Stock market is starting to ‘show signs of cracking and bursting’: Harvard lecturer

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The explosive growth in passive trading, a fear of missing out, and a blind faith in “celebrity CEOs” have contributed to froth in high growth tech names, according to Harvard lecturer and renowned writer Vikram Mansharamani.

Now, the author who made a name spotting market bubbles in his book “Boombustology: Spotting Financial Bubbles Before They Burst,” says another one may be about to pop.

“I believe a passive investing bubble has been brewing and may, in fact, have started showing some signs of cracking and bursting here,” Mansharamani said, speaking on Yahoo Finance’s Future of Finance. “We’ve had flows driving prices, more than fundamentals in many sectors. And part of that’s being driven by just the massive amounts of money flowing into some of these indexes.”

Passive investing, which tracks a market-weighted index or portfolio now accounts for more than half of all U.S. publicly traded equity index funds, according to Bloomberg Intelligence. The funds have seen explosive growth in part because they charge much lower fees, by virtue of the way they are managed. But Mansharamani, who is also a lecturer at Harvard University, argues the outsized influence of passive investing has led to price distortions in stocks, with the market increasingly driven by capital flows and momentum-driven algorithms.

A senior woman looking on her computer worried about her future retirement investments and finance accounts.

The stock market is increasingly driven by capital flows and momentum-driven algorithms, says one expert. [Credit: Getty]

As an example, he points to the growth in funds focused on environmental, social, and governance (ESG) issues. Driven by an increasing awareness of climate-related issues, a near $650 billion poured into ESG-focused indexes through the end of November last year, according to Refinitiv Lipper data, leading to a record 2021. But Mansharamani argues the demand hasn’t necessarily matched the supply in the market.

As a result, capital inflows from funds with ESG mandates have largely concentrated in a handful of stocks, leading to inflated valuations of firms deemed sustainably investible, he said.

“Those funds didn’t have many places that they could park as much money as they were receiving. And so those flows drove stocks to levels perhaps that they might not have had, had they not had this ESG style mania bubble, if you will, that was brewing on the side,” he said.

‘Visionary logic’

Mansharamani said valuations have been compounded by a fear of missing out, and the “power of storytelling” by celebrity CEOs, singling out Tesla (TSLA) as a prime example. CEO Elon Musk’s outsized influence in the company and his ability to sell potential investors on a “fantastic new world” has fueled the stock higher, creating a disconnect between the firm’s fundamentals and the price with which investors value the company, he said.

Social media has only elevated that.

“There’s this visionary logic, which is, it’s all in the future. It’s all coming. We’ve got full self driving, we’ve got robo taxis, we’ve got solar zones, we’ve got batteries… we’re going to Mars, and sending a car into Mars. Whatever it is, it all is believable to those who want to believe in the hill. The minute sentiment shifts, you can see sentiment shift quickly,” he said. “I think if you got rid of some of these pressures, as they’ve been supporting the stock, that maybe the stock wouldn’t be where it is.”

Recent moves in Tesla’s stock may point to that sentiment shift already underway. Shares have fallen more than 25% from the highs it reached last fall, despite the firm posting a record profit in its most recent quarter.

Other high tech growth stocks have declined alongside the electric vehicle maker on fears of higher rates, bringing valuations back down, closer to reality, Mansharamani said.

“[With] higher prices equaling more demand, you get a self fulfilling cycle going up,” he said. “By the way that’s going to happen going down as well. Lower prices, less demand, lower prices, less demand.”

Akiko Fujita is an anchor and reporter for Yahoo Finance. Follow her on Twitter @AkikoFujita

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