Hidden Index Bubble - I'd love to hear some thoughts!

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AaronScott
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Hidden Index Bubble - I'd love to hear some thoughts!

Post by AaronScott » Sun Jun 24, 2018 9:53 am

Saw this article this morning and I'd love to hear some responses!

https://www.fool.com/investing/2018/06/ ... ubble.aspx

magicrat
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by magicrat » Sun Jun 24, 2018 10:05 am

Faulty arguments like this have been discussed many times on the forum, however this is the first time I've seen the stock market compared to a pumpkin patch.

In a nutshell, if the shift to index investing results in mispricing, then traders will identify, exploit and correct the price.

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JMacDonald
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by JMacDonald » Sun Jun 24, 2018 10:17 am

Isaac Pino, who wrote this article, states:
savvy investors can see the opportunity this presents, especially in smaller companies with strong fundamentals. If everyone else is unconsciously distorting the market toward one end, there's likely to be tremendous value at the other.
Take a look at the stocks he owns: https://my.fool.com/profile/XMFSooner/info.aspx
I don't know all of the ticket symbols, but I do recognize some of them as the biggest stocks around. Well, so much for the the savvy investor investing in smaller companies.
Best Wishes, | Joe

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by nisiprius » Sun Jun 24, 2018 10:18 am

Investing in cap-weighted total-market index funds really is different from every other strategy. It is the only strategy in which investors, by investing in the fund, do not alter the composition of the remaining assets available for purchase by other investors. It is the only strategy which does not create relative scarcity of chosen assets in the rest of the market, or change the relative availability of assets. Therefore, it is a strategy which does not drive up the prices of preferred assets, does not "overgraze" anything, and does not create any kind of bubble.

Only 2% of the stock market consists of small-cap value stocks. If everybody wanted a 20% small-cap value allocation, they couldn't get it. Long before everyone had it, all available small-cap value stocks would have been bought up... and long before that, scarcity would have driven the price up to the point where they couldn't possibly be worth having any more.

But almost everyone can hold a cap-weighted total market allocation without disturbing anything. All that dumb investors buying index funds does is to remove a source of random noise from the price discovery process... or, possibly, removing a pool of potential patsies and suckers from the price discovery process.

In most areas of life, with the possible exception of buying houses and cars, most of us are passive price-takers who do not participate in price discovery. We do not haggle with the supermarket checkout clerk, and most of us do not even engage in much comparison shopping. Nobody seems to think this is much of a problem, or "worse than Marxism" (a colorful phrase used by someone recently to attack passive investing). The concept of the price tag and one price for everyone was originated by John Wanamaker in 1861 and has been almost universally adopted since then. It did not lead to the collapse of retail, and Wanamaker's lasted for about 140 years, declining for unrelated reasons. Markets can work perfectly well even if most of the dollars in them are the result of passive price taking.
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by oldcomputerguy » Sun Jun 24, 2018 10:21 am

Don’t even have to read the article. It’s from Motley Fool. Investment noise.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by runner3081 » Sun Jun 24, 2018 10:41 am

oldcomputerguy wrote:
Sun Jun 24, 2018 10:21 am
Don’t even have to read the article. It’s from Motley Fool. Investment noise.
Came here to say the same exact thing. All articles from Motley Fool should be ignored.

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by BrooklynInvest » Sun Jun 24, 2018 10:54 am

oldcomputerguy wrote:
Sun Jun 24, 2018 10:21 am
Don’t even have to read the article. It’s from Motley Fool. Investment noise.
This, plus since I was bored and read it, doesn't the same "logic" apply regardless -

Whether I invest in an S&P500 index fund or an active fund that uses the S&P as its benchmark, aren't I investing in 90-odd percent of the same stuff? Only with the index fund I'm not underwriting the portfolio manager's yacht.

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Pajamas
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by Pajamas » Sun Jun 24, 2018 11:03 am

That article seems to criticize indexing as distorting the market by being responsible for increasing the size of the largest stocks disproportionately to the overall market. Seems to me that it is actually active investing that is responsible for that, not passive indexing, which places bets according to the status quo.

The author of the Motley Fool article appears to be taking much of the information from the 85 page pdf from Semper Augustus that it links to and which is a much more interesting publication.

It seems to me that passive indexing could exacerbate price movement on stocks that are added to and removed from an index such as the S&P 500, literally an effect at the margin of the indexes.

What I always find hilarious is that active managers often criticize passive indexing even though many of them are closet indexers.
runner3081 wrote:
Sun Jun 24, 2018 10:41 am
All articles from Motley Fool should be ignored.
As an absolute statement, that is not true. There are some good articles on Motley Fool and other similar sites such as Seeking Alpha and InvestorPlace. It's just that there is a lot of chaff to sift through and it is probably not worth the time to do so.

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Sandtrap
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by Sandtrap » Sun Jun 24, 2018 11:18 am

Interesting article.
Thanks for posting.
Made sense and sounded good while reading.....but like frozen fish had a lingering aftertaste of doubt.😬
J

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by Nate79 » Sun Jun 24, 2018 11:24 am

How can this be hidden when there is a new thread on this stupid topic almost every day?

selters
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by selters » Sun Jun 24, 2018 11:43 am

nisiprius wrote:
Sun Jun 24, 2018 10:18 am
Investing in cap-weighted total-market index funds really is different from every other strategy. It is the only strategy in which investors, by investing in the fund, do not alter the composition of the remaining assets available for purchase by other investors. It is the only strategy which does not create relative scarcity of chosen assets in the rest of the market, or change the relative availability of assets. Therefore, it is a strategy which does not drive up the prices of preferred assets, does not "overgraze" anything, and does not create any kind of bubble.
Imagine this:

A country has a stock market with a combined market cap of $300 billion. It has 100 listed stocks ranging from $30 billion for the largest to $100 million for the smallest. The stock market has a daily trading volume of $1 billion. No fund providers offer index funds, so 0% of the stocks is owned by index funds.

One of the stocks is a $3 billion utility company that is perceived as a boring company by investors in this country, so its daily trading volume is about $1 million. Now we have a situation where one company has 1% of the stock market's market cap, but 0.2% of the stock market's trading volume.

If two aggressive fund providers launch index funds at a very low cost, resulting in 10% of the country's investors converting to the index funds in one year, these index funds will have to purchase $300 million of stock in one year. With 200 trading days a year, that amounts to $1.5 million of stock every day, 50% more than the stock's daily trading volume. One year is obviously a very extreme and unrealistic scenario, but even if you give the index funds ten years to reach a 10% market share, the index funds will still add $150,000 of buying pressure to the stock every day.

There are many companies like this in international markets.

I think the growth rate of index funds and the liquidity of most stocks to be sufficient to avoid inflation of stock prices. But the idea that index fund flows cannot ever inflate stock prices does not make sense to me.

PFInterest
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by PFInterest » Sun Jun 24, 2018 11:47 am

i dont pay attention to many things that start with www.fool......

msr999
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by msr999 » Sun Jun 24, 2018 11:53 am

nisiprius wrote:
Sun Jun 24, 2018 10:18 am
Investing in cap-weighted total-market index funds really is different from every other strategy. It is the only strategy in which investors, by investing in the fund, do not alter the composition of the remaining assets available for purchase by other investors. It is the only strategy which does not create relative scarcity of chosen assets in the rest of the market, or change the relative availability of assets. Therefore, it is a strategy which does not drive up the prices of preferred assets, does not "overgraze" anything, and does not create any kind of bubble.
While the general theme is correct, I wonder if this is accurate. As an example, if everyone starts buying SP500, wouldn't that drive up the price of SP500 vs the rest?

RL1013
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Will passive index investing eventually fail if we continue like this.

Post by RL1013 » Sun Jun 24, 2018 12:26 pm

[Thread merged into here, see below. --admin LadyGeek]

Idea of index investing is becoming more and more popular each day. Every famous news channels, pundits, podcast and FI community in general advocates index investing. I always wondered as this piece of the total world investing pie gets larger and larger, people are blindly putting more money into the top companies in index. In other words, regardless of whether they have strong fundamentals or not, fresh money via indexing is flowing to them consistently. See this article https://www.fool.com/investing/2018/06/ ... ubble.aspx

Is this trap real as they say it is and should bogleheads be aware of this trap?

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JoMoney
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Re: Will passive index investing eventually fail if we continue like this.

Post by JoMoney » Sun Jun 24, 2018 12:35 pm

RL1013 wrote:
Sun Jun 24, 2018 12:26 pm
... people are blindly putting more money into the top companies in index...
No, broad-market indexers are putting money into every stock in the index at market weights.
The people actively picking stocks and strategies are the ones distorting market weights. There might be a handful that have good information and are contributing to more efficient price discovery, but that's not likely the case for most participants.
If you look at how big "factor" investing and tilts are, and all the odd-ball ETF's and esoteric "indexes" being offered, there's an awful lot of people who aren't holding cap-weighted portfolios.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by WestUniversity » Sun Jun 24, 2018 12:52 pm

oldcomputerguy wrote:
Sun Jun 24, 2018 10:21 am
Don’t even have to read the article. It’s from Motley Fool. Investment noise.
+1

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oldcomputerguy
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Re: Will passive index investing eventually fail if we continue like this.

Post by oldcomputerguy » Sun Jun 24, 2018 1:00 pm

Discussed here. Ignore the Motley Fools.
It’s taken me a lot of years, but I’ve come around to this: If you’re dumb, surround yourself with smart people. And if you’re smart, surround yourself with smart people who disagree with you.

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Re: Will passive index investing eventually fail if we continue like this.

Post by am » Sun Jun 24, 2018 1:08 pm

RL1013 wrote:
Sun Jun 24, 2018 12:26 pm
Idea of index investing is becoming more and more popular each day. Every famous news channels, pundits, podcast and FI community in general advocates index investing. I always wondered as this piece of the total world investing pie gets larger and larger, people are blindly putting more money into the top companies in index. In other words, regardless of whether they have strong fundamentals or not, fresh money via indexing is flowing to them consistently. See this article https://www.fool.com/investing/2018/06/ ... ubble.aspx

Is this trap real as they say it is and should bogleheads be aware of this trap?
Indexing is still a minority. Even those who index will fall into classic traps of buying high selling low, abandoning the strategy in bad times, chasing winners, etc. I am not worried. The market has been generous for those who are patient and disciplined.

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by LadyGeek » Sun Jun 24, 2018 1:22 pm

I merged RL1013's post into here, which is a similar discussion.
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Maple
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by Maple » Sun Jun 24, 2018 1:31 pm

selters wrote:
Sun Jun 24, 2018 11:43 am

Imagine this:

A country has a stock market with a combined market cap of $300 billion. It has 100 listed stocks ranging from $30 billion for the largest to $100 million for the smallest. The stock market has a daily trading volume of $1 billion. No fund providers offer index funds, so 0% of the stocks is owned by index funds.

One of the stocks is a $3 billion utility company that is perceived as a boring company by investors in this country, so its daily trading volume is about $1 million. Now we have a situation where one company has 1% of the stock market's market cap, but 0.2% of the stock market's trading volume.

If two aggressive fund providers launch index funds at a very low cost, resulting in 10% of the country's investors converting to the index funds in one year, these index funds will have to purchase $300 million of stock in one year. With 200 trading days a year, that amounts to $1.5 million of stock every day, 50% more than the stock's daily trading volume. One year is obviously a very extreme and unrealistic scenario, but even if you give the index funds ten years to reach a 10% market share, the index funds will still add $150,000 of buying pressure to the stock every day.

There are many companies like this in international markets.

I think the growth rate of index funds and the liquidity of most stocks to be sufficient to avoid inflation of stock prices. But the idea that index fund flows cannot ever inflate stock prices does not make sense to me.
selters,

Your thought experiment omits an important consideration, by solely focusing on the buying pressure. Given "10% of the country's investors converting to the index funds", many of them will sell the utility company to convert. This adds extra volume and selling pressure, balancing out the buying pressure.

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by david1082b » Sun Jun 24, 2018 2:05 pm

msr999 wrote:
Sun Jun 24, 2018 11:53 am
nisiprius wrote:
Sun Jun 24, 2018 10:18 am
Investing in cap-weighted total-market index funds really is different from every other strategy. It is the only strategy in which investors, by investing in the fund, do not alter the composition of the remaining assets available for purchase by other investors. It is the only strategy which does not create relative scarcity of chosen assets in the rest of the market, or change the relative availability of assets. Therefore, it is a strategy which does not drive up the prices of preferred assets, does not "overgraze" anything, and does not create any kind of bubble.
While the general theme is correct, I wonder if this is accurate. As an example, if everyone starts buying SP500, wouldn't that drive up the price of SP500 vs the rest?
This would give opportunities for smart traders to buy these cheap smallcaps. Someone has to be selling S&P 500 stocks if someone is buying them. It's not possible everyone to buy it, for every buyer you need a seller.

Motley Fool promotes itself as a stockpicking utopia, running rings around the indexes and the sheep being herded into index funds. They should welcome indexing, but instead they attack it.

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by lostdog » Sun Jun 24, 2018 3:28 pm

It's just noise.
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by markcoop » Sun Jun 24, 2018 3:44 pm

I thought the main point of the article is that as more money has moved into index funds, it has had an affect - larger companies have benefited more. I have actually wondered about such an affect. We have no idea how much money will be added to index funds vs active funds going forward, so I don't believe you can really capitalize on it, but that doesn't mean the affect is not there. I found it interesting.
Mark

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by NotWhoYouThink » Sun Jun 24, 2018 4:34 pm

Nate79 wrote:
Sun Jun 24, 2018 11:24 am
How can this be hidden when there is a new thread on this stupid topic almost every day?
+1


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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by KlangFool » Sun Jun 24, 2018 4:39 pm

Folks,

Some people use S&P 500 Index as a strawman argument. But, the whole argument could be destroyed if we invest in the total stock market index fund. So, why do we need to discuss further? Do I miss anything?

KlangFool

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JoMoney
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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by JoMoney » Sun Jun 24, 2018 4:46 pm

KlangFool wrote:
Sun Jun 24, 2018 4:39 pm
Folks,

Some people use S&P 500 Index as a strawman argument. But, the whole argument could be destroyed if we invest in the total stock market index fund. So, why do we need to discuss further? Do I miss anything?

KlangFool
There are constituency requirements and turnover even in "Total Market" funds, so you could still point to the problem, it would just be greatly diffused by the broader holding. Critics could also start finding other things to deride it like IPO investment.
Despite the criticisms, the S&P 500 index quite regularly trounces the majority of active mutual funds.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Hidden Index Bubble - I'd love to hear some thoughts!

Post by longinvest » Sun Jun 24, 2018 5:02 pm

AaronScott wrote:
Sun Jun 24, 2018 9:53 am
Saw this article this morning and I'd love to hear some responses!

https://www.fool.com/investing/2018/06/ ... ubble.aspx
Instead of listening to the noise spread by the fool.com website, I would consider the wise words of Taylor Larimore, author and co-founder of this forum, in this post: The Three-Fund Portfolio

This simple (yet highly sophisticated) three-fund portfolio holds more than 18 thousands securities from three distinct markets. By choosing a target asset allocation and rebalancing to it, one will naturally sell an overpriced asset class to buy an asset class on sale.

The financial industry doesn't want us to know about how simple investing can be.
Just as the gambling industry wants people to think they can beat the casino, the investment industry wants investors to think they can beat the market. Of course, a few lucky gamblers do beat the casino, but MOST DON’T. It is the same for investors: Some will beat the market, but MOST WON’T.

-- Taylor Larimore, The Bogleheads’ Guide to the Three-Fund Portfolio
If you like the quote, I suggest that you click on the link and buy the book. (The author is donating all royalties to The John C. Bogle Center for Financial Literacy).
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