates!” He studied his opponents’ strengths and weaknesses, winning battles by playing to their weaknesses and to his strengths.
One of Hannibal’s most remembered achievements was marching an army that included war elephants over the Pyrenees and the Alps to invade Italy at the outbreak of the Second Punic War. He occupied much of Italy for 15 years but was unable to conquer Rome. A Roman general, Scipio Africanus, counter-attacked in North Africa, forcing Hannibal to return to Carthage, where he was decisively defeated by at the Battle of Zama. Scipio had studied Hannibal’s tactics and devised some of his own to defeat his nemesis.
So far, the current bull market has marched impressively forward despite 56 anxiety attacks, by my count. They were false alarms. I remain bullish. My long-held concern is that the bull market might end with a melt-up that sets the stage for a meltdown. The latest valuation and flow-of-funds data certainly suggest that the melt-up scenario may be imminent – or underway. Consider the following:
(1) Valuation Melt-Up
The Buffett Ratio is back near its record high of 1.81 during Q1-2000. It is simply the US equity market capitalization excluding foreign issues divided by nominal GDP. It rose to 1.69 during Q4-2016. It is highly correlated with the ratio of the S&P 500 market cap to the aggregate revenues of the composite. This alternative Buffett Ratio rose to 2.00 during Q1 of this year, matching the record high during Q4-1999. It is also highly correlated with the ratios of the S&P 500 to both forward revenues per share and forward earnings per share. All these valuation measures are flashing red.
(2) ETF Melt-Up
The net fund flows into US equity ETFs certainly confirms that a melt-up might be underway. Over the past 12 months through April, a record $314.8 billion has poured into these funds. That was led by funds that invest only in US equities, with net inflows of $236.4 billion, while US-based ETFs that invest in equities around the world attracted $78.4 billion in net new money over the 12 months through April.
Some of the money that went into equity ETFs came out of equity mutual funds. Over the past 12 months through April, net outflows from all US-based equity mutual funds totaled $155.3 billion, with $163.7 billion coming out of US mutual funds that invest just in the US and $8.4 billion going into those that invest worldwide.
So the net inflows into all US-based equity mutual and indexed funds totaled $159.4 billion over the past 12 months, $72.7 billion going into domestic funds and $86.7 billion into global ones. These totals don’t seem to be big enough to fuel a melt-up. However, the shift of funds from actively managed funds to passive index funds is significant and could be contributing to the melt-up. That’s especially likely since money is pouring into S&P 500 index funds, which are market-cap weighted. This may partly explain why big cap stocks, like the FAANGs, are outperforming assuming that money is coming out of mutual funds that are underweight the outperforming FAANGs.
(3) FAANG-Led Melt-Up
The market cap of the FAANGs is up 41.4% y/y to a record $2.49 trillion, while the market cap of the S&P 500 is up 14.3% to $20.95 trillion over the same period. The FAANGs account for 27.8% of the $2.6 trillion increase in the value of the S&P 500 over the past year. The FAANG stocks now account for 11.9% of the S&P 500’s market capitalization, up from 5.8% on April 26, 2013. Collectively, over this period, they’ve accounted for $1.6 trillion of the $6.9 trillion increase in the S&P 500! Their collective forward P/E is now 27.1 and 42.8 with and without Apple (NASDAQ:AAPL), respectively. The S&P 500’s forward P/E is 17.7 and 16.9 with and without the FAANGs. These elephants continue to sprint up mountains, leading the market’s bulls, even though the air is getting thinner.
