Lead-Lag Live

Fantasy vs Fundamentals: Seth Cogswell on Bubbles, Passive Flows, and What Breaks Next

• Michael A. Gayed, CFA

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In this episode of Lead‑Lag Live, I sit down with Seth Cogswell, Founding Partner and Portfolio Manager at Running Oak, to cut through the hype and examine what’s really underpinning today’s market momentum.

From zombie companies to the staggering dominance of passive investing, Seth lays out how fundamentals no longer align with price—and why the next correction may be bigger than it looks.

In this episode:

– Why today’s market strength is more fantasy than fact
– The hidden risks built into passive strategies
– The destabilizing role of concentrated index flows
– How Fed stimulus has delayed, not eliminated, downside risk
– Why mid- and small-cap names matter when the narrative shifts

Lead‑Lag Live brings you inside conversations with the financial thinkers who shape markets.
Subscribe for interviews that go deeper than the noise.

#LeadLagLive #Markets #Investing #SethCogswell #PassiveInvesting #MarketFragility #RunningOak

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Speaker 1:

Instead, if you invest where others aren't, which again nobody. Very few people are investing in mid cap, you get lower valuations because people are not driving those prices up, which implies higher potential upside and a margin of safety. So higher return, lower risk.

Speaker 2:

Welcome to Lead Leg Live. I'm your host, melanie Schaefer. Right now, investors are grappling with a strange split in sentiment. There's plenty of discomfort and uncertainty about the economy, yet money continues to pour into momentum and passive strategies, even with valuations running higher than we saw during the tech bubble. It's exactly the kind of environment where portfolio construction decisions can make or break returns. My guest today is Seth Cogswell, founding partner and portfolio manager at Running Oak. Running Oak Running Oak's approach focuses on equal weighting, mid-cap opportunity and a disciplined process designed to avoid the pitfalls of over-concentration that come with traditional cap-weighted indexes. Seth, thanks for joining me today.

Speaker 1:

Thank you for having me. I love that intro.

Speaker 2:

Thank you. So, seth, to start out really broadly, what topic is sort of most on your mind right now?

Speaker 1:

Really, you just summed it up. I feel that there is a pervasive feeling of discomfort and uncertainty for the everyone feels and yet they're investing in precisely the opposite, precisely the opposite manner. And so there's this contradiction and I've I want people to trust that feeling that they have and that unease running oak. Our strategy is simple common sense. We invest in three very obvious principles. So maximize earnings growth, because nothing drives performance like a company making more and more money while being disciplined around valuations, because the last thing you want to do is own assets. That should go down over the long run, that's worked out for a little bit recently, but over the long run, that is not a good exercise for a little bit recently, but over the long run, that is not a good exercise. And then, lastly, an overarching focus on handful of simple but again obvious metrics or qualities that clearly lead to greater downside risk. Nothing kills exponential growth like big drawdowns, and that's why we're all doing this and so avoiding that's extremely important. Our strategy, that simplicity, gives me certainty and hopefully gives our clients certainty, not necessarily in the outcome, but certainly as far as the qualities that we're investing in and knowing that we are thoughtfully investing in ways that make sense.

Speaker 1:

Meanwhile, on the flip side, people are now all in on in an uncertain world. They're effectively all in on certainty. Investing is inherently uncertain, even if you stack the odds in your favor by doing a whole lot of research and investing in a company that you think is highly likely to work out. Keywords there are highly likely, there's a chance it doesn't and the economy or the world is feels wildly uncertain and many people feel that investing is basically a sort of a derivative of the real world. Right, it reflects what's happening in the real world. So you take an uncertain world that everybody feels and senses and then you compound that with the uncertainty of investing and it's somewhat doubly uncertain. Certain Meanwhile recent numbers came out where households have more money invested in equities as far as a percentage of their net worth 20 to 30% more than they did at the tech bubble. So they're somewhat all in on equities. At the same time, according to certain numbers, over 50% of equity assets are now in passive portfolios or index funds, a lot of which people aren't necessarily thinking about. The risks that they're taking impact on the investing world and on investors, certainly relative to what was in the past as far as active management, charging two and a half percent while providing no value whatsoever.

Speaker 1:

In closet benchmarking. It's been a positive evolution, but that doesn't mean that it's the final evolution. What many miss is passive at its heart, or we'll say cap weight in construction is inherently nonsensical. If, let's say, hypothetically, we start out with a company that is fairly valued because historically there's been a belief that markets are efficient, so we start with a company that is fairly valued and that fair valuation reflects a percentage of the S and P 500. So that market capitalization that's related to that fair value results in a percentage that's allocated and let's say everything else is perfectly allocated. That's this one moment. Then, because people are trading, buying and selling stocks all day, every day someone comes in and buys it. That will push it up, because that's what happens Demand pushes the price up. Now that company, despite nothing changing, fundamentals haven't changed at all the company is now valued more highly, which means it receives a higher percentage of the S&P 500.

Speaker 1:

If you extrapolate that over the course of 16 years, in the highest momentum period of momentum ever, what you get as momentum investing is effectively something was up, so I'm going to buy more of it. Then it's up and so someone buys more of it and you get this feedback loop. You do that for 16 years. Now all of a sudden, you are massively overweight, overvalued companies and underweight, undervalued companies, just by definition. That is the way that passive investing or or cap weighting is constructed. You will always have more invested in overweight companies because are overvalued companies because they're overvalued, and you will be underweight what they should be undervalued companies because they're overvalued and you will be underweight what they should be undervalued companies because they're undervalued. And the issue with that is again, if you think of momentum, you buy because it was up yesterday and people buy yesterday because it was up the day before.

Speaker 1:

And extrapolate that over 16 years and if everybody is all in or many, I shouldn't say everybody but if over 50% of equity assets are now invested in cap-weighted portfolios or index funds, it expresses certainty.

Speaker 1:

It is people are all in expressing certainty in a wildly uncertain environment and making a bet that what happened last year or what happened over the last 15 years will continue to happen. Maybe it does, but last year momentum hit the 99.8th percentile in history. That is a one in 500 event. So if you're all in on cap weighting or index funds, or even the max seven, because there's such a massive percentage of index funds, you are investing with certainty when almost everybody feels incredibly uncertain and uncomfortable. And so it's really that juxtaposition between how people feel and, I think, how people to listen to their not necessarily their brains, but I guess maybe their souls a little bit more and actually trust themselves, as opposed to just trusting those who tell you that the market will always be up over the long run, because that is wildly misleading. It may be and it probably will be over the very long run, but that doesn't mean it will be in the next few years.

Speaker 2:

It's a really excellent explanation of the current state of the market and, as you mentioned and I did, Running Oak's portfolio is equally weighted. Why equal weighting versus alternatives?

Speaker 1:

On one hand, you can invest, you can allocate the same portfolio in a number of different ways. Some will add value, some others won't. Equal weighting puts mean reversion in your favor. So again, I feel the world's uncertain. Investing is uncertain. People are buying and selling every day, which creates noise and volatility. And if you have noise and volatility, equal weighting puts that in your favor because, as a stock has popped up for whatever reason, an equal weighting portfolio will sell that. If a stock is knocked down or lags for whatever reason, equal weighting will add to that. And so if the market's noisy and volatile, that will actually add value. Again, there's times where cap weighting adds value. If momentum is especially hot and you get this feedback loop where everything that went up yesterday is up again today, great Cap weighting will do well. But that assumes that it's going to go up, that these over value stocks will go up forever, into perpetuity. Again, equal weighting is a great way to express uncertainty because, again, it takes advantage of that noise, but also it adds diversification.

Speaker 1:

Today, more is invested in the top 10 companies in the S&P than any time in history. That's paid a lot of lead service and we're inundated with data and the same soundbites all the time, and so we tend to check out. But it's worth taking a second and just really think about that right. Whether it's advisors investing on behalf of clients, whether it's clients, people's net worth that they have worked so hard to build is massively invested in a small number of companies that are arguably highly correlated. They're all big tech, and that expresses, again, certainty, whereas equal weighting you know you might have, let's say, if you have 50 companies now, you have 2% invested in each one.

Speaker 1:

That expresses uncertainty, and and it's uncertainty and it's an alternative way to invest it puts the odds in your favor over the long run. Another good point is, prior to this last decade, equal weighting had outperformed cap weighting over every single rolling decade, every single one. It's only the last 10 to like 12 years when we've been in this sort of momentum machine driven by a number of things passive, all the stimulus, what have you but equal weighting was always the way to go. The one exception is right now or recently, and so the question is are you going to bet against history, or are you going to bet on uncertainty and history?

Speaker 2:

Yeah, and I wanted to talk a little bit about RSP. That's some P500s equal weight ETF. It's popular for investors looking to hedge against cap weighting. How does running Oaks portfolio compare to RSP?

Speaker 1:

Yeah, rsp is an excellent way to diversify from cap weighting. It's a good way to express uncertainty. The problem is does anyone believe that all 500 companies in the S&P are created equally and that they're all attractive? I don't. I think that some are probably better investments and better companies than others. If you feel that way, then RRSP, while it's better than some alternatives, is incomplete. You know, at its heart, the simplicity of our strategy is we help clients focus on traits or qualities that you know are desirable. They're clearly desirable, such as, again, maximizing earnings growth, avoiding overvalued companies or, ideally, investing in undervalued companies, investing in profitability, because making money is certainly a good thing there's no argument in that and maybe more importantly than what we help clients invest in is what we help them avoid, especially right now. So we help companies, we help investors avoid companies that are unprofitable. We help our investors avoid companies that are wildly overvalued. Right now, the top 10 holdings in the S&P, the forward P is, I think, 20% higher than the forward P of the top 10 in the tech bubble. I mean, we thought the tech bubble, I thought we would never see anything like the tech bubble again, at least not for a while. But here we are and maybe it continues, maybe it doesn't, but we help clients hedge against that and invest away from overvalued companies. We also help clients invest away from companies that have too much debt.

Speaker 1:

As individuals, we know that if we take on too much debt, it's not going to be good. We've all probably made that mistake and regret that, and companies over the last decade have taken on more debt than any time in history, no matter how you measure it. And they didn't do it to build better companies that will be more profitable and that will be able to pay that interest and then pay that principal down and then deliver profits on top of that. They didn't do that. That's what they did in the past. In the last decade they did not because interest rates were so low. Instead, they mortgaged their futures to buy back stock.

Speaker 1:

Buying back stock has some benefits as far as kind of shrinking share count, which, at least for those who are still invested, increases earnings per share. But you're adding a lot of risk, and now interest rates are a lot higher. So it was one thing to take on a bunch of debt when interest rates were lower. They're now higher and at some point companies have to refinance. That's the way debt works. Lenders only lend money for a certain period of time and then you got to go back to the table. These companies are going to have to go back to the table. Interest rates are higher.

Speaker 1:

If they roll that debt into higher interest rate debt, it's going to hurt profitability. If it hurts profitability generally, growth and profitability is an argument for higher PEs. That could bring down valuations. That won't be good. But the other thing is, as people we tend to swing from one extreme to another and again, in the last decade companies took on more debt than any time in history just to buy back stock. There's a good chance you see the opposite and companies have to sell stock to buy debt, which is not good for equity holders. So again, to kind of wrap all of that up, rsp is a great investment certainly relative, in my opinion, in the longterm versus cap weighted and S and P a 500, but are all 500 companies in there creatively? Are, or would you rather invest in desirable ones versus less desirable ones? That's what we help, help clients do, uh, and we do it in very simple, obvious manners avoiding companies with too much debt, avoiding companies that are overvalued and should go down, and so it's basically just a more thoughtful RRSP.

Speaker 2:

And so another way that you do it is focusing significantly on mid caps. Why do you think advisors should consider running Oak versus MDY or other passive mid cap exposures? Consider running Oak versus MDY or other passive mid-cap exposures.

Speaker 1:

So we invest in basically the upper mid-cap to lower large. It's important to remember that that line between mid and large is completely made up. The people that make up those lines, the multiple people, don't even agree on where that line is. But mid-cap is a completely overlooked space, kind of like your middle child. Everybody focuses on the first born. They put all the pressure on him to deliver, and then the third born you know it's the baby, you got to do it and the middle kids just left to fend for themselves. That's very much the case for mid cap. Yeah, so most allocators that I talk to and with the launch of our ETF a couple of years ago I speak with, I've had the opportunity to speak with many of the largest. They build portfolios basically in the same way. They start out with large cap growth because if you didn't have a lot of large cap growth over the last decade, you got fired, which nobody wants. And then they you know they diversify that with small cap, so you get this kind of barbell approach.

Speaker 1:

Some use SMID as sort of a one stop shop. Very few use pure MED, and so if you think of large cap growth balanced by small or SMID, it leaves this huge area between the middle of mid cap all the way up to basically the high end of large cap. So there's a lot of lip service that's paid toward the concentration risk in the S&P. What's overlooked is that same concentration risk exists in many probably the majority of large cap growth portfolios, whether they're passive or active, partially because the only way to keep up over the last decade was to try to, you know, just throw in the towel and participate. And so I use SCHG a lot, which is a Schwab large cap growth passive portfolio, as an example, because I see it so often. Schg, last I looked, had almost 60% of its portfolio was invested in only eight companies.

Speaker 1:

So people think that they're investing, thinking they're getting this diversified exposure, that their risks are, you know, somewhat being managed because you're not all in on a few companies. Turns out that's not the case. You actually have very little invested in almost the entirety of large cap growth or core, and that's sort of where we sit now. That leaves mid cap completely underinvested. And why that really matters is when people invest in something, as we talked about earlier, that demand pushes the price up. Over the last decade, again, people have been piling into large cap growth the same names and then balancing with small, and as demand pushes those prices up, it pushes valuations up. Higher valuations imply lower potential return and higher risk. Neither of those. We don't want those. Instead, if you invest where others aren't which again nobody very few people are investing in mid cap you get lower valuations because people are not driving those prices up, which implies higher potential upside and a margin of safety. So higher return, lower risk. That is an asymmetric risk return opportunity. That is what we all want.

Speaker 1:

So the other thing is mid-cap, over the last 30 years, has actually outperformed large. I think over the last 33 years. Last I saw mid it outperformed large by more than 60 basis points per year, which ends up as an aggregate of 20% more return, which is great. That's what we want. Also, according to certain numbers, large is maybe 100% overvalued, whereas mid, according to certain numbers, is actually undervalued. So if history ever repeats itself and things just go back to what made sense historically, large could actually decline 50%, while mid would have to go up. All those are great reasons to consider mid.

Speaker 1:

Now, as far as MDY, though, again going back to the RSP conversation, do we feel that every single company in? I think MDY is the S&P 400, I think. Do we feel that every single company in that index is created equally? Every single one is a great opportunity? I don't. I think some are great and some are less great, and we help clients again really focus on qualities that we can expect, or at least we would bet on delivering value over the long run, as well as avoid qualities such as too much debt, such as overvaluation, that are likely to destroy value and wealth.

Speaker 1:

The other issue that I would also mention and why I might favor, say, the Russell mid cap versus MDY, is MDY tends to be a little lower in the cap spectrum. Right, invest in smaller companies and it just seems like it's going to be a difficult road, at least in the near term, for smaller companies. There's so many because of interest rates being low, because of stimulus. There's so many zombie companies or companies that are barely hanging on that tend to be in that, like lower mid and small cap area, those are companies that you just don't want to invest in, whereas as you invest in larger and I love more entrepreneurial companies, I'm running a small business, but at this time I think that the upper mid cap area provides, again that asymmetry, higher return potential in lower risk.

Speaker 2:

There's probably lots of middle children out there watching who will enjoy this analogy. Before we wrap up, can you tell our viewers where they can go to learn more about you and your firm?

Speaker 1:

We have a brand new shiny website, running oakcom. You can also go to running oak ETFscom. I have very begrudgingly been more active on LinkedIn and social, so definitely you can check out my LinkedIn site. I've also very begrudgingly done more interviews like this. Luckily, it's less painful for many to watch than it used to be, so there's content out there that's maybe a little more targeted. That might be beneficial. So reach out or check out any of those and then also feel free to email me at seth at runningoakcom. I love talking stocks, love talking what's going on in the world, so feel free to reach out.

Speaker 2:

It's awesome. Well, thanks again for joining me, Seth, and thanks to everyone for watching. Be sure to like, share and subscribe for more episodes of Lead Leg Live. I'm Melanie Shaper. See you next time.

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Michael A. Gayed, CFA

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