Narratives
I strongly believe that stories significantly influence our perception of the world around us. In turn, narratives sway our decision-making process. Whether it’s the stories we tell ourselves about mundane purchases (“they were 30% off”) or chronicles of the geopolitical landscape (“WWII was the war to end wars”), humans have the desire to frame decisions based on a narrative. Yuval Noah Harari, a public intellectual and author, believes that “storytelling is our superpower.” “Humans are the only species with the ability to use language – not just to describe things we can see, taste and touch, but also to invent stories about things that don’t exist.” In Sapiens, Harari posits that storytelling emerged about 70,000 years ago and has been instrumental in catapulting humans to the top of the food chain.
So, what stories are you telling yourself about your investments? About your potential risks? We all do it.
In my opinion, volatility is such a distressing term to many because it can be thought of as the process by which we reconcile the natural world with the stories we’ve told ourselves. Volatility, writ large, happens when events occur that upset the dominant narratives. Or, as Chris Cole put it, “Volatility is no different in markets than it is in life. Regardless of how it is measured, volatility reflects the difference between the world as we imagine it to be and the world that actually exists.”
Reframe
It’s easy to “reframe” the stories we tell ourselves, and the implications can be powerful. In my estimation, effort centers around the ego. In this context, I believe that “less is more.” Or, as I was told many years ago on the trading floor, “You have to want to make money more than you want to be right.” Ego can interfere with prudent risk management.
My ego motivates me to stick with investments that are as useful as four-month-old yogurt. As I’ve grown older, I understand that there’s power in saying “I was wrong” and moving on. I tend to get more productive results when my mental starting point is, “I don’t know what will happen (I could be wrong), but if _____, then I will ______.”
Most of my investments are macro-focused. I’m not unique in that regard. Data shows that portfolios are increasingly passive and designed to track an equity benchmark with some age-dependent allocation to fixed income. My personal belief is that the current and next generation of long-term investors will have portfolios that closely resemble the makeup of the Nasdaq-100 Index (NDX).
I think that recent and future grads will gravitate toward the construction of the NDX. I expect the methodology that includes the 100 largest (by market capitalization) Nasdaq-listed companies will resonate. The index encompasses a diverse range of industries and sectors that have and will (likely) continue to shape the 21st-century economy. In my opinion, the exclusion of financials from the index will be viewed positively by those who matured in the wake of the Financial Crisis.
Historically, the knock on the NDX was “tech heavy.” That was true and remains true. Let’s put some numbers around the reality. Understanding that sector weights vary through time, at present, the S&P 500 Index (SPX) has a 31.7% exposure to Technology.
Source: S&P Global
By contrast, the NDX currently has nearly 60% exposure to Technology.
Source: Nasdaq
Given the interconnected nature of the global economy, I contend that a 60% weight in technology seems appropriate. My reasoning is Socratic as opposed to quantitative. I ask myself; what part of the economy isn’t dependent on technology in 2024? My belief is that whether you’re running a small business in New Mexico, or a multinational based in New York – some form of technology powers your bottom line. Alternatively, just get into your car and imagine it stripped of any technological advances over the past decade or so. Good luck. Perhaps that’s simplistic.
Let’s look at some of the smallest (by weight) constituents in the S&P 500. They currently include Walgreens (WBA), Franklin Resources (BEN), Paramount Global- B Shares (PARA), Fox Corporation – B Shares (FOX), Amentum Holdings (AMTM) and News Corporation – B Shares. My belief is that every one of those companies is dependent on the technology providers that power the NDX.
For example, Paramount, Fox and News Corp all rely on Alphabet (Top 10 NDX holding) for marketing and engagement with their media. They may have distribution agreements with Netflix (the 11th largest NDX constituent). Walgreens almost certainly needs tech from AMD, QCOM, TXN, AMAT, MU and or PANW (all in the Top 30 for the NDX).
There’s an element of Darwinism in capitalist economies. I prefer my investments to be at the top of the food chain as opposed to being dependent on those at the top.
I believe the “survival of the fittest” is evident in a variety of longer-term performance metrics. Those higher on the food chain have been rewarded handsomely.
Performance
The visuals below plot NDX total returns and compare them to S&P 500 total returns over a handful of time horizons. NDX performance is purple, and S&P is orange. The 5-year returns include the COVID selloff from early 2020. Over that window, the NDX outperforms the S&Ps by 49% {(164.6 – 119.4)/(110.4)}. At the 10-year mark, the NDX is up 77.6% on the S&Ps. Going back to the top of the “dot com” boom from the late 90s, the NDX still handily outperforms. In fairness, it took a long time to get back to the old high-water mark after an 83% drawdown. The last comparison dates back to the inception of Nasdaq-100 Index Options (NDX) at the beginning of 1994. The spread there is stunning. The NDX has outperformed by more than 3-fold.
Source: YCharts
Putting the long term (1994) chart in different terms. If someone invested $10,000 (one time) at the beginning of 1994 in an NDX (total return) tracker, that investment would be worth more than half a million dollars today. Had they instead invested $10k in an S&P 500 (total return) tracker – the investment would be worth $124,780. There’s nothing shabby about the S&P 500 performance. It’s better than the Dow Jones Industrial Average or Russell 2000, but the NDX clearly stands out.
Source: YCharts
Mean Reversion
It’s entirely possible that the NDX outperformance over longer time frames will reverse in the coming years. If you’re concerned about a “2000-like” decline, then NDX index options might allow you to remain invested with some guardrails. Institutional and individual use of NDX index options has grown alongside the index. On average, in 2024, 1.11 million NDX index options trade per month. That’s nearly double the average monthly volumes from just two years ago.
Index options afford end users countless ways to structure a position based on their outlook. You can use them to potentially enhance portfolio yield. NDX index options could insulate a portfolio against an adverse price move over nearly any time frame. There are NDX index options that expire daily, and there are expirations listed as being more than two years out in time. The permutations are endless, like a Choose Your Own Adventure book without an ending.
My explicit goal is to help grow the use of NDX index options. As a derivative product, I believe that the success of NDX index options is largely tethered to the ascendancy of the NDX itself. The more institutional and individual end users move toward the index, the greater the need for precise risk management tools like index options. Every participant in the asset management world tells themselves a story. None of us know what the future holds, but a growing number understand the potential utility of a tool, like NDX index options, that can narrow the range of potential outcomes.
“Questions you cannot answer are usually far better for you than answers you cannot question.”
-Yuval Noah Harari, 21 Lessons for the 21st Century
