The Passive Indexing Trend Is An Unstoppable Freight Train

The automatic buying of passive funds has warped the stock market, where stock prices have become largely disconnected with the companies they represent. This has created an enormous equity bubble that has blown past all prior measures of valuation, making U.S. stocks the most expensive in history.

However, unlike past bubbles like dot com Internet frenzy of 1999/2000, this bubble has been harder to kill than a vampire, because it is on autopilot. As this overvaluation persists over a long time, investors gain confidence that the market can never go down for long — evidenced by the “buy the dip” mentality of recent years. And the bubble gets bigger. As active funds underperform because all the money is flowing into the indexes, more money comes out of active funds in a self-reinforcing cycle.

You don’t need to take our word for it. Several brilliant people in finance and academia, chiefly Michael Green at Simplify Asset Management, have detailed the large distortions that passive investing has caused on the stock market. Since Mr. Green is one of the leading figures analyzing the effects of passive investing on the market, we cover many of his presentations and interviews on our site.

After Mr. Green began popularizing his research, around 2019-2020, the academic community became more interested in the topic, with a multitude of papers released in the last few years. You can find links to these studies on our website.

The big indexing firms take in billions from automatic deductions from workers’ paychecks that are invested into index funds held in 401(k) accounts. Money flows in every pay period, like clockwork.

So there is automatic buying of every stock in the index, which is typically the S&P 500. Passive funds almost never have net outflows, which means it is almost never the case that more money is exiting these funds than entering them. So their buying pressure on the market has been 99% positive throughout passive funds’ existence.

In fact, according to Mr. Green there were only a few days in history when index funds sold some of their holdings. Some of these occurred in March of 2020, which coincided with some of the most violent down moves in the market’s history.

This is not a coincidence.

Next Page – The Passive Indexing Endgame