Bear Mkt has begun.My FIRE plans solidified.

[OldShooter]

Yes, all the passive index investors (like most people on this site) are contributing to market volatility.

Well, IMO not exactly.

Every bull market (in my 40+ years of investing) seems to end with the pundits warning of "weak hands." These are the late-arriving and naive investors who are forecast to bail as soon as the market scares them. They probably do bail, and that probably really does contribute to volatility.

So now this "weak hands" story has added the footnote that the weak hands are passive investors. Probably that is true. But the index is just a collection of stocks, so whether that collection is sold off by weak hands that hold those stocks individually (or hold stock-picking mutual funds) or by weak hands that hold a broad index, I think the result is pretty much the same. A broad range of stocks are sold as the weak hands bail out.

So, IMO no news here. Passive investors probably contribute to volatility in about the same way that weak hands have always done. No more. No less.

 

[Floridatennisplayer]

Love the Jim Morrison lyrics!

 

[copyright1997reloaded]

Well, IMO not exactly.

Every bull market (in my 40+ years of investing) seems to end with the pundits warning of "weak hands." These are the late-arriving and naive investors who are forecast to bail as soon as the market scares them. They probably do bail, and that probably really does contribute to volatility.

So now this "weak hands" story has added the footnote that the weak hands are passive investors. Probably that is true. But the index is just a collection of stocks, so whether that collection is sold off by weak hands that hold those stocks individually (or hold stock-picking mutual funds) or by weak hands that hold a broad index, I think the result is pretty much the same. A broad range of stocks are sold as the weak hands bail out.

So, IMO no news here. Passive investors probably contribute to volatility in about the same way that weak hands have always done. No more. No less.

Hypothetical: Suppose that *all* investing is passive, and is invested only in the SP 500. If so, what happens to the price of MSFT (heaviest weight) vs. BHF (Bright House Financial, 500th). Well, since all investment flow (positive or negative) is to the SP 500 index, they would retain their relative % weight. I would hope you would agree that this would be a bad thing, because over time they will likely see different outcomes that should reflect their relative prospects.

Now what happens if we go from 100% active, 0% passive to environment where the % active gets relatively small? Does the market start to lose its outcome weighing ability because net investment weights become sticky? At what percentage of blind passive purchasing/sales does this become a problem?

 

[OldShooter]

Hypothetical: Suppose that *all* investing is passive, and is invested only in the SP 500. If so, what happens to the price of MSFT (heaviest weight) vs. BHF (Bright House Financial, 500th). Well, since all investment flow (positive or negative) is to the SP 500 index, they would retain their relative % weight. I would hope you would agree that this would be a bad thing, because over time they will likely see different outcomes that should reflect their relative prospects.

Now what happens if we go from 100% active, 0% passive to environment where the % active gets relatively small? Does the market start to lose its outcome weighing ability because net investment weights become sticky? At what percentage of blind passive purchasing/sales does this become a problem?

Well, those are common criticisms of passive investing, but neither has anything to do with the topic at hand: volatility.

To your first hypothetical: It is really too hypothetical to be useful. If I gave you a hypothetical that said: "Hypothetically, if the earth stopped spinning, all the people at the equator would still be moving 1000 miles/hour ..." you would laugh and dismiss the thought. IMO your hypothetical is similar; so silly as to not be in the realm of consideration. What you are trying to make is the "price discovery argument."

To your second sally, that is also the price discovery argument. It's very popular among people wanting to criticize passive investing: If all investing is passive, price discovery cannot occur. (https://en.wikipedia.org/wiki/Price_discovery)

That's true, but it begs the question of whether all investing can/will ever become passive. And the answer is "Of course it can't and won't." for several reasons. The most fundamental reason is human nature. We are greedy and optimistic mammals. These traits mean that casinos and lotteries will never go away and it also means that stock picking will never go away. Another reason is the investment industry itself. There are probably a couple of million people whose salaries depend on customers believing the myth that stock picking works. So many customers will remain benighted and hence, will not switch to passive strategies.

Another flaw in the price discovery argument is to observe that passive funds rarely trade (like 5%-10% per year), where stock pickers with 100% or more per year turnover are common. IIRC the markets are something like 40% passive right now but passive trading is only 1/20th (5%) of market activity. So those stock-pickers are still beavering away doing their price discovery and will continue to do even when they become a minority as asset holders.

Finally, these are "tragedy of the commons" type arguments (https://en.wikipedia.org/wiki/Tragedy_of_the_commons) that are irrelevant to individuals' personal investment decisions.

 

[flintnational]

Love the Jim Morrison lyrics!

Yea, sometimes you wonder if anyone catches this stuff!

 

[copyright1997reloaded]

Another flaw in the price discovery argument is to observe that passive funds rarely trade (like 5%-10% per year), where stock pickers with 100% or more per year turnover are common. IIRC the markets are something like 40% passive right now but passive trading is only 1/20th (5%) of market activity. So those stock-pickers are still beavering away doing their price discovery and will continue to do even when they become a minority as asset holders.

I know I insulted you when I blamed passive investors.

What I should have written was to discuss ETF trading, which is used by both passive and active strategies. ETF volumes have become the tail that is more than just wagging the dog, it is violently throwing the dog around.

However, those passive investors who giveth can also taketh away, and the recent fund flows are showing they are taking away quite rapidly.

 

[corn18]

I always enjoy the reductio ad absurdum used with 100% passive investing. If we were 100% passive, there would be no volatility because there would be no trading. The S&P would be stuck at the same price all the time. Do you REALLY think that humans (and their greed) will allow that to happen? Not in my lifetime.

Carry on.

 

[Free bird]

Fed language will indicate they have achieved nirvana/neutral status with rates. A pause in rate hikes going forward. Market will climb the wall of worry as Blondies troybles mount. Risk assets acting like risk assets again is unsettling after 10 years of rehab.

 

[OldShooter]

I know I insulted you when I blamed passive investors.

Not at all. I sometimes think your logic is flawed but I don't take any of it personally.

What I should have written was to discuss ETF trading, which is used by both passive and active strategies. ETF volumes have become the tail that is more than just wagging the dog, it is violently throwing the dog around.

However, those passive investors who giveth can also taketh away, and the recent fund flows are showing they are taking away quite rapidly.

OK, the topic was volatility, you switched it to price discovery (Post 78), and now we're back to volatility. Sigh.

Re ETF trading being crazy we can agree on that. ETFs were invented to stem the flow of assets out of traditional brokerage houses and to tempt EFT holders to trade frequently -- hence enriching the brokers. Sadly, it worked. I have no idea what this frenetic ETF trading's effect on the market might be, but IMO it is a somewhat different problem than the weak hands problem. My guess is that the flash boys are involved, too, with unpredictable effect.

Here is the flaw in your logic re passive investors' effect on the market: While you are certainly correct that passive investors are starting to flee, what about the weak hands that are holding stock-picking funds and individual stocks? I think they are likely to be fleeing at a similar rate to the weak hands holding passive investments. So until you can show me that it is only the passive investors who are fleeing, you can't argue that they are to blame for the volatility. (I do understand, though, that this is a very popular argument from those whose paychecks depend on perpetuating the myth that stock-picking works.)

 

[Chuckanut]

If index funds and passive trading prove to be creating inefficiencies in the price of assets, I am sure some cleaver people will figure out how to make money on it and equilibrium will be restored.

 

[KCGeezer]

I can see Eddie Haskell scheming to take advantage of any inefficiency but surely not the Beave.

 

[Free bird]

Too many premature bear market calls. Greenspan has to be the ultimate contrary indicator. Mr irrational exuberance. He's about 3 double digit gain years early.

 

[Dtail]

Too many premature bear market calls. Greenspan has to be the ultimate contrary indicator. Mr irrational exuberance. He's about 3 double digit gain years early.

+1 beat me to it. Will take the 97-99 gains followed by 2000-02 losses.

 

[Free bird]

Rate hike followed by we've hit neutral announcement. Then get your 3.5-4.0% CDs & buy a global fund if you are light on stocks. Your buying at a discount now not at record highs. The window of opportunity is opening.

 

[HadEnuff]

After today's rally (S&P up .22, .009%) I think we're all good.

Happy Days Are Here Again!!!

 

[Free bird]

Yeah might have to look past today into the distant future. Say like the next several months.

 

[RobLJ]

Actually, I suspect the large mo-mo funds and smart money large holdings (and dark money) charge one way, the weak hands follow, rinse and repeat. That's based on holdings %. This only becomes important, however, after the fact when the momentum has decisively changed. Before, they're just skimming.



Price/earnings are now almost cloe to average levels so I'm feeling better about rebalancing stocks, as opposed to adding stocks over the last few years. If earnings continue to crater, the price action will follow, however, not making it such a deal.
But that's me.

Well, IMO not exactly.

Every bull market (in my 40+ years of investing) seems to end with the pundits warning of "weak hands." These are the late-arriving and naive investors who are forecast to bail as soon as the market scares them. They probably do bail, and that probably really does contribute to volatility.

So now this "weak hands" story has added the footnote that the weak hands are passive investors. Probably that is true. But the index is just a collection of stocks, so whether that collection is sold off by weak hands that hold those stocks individually (or hold stock-picking mutual funds) or by weak hands that hold a broad index, I think the result is pretty much the same. A broad range of stocks are sold as the weak hands bail out.

So, IMO no news here. Passive investors probably contribute to volatility in about the same way that weak hands have always done. No more. No less.