I worry that this kind of [bad] effect may hit all of us who bought into the index funds theory in the 1980s and 90s when the concept was not popular as it is now. Now we have an environment with retail investors flooding into indexed, automated ETFs in numbers never before seen.
In 2008 when retail investors sold out of the market they sold mostly stocks and stock-picking funds. What happens when they sell the whole S&P 500?
Any thoughts about this you'd like to share?
The question about whether indexing sows its own doom comes up regularly here. In addition to points made by previous posters, if a great majority of the value of equity markets was held by cap-weight indexers, the pricing mechanism would begin to lose efficiency. That would open opportunities for arbetrageurs. People being as they are, some would take advantage of the chance, which would tend to move pricing back toward greater efficiency.
In a nutshell, the point beyond which investors indexing would, in and of itself, distort markets would not be reached. Instead there would become an equilibrium between indexers and those extracting arbitrage profits.
With respect to the effect of indexed market participants leaving all at once: to the extent they did so when not indexed, some held one fund, some another, and the net total is the total market. That skittish investors acting against their own interests might now use more- rather than less-efficient vehicles would not change the impact.