Interesting Prediction about Indexing

Bogle's Folly chapter 39?
 
Not sure I fully agree with the article. I think it is an apples to oranges analogy. The subprime crisis was made worse (or could argue created) by packaging and selling loans that should never have been made, at supposedly better risk rates than they should have. It created false value, which when that bubble burst had nothing to back it up.



Index funds are based on an underlying value of the stocks. I do not think there is any false created value. I do agree that the funds may increase volatility, since there is a small amount of the actual fund traded that sways the entire fund total. With computer based trading, it can create a over-reaction and sell-off. There could be a bubble of some effect, but even if it bursts, there is underlying value to minimize the result of the bursting bubble.
 
It doesn’t take much to create price discovery. There will always be arbitrageurs.
 
audreyh1 said:
It doesn’t take much to create price discovery. There will always be arbitrageurs.
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I do contemplate whether there is real price discovery or not.

Let’s take the S&P 500. The stocks in it are chosen somewhat qualitatively (ie not a fixed formula for entry or withdrawal from index) and huge chunk of these stocks are owned by index funds.
It is documented that a stock will automatically go up when it is added to the index and down when removed.
https://www.investopedia.com/terms/s/spphenomenon.asp

So is the price discovery for members of this index real or not?

Maybe there is a temporary price effect because of buying and selling but then it goes away?

At what percentage of index funds owning equity would price discovery not work? Why?

I guess price is set by buyers and sellers NOT holders so maybe that is part of it?
 
Not sure I fully agree with the article. I think it is an apples to oranges analogy. The subprime crisis was made worse (or could argue created) by packaging and selling loans that should never have been made, at supposedly better risk rates than they should have. It created false value, which when that bubble burst had nothing to back it up.

+1 w/454. Mixed into those "toxic assets" were the suddenly popular interest only (for a fixed period) loans and the 40 year mortgage. Nothing inherently wrong with either concept, but they were also directed at consumers who likely had little or no credit quality WRT obtaining a mortgage.

We sold a house in 2004 and another in 2006. In both cases, we were looking across the table at some very sketchy loan candidates. However, both closed without issue. In each case, the buyers brought 2 checks to the closing; one for 20% and another for the balance (no SITG - basically renters)). Shortly after the economic tsunami, both properties were bank owned.

Giving credit to wholly under qualified consumers drove real estate prices (artificially) into the stratosphere. I don't see any correlation with index funds. YMMV.
 
I think the ratings agencies had a bigger part in the bust than generally given (non) credit for. They were in the pocket of the packagers that sliced & diced until small enough deals could be made. IIRC the ratings agencies knew (and I believe told) what the rating needed to be.

If the raters had been truly independent they could have held the line on foreclosures
 
Scrapr said:
I think the ratings agencies had a bigger part in the bust than generally given (non) credit for. They were in the pocket of the packagers that sliced & diced until small enough deals could be made. IIRC the ratings agencies knew (and I believe told) what the rating needed to be.

If the raters had been truly independent they could have held the line on foreclosures
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Yep - can’t believe the ratings agencies came out unscathed.
 
audreyh1 said:
Yep - can’t believe the ratings agencies came out unscathed.
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Too many organizations and people came out relatively unscathed. I can understand that some organizations were too big to be allowed to fail but I can't accept that any individuals were too big to suffer consequences. We really dropped the ball and we'll suffer the consequences.
 
Just for the sake of argument say Burry is correct, how would you posture your equity investments that were in index finds ?
 
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BeachOrCity said:
At what percentage of index funds owning equity would price discovery not work? Why?

I guess price is set by buyers and sellers NOT holders so maybe that is part of it?
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People forget that the late Bogle, the father of index investing, brought this up late last year.

He wrote an article for the Wall Street Journal in Nov 2018, which requires a subscription to read.

The summary of the article reads
"The father of the index fund says it’s probably only a matter of time before they own half of all U.S. stocks; ‘I do not believe that such concentration would serve the national interest’"
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He said the reason for this was that index fund managers would then hold a majority of voting rights on public companies. And such concentration of control power would not be good.

See: https://www.wsj.com/articles/bogle-sounds-a-warning-on-index-funds-1543504551.




Even earlier, in June 2017, at an interview at a Berkshire Hathaway annual meeting, Bogle already said the same thing, but regarding price discovery and fair evaluation of individual stocks.

“If everybody indexed, the only word you could use is chaos, catastrophe,” Bogle told Yahoo Finance at the Berkshire Hathaway annual meeting last month. “The markets would fail,” he added.
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He went on to suggest that with indexing at about 75% of market, market instability might happen.

See: https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01.
 
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I agree with the posters above. More indexing might squeeze out some analyst jobs, and the market may be more volatile because there are fewer people making buy/sell decisions, but I don't see the parallel to the mortgage bubble.

The underlying mortgages had less value than advertised. The CMO bonds dropped because the mortgages didn't pay off. Some of the firms holding those bonds thought they had matched their liabilities, but they had too little capital to cover the losses. Can't see that with stocks.
 
BeachOrCity said:
I guess price is set by buyers and sellers NOT holders so maybe that is part of it?
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I forgot to expound on this some more.

What Bogle finally acknowledged was that indexers buy/hold/sell an entire market, and if they become the majority, it can get bad. It does not matter to them if a stock is good or bad. There is no longer reward for good companies, nor penalty for bad companies.

We saw this already in the 2008-2009 market fiasco. Instead of dumping only the financial stocks, the entire market dropped as people bailed out en masse. When John Doe got scared and sold his index fund, every stock went down. There's no way for an indexer to get rid of just the bad stocks.

People say, but then active investors will sort things out, and buy the good stocks to save them. What if there are no longer enough of them to carry out this Herculean task? :)
 
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I think lots of people panic and sell everything indiscriminately in their scramble to “get out” when crashes happen - indexes or not.

And speculating individual investors as well as professional investors get hit with margin calls and have to sell whatever is still up, so good stocks get taken down with bad. We see this during any market disruption. Index funds didn’t change this.
 
Depending on what your withdrawal strategy is this indexing issue may not matter.

My withdrawal strategy is to only spend the dividends. So, it doesn't matter if stocks tank. What matters is that any turnover I have in my portfolio due to the algorithm used to construct the index does not hurt me. If you are using a total market strategy weighted by market cap, and your withdrawal strategy is to only spend dividends, then your immune to this issue with one caveat.

The one caveat is that you could still lose out if a bunch of private equity starts to take companies private at unfair prices. We actually have something like this going on right now in the MLP sector.
 
My DD knows Burry's investment approach. Several years ago she observed that he has a great analytical mind but doesn't have the personality to work as a team member in a firm such as a venture capital partnership. That isn't his strong suit.

Frankly, I have been concerned about just what Burry is writing about. I was wondering if the index funds owned the stock in the index. Recently I purchased an ETF that doesn't focus on firms found in major indexes. That doesn't mean that it won't seriously sink if the market goes down but, God willing, those firms should be rock solid long term investments.

From what I read Burry is investing in real estate firms, particularly hotels/housing. Because I don't have the skills to analyze those businesses I will pass but his focus is interesting. I wouldn't touch REITs buying retail sites because of the impact of on-line purchasing but, at least in his neighborhood hotels and housing should be a winner.

Another factor that few have mentioned... the impact of demographics as retirees shift from long term stock investments to bonds, then subsequently liquidating their investments to support income in retirement. Offsetting this is investment money seeking safe harbor from abroad but, frankly, many of those investors are also 'mature' (approaching retirement). If interested in this situation from a broad perspective watch Peter Zeihan's presentation on Millennial Consumption at this year's Land Investment Expo, find it on UTube.
 
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NW-Bound said:
We saw this already in the 2008-2009 market fiasco. Instead of dumping only the financial stocks, the entire market dropped as people bailed out en masse. When John Doe got scared and sold his index fund, every stock went down. There's no way for an indexer to get rid of just the bad stocks.
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There was panic but then there was talk about how the credit markets would be frozen.

People worried about bank runs too. MM interest went negative shortly IIRC.

That is when they raised the FDIC limits to 250k, to calm the public somewhat.

There was even talk about GE going down and we subsequently discovered that GE isn't very well run.

Of course it led to the biggest recession since the Great Depression so maybe the market wasn't wrong to take down not just bank stocks.
 
I see more risk in the adoption of mutual funds in general with the inherent disconnect between shareholders and the companies they invest in. I think Fidelity gets to vote on my behalf on all shareholder matters.
 
frayne said:
Just for the sake of argument say Burry is correct, how would you posture your equity investments that were in index finds ?
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Michael Burry's my hero. What a fascinating story he is. I'm surprised by his call, but I ask myself too, where do I put my money if not in stocks? I'm somewhere ~50/50 Bonds/Stocks. On this one, I'm letting my Vanguard accts stay the course.
 
FREE866 said:
Given I'm all in major market indexes I admit I'm totally biased and agreed with this response to Burry's predictions

https://awealthofcommonsense.com/2019/09/debunking-the-silly-passive-is-a-bubble-myth/
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That was a good article, thanks. That's pretty much how I see it. The active investors are creating all the volume, and that's where the price discovery (i.e. speculation) happens. Index funds contribute little to volume.

The stock market goes through periods where nearly everyone rushes to the exits including professionals/active traders chased by margin calls which brings down the "good" stocks with the bad. This happens regardless of index funds. Remember 1987?
 
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