Those dangerous index funds!

[audreyh1]

I saw two points being made. One was that retail investors do not matter, and the other than the fact that people invest in indexes does not matter.

Individual investors directly hold 38% of the market at least as of 2013. It is enough to matter, especially since stocks are priced at the margin.

Passive holdings (ETFs and index funds) are north of 40% of equity holdings, and growing, having tripled since 2007.

I would argue both of these facts matter. A lot is being written on the impact of index investing versus stock picking. Most of that I see being written is wondering the impact on pricing long-term and in a big selloff. I am not seeing too much suggesting it will not matter.

But it may not. We don't know.

Those were not my points. My point was that it’s overwhelmingly the institution/big traders that cause the extreme volatility during market disruptions. I didn’t say anything about who didn’t matter.

 

[OldShooter]

The big guys have been using indexes and index futures to slam the markets around during/causing disruptions for the last 20 years. ...

Sorry, I don't buy the logic. Institutions are strictly money-motivated. "Slamming the markets around" and "causing disruptions," if it exists at all, would be a side-effect, not an objective. Yes, I have read Flash Boys.

... My point was that it’s overwhelmingly the institution/big traders that cause the extreme volatility during market disruptions. ...

I have no idea whether that is true or not. And I think its veracity also depends on who is categorized as "institutions/big traders." For example, does Vanguard fall into that category when their investors are net sellers or buyers, resulting in big trades? Do you have a reference or a link to back up your statement?

 

[Gotadimple]

Well one of the problems being that some of the biggest ETFs only have a small number of stocks in them. Many people think they are "diversified" because they are buying 3 or 4 of them without looking at the overlap and the ETFs seem to have a lot of group think going on.

It depends on the ETF. Those with a limited number of stocks are focused on a speciality index. Just like speciality MF they can be volatile (and expensive), but EFTs focused on broad market indices do provide a great deal of diversity (at a lower expense ratio). The buyer has to understand the index they are buying.

- Rita

 

[NW-Bound]

Sorry, I don't buy the logic. Institutions are strictly money-motivated. "Slamming the markets around" and "causing disruptions," if it exists at all, would be a side-effect, not an objective. Yes, I have read Flash Boys.

When I was still working, whenever the market jumped around quite a bit, a colleague always complained that the market was "manipulated", and how else it jumped around for no apparent reasons. I said that the market had many big players. If one tried to dump stocks to depress the price, and the stocks deserved to be higher, another institution would pick up these cheap stocks and make profits at the expense of the stock dumper.

He was not convinced. So, I said how about you trading opposite the stock manipulators to teach them a lesson. Let them sell low/buy high, while you do the reverse?

I have no idea whether that is true or not. And I think its veracity also depends on who is categorized as "institutions/big traders." For example, does Vanguard fall into that category when their investors are net sellers or buyers, resulting in big trades? Do you have a reference or a link to back up your statement?

Is there a compilation of the trades originated from the individuals vs. the entire market volume? If a person logs into his Vanguard or Fidelity 401k/IRA to sell his MF, does that trade get logged as an "institutional trade"? I am very curious.

In 1999 during the dot-com mania, I read the lament of an active MF manager. In an interview, he said that he tried to avoid dot-coms and keep some cash as a margin to meet redemption if the market went south. His shareholders called in to berate him for not matching his competitors' performance and not loading up on "hot stocks". Also, seeing that he held cash, they scolded him that they sent money for him to invest, not to sit on it.

And so, without much cash on hand, when the market went south, people started to call in for redemption, MF managers had no choice but to sell into a falling market to get cash. MF managers are a lot smarter than their clients, but they have to follow their clients' wishes. Tough job.

 

[Big_Hitter]

long live Boho!

 

[DrRoy]

I thought the argument was that ETF's can be traded at any time, rather than only at the close, so some people might panic and sell intraday.

 

[audreyh1]

Sorry, I don't buy the logic. Institutions are strictly money-motivated. "Slamming the markets around" and "causing disruptions," if it exists at all, would be a side-effect, not an objective. Yes, I have read Flash Boys.

I have no idea whether that is true or not. And I think its veracity also depends on who is categorized as "institutions/big traders." For example, does Vanguard fall into that category when their investors are net sellers or buyers, resulting in big trades? Do you have a reference or a link to back up your statement?

I didn’t say slamming around markets was the objective. It’s the consequence of their large volume style of trading and hedging.

I wasn’t referring to an institution like Vanguard. I was referring to program trading and algos, hedge funds, financial companies that do their own in house trading, etc.

I’m using my own observations of stock market behavior over the past 30 years. Things always eventually go to extremes. A position gets way overcrowded. Or some other algo nuttiness such as Long Term Capital Management. It falls apart at some point and has wide market repercussions - sometimes seriously so, sometimes just extra market volatility. There are questions about whether the VIX was manipulated recently. https://www.marketwatch.com/story/h...-used-to-manipulate-vix-fear-gauge-2017-06-19 . https://www.wsj.com/articles/wall-s...-of-vix-a-popular-volatility-gauge-1518547608

IMO the retail investor contributes little to the very short term madness. Sure, longer term they contribute selling pressure or buying pressure.

 

[NW-Bound]

I think it is true that small investors are not the cause of toppling. But they are easily spooked, and the stampede makes it a lot worse.

 

[NW-Bound]

From a recent article in Bloomberg:

Whatever the role of computers and automated traders as markets bucked and recovered, the events had a recognizable human ring. Investors -- many of them of them newly christened, going by account data at discount brokerages -- sent $16.4 billion to U.S. stock mutual funds and ETFs between Jan. 2 and the market peak of Jan. 26, EPFR data show.

It was a decision they quickly reconsidered. Spooked by signs of inflation, shocked by the sight of traders unwinding bets against volatility, clients pulled almost $27 billion from the same set of funds in the next nine sessions. One security, the SPDR S&P 500 ETF Trust, saw $23.6 billion withdrawn in one week, separate data compiled by Bloomberg show.

Note that $23.6B out of $27B converted to cash came from the granddaddy S&P ETF.

As more and more people are indexing, this should not be surprising. Instead of selling individual stocks as they did on the old days, now they are dumping the entire S&P 500.

By the way, the people who dumped stocks during the rout may not be the same people who bought in January. The sellers may simply be rebalancing, trying to lock in whatever gain they still have. We will never know how many sellers were January buyers.

 

[OldShooter]

... Instead of selling individual stocks as they did on the old days, now they are dumping the entire S&P 500. ...

Yes. In the old days, in aggregate, they also held and sold the S&P 500 but that the mix was different. Each seller dumped a larger quantity each of a smaller number of stocks but in aggregate it was the same thing as if everyone sold an index fund. The point of the thread is that indexing or pre-indexing, the effect of the weak hands' selling is roughly the same.

The only way it could be different is if their mix of stocks in the old days was dramatically different than the S&P. I doubt that is the case, because at 80% of the market, the S&P comprises the familiar stocks that novice investors would probably have been buying before index funds came along.

Edit: Oops, sorry. This post is pretty much a repetition of post #21.

 

[njhowie]

The fact that most indexes are cap weighted does not really change the discussion. When you own individual stocks and you sell, you pick and choose. If you own and index and sell, you are selling all the components at one time.

However, you "own" more (dollarwise) of the largest caps and are selling more of it relative to all the other components.

I believe that we have not begun to see, nor can we envision the extent of what might happen when the market enters a prolonged bear cycle. As things go today, we hear of the big inflows to Vanguard and they obviously cause big buying in the index component stocks...and again, with the bulk of the money going in to those top components of the index...Apple, Microsoft, Facebook, Google, Amazon. This causes an upward spiral - the buying pushes the index higher, entices more folks to throw more money into it, lather/rinse/repeat.

Technically, it works the same on the way down as on the way up. The only question is, what will be the trigger which causes Vanguard to begin seeing net outflows over an extended period?

I believe the stock market gets way too much airtime these days. Folks are becoming much more dependent on it than they should.

 

[OldShooter]

... I believe the stock market gets way too much airtime these days. Folks are becoming much more dependent on it than they should.

Agreed, but in my experience bull markets are always like that. The more things change, the more they stay the same.

 

[NW-Bound]

Yes. In the old days, in aggregate, they also held and sold the S&P 500 but that the mix was different. Each seller dumped a larger quantity each of a smaller number of stocks but in aggregate it was the same thing as if everyone sold an index fund. The point of the thread is that indexing or pre-indexing, the effect of the weak hands' selling is roughly the same.

The only way it could be different is if their mix of stocks in the old days was dramatically different than the S&P. I doubt that is the case, because at 80% of the market, the S&P comprises the familiar stocks that novice investors would probably have been buying before index funds came along...

The easiest and simplest thing to check is how the mid-cap and small-cap segments did compared to the S&P 500 which is all large-cap.

I just did that. All went down a bit more than 10% from 1/26 to 2/9, and tracked each other quite well along the way. So, it was wholesale selling across the entire stock market.