The RIC Report from BofA updates are available to our regular subscribers. Subscribe here or get a one week trial.
The RIC Report Outlook from BofA: where are the customers’ killer apps?
The bull case for equities looks stronger: profits growth is broadening as 89% of stocks are expected to have positive EPS by Q4 and the ISM PMI moved to expansion (>50) for the 1st time since Oct’22. Bear case: great AI expectations of 17-20% EPS growth could falter if training data runs out, macro turns stagflationary, or customers say “enough!”
Passive dominance raises the stakes for investors
Passive funds dominate with 54% market share; since most are market-cap weighted, flows to passive funds exacerbate market concentration (Exhibit 1). Just five stocks comprise >25% of the S&P 500. Systemic concentration raises the stakes: passive disregard for valuations & fundamentals means big upside from innovations (US 11%/yr. vs. RoW 6%/yr since ‘87) but big risk in a bust cycle (Nifty Fifty, dot com).
How passive funds came to power
Passive dominance is a creation of law. Some rules ensure out performance by passive (e.g. the ‘40 Act); others expand demand for equities. The overlooked link to the real economy is that passive flows give market leaders a lower cost of equity, and legalized buybacks help them buy competitors & hire the best labor.
Three things to do about it
High valuation & concentration alone are not good reasons to sell: returns are similar in years with rising & falling concentration, and the US looks better than many others. But watch equal- vs. cap-weighted returns for signs of a shift. Portfolios of high-quality stocks have outperformed passive indexes across market cycles, sometimes with no Mag 7 exposure. Finally, risk management is key: see our interview with Derek Harris about the risk approach that makes his team indifferent to concentration.
BofA RIC Report updates and other pdf research reports from top investment banks are available to our regular subscribers. Subscribe here or get a one week trial.