Passive investing has become one of the most powerful forces in today’s stock market.
As more money moves into low-cost index funds, less remains available for active management. With well over half of stock market capital now invested passively, a once-enormous pool of assets that individual investment advisors relied upon has largely moved out of their reach.
My point is not to argue whether passive investing is better or worse than active management. That debate has been taking place for years, and there are strong opinions on both sides.
The real question is whether passive investing has become the stock market’s fountain of youth, continuing to push prices higher, or whether it is the goose that laid the golden egg. Could the hatching of that egg help inflate the largest financial bubble of all time and, when it bursts, leave far more than egg on the faces of its supporters?
That is a question worth considering, especially after the extraordinary rise the stock market has experienced and the confidence that has developed along with it.
If I have learned anything in my 42-plus years in and around finance, it is that I will never be close to the smartest person in the room. But if I can identify those who are and ride their coattails, I can still profit handsomely.
In my view, one person who has been at the forefront of this subject is Michael Green. His depth of knowledge on passive investing is, to me, second to none. He has been discussing the issue for some time, and for that reason, some people have dismissed his view.
History, however, has shown that prophets are often early and frequently ignored until it is too late.
Simply put, I believe passive investing, combined with a generation of so-called professional advisors and clients raised in a market that has felt like a one-way street, has created real risk.
Many advisors and investors have little experience with a true bear market. They have become accustomed to markets eventually moving higher, even after periods of uncertainty or decline. Both advisors and their clients may be likely to overreact on the downside, just as they did on the upside.
It is worth remembering that from 1966 through 1982, the Dow Jones Industrial Average traded in a range of roughly 700 to 1,000. Bearishness on Wall Street was so thick you could cut it with a knife. That period culminated in BusinessWeek’s famous cover story, “Equities Are Dead.”
Then a little-known young man using an equally little-known technical approach declared that the Dow was going to 3,600.
His name was Robert Prechter Jr., and his work was based on Elliott Wave Theory.
Most of Wall Street ridiculed him. The Dow could not even remain above 1,000, they argued, so how could it possibly reach 3,600?
Today, I believe we are 180 degrees from that era.
Rather than assuming that stocks cannot rise, most investors now assume the market always goes higher. They also assume that if the market hits a bump in the road, the Federal Reserve will step in and fix everything.
Mention the possibility of a genuine bear market today and you may be laughed at, or worse, treated as if you deserve to be tarred and feathered.
None of this means that anyone can say exactly when the market will turn or what will ultimately cause it. It does mean that investors should not allow today’s confidence to erase the lessons of market history.
As for me, if you see a chicken in a foxhole, say hello.
Peace Be With You!
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