Indexing Sucks

Bill Ackman had some comments about indexing the other day—I will do my best to paraphrase without too much getting lost in translation.

So basically, the big index providers (Vanguard, State Street, etc.) are hoarders of stocks—they buy them and sit on them. They take a bunch of stock out of circulation. Throw in buybacks, which has also retired a bunch of outstanding stock, and there is very little stock left to trade. The marginal buyer of stock is a hedge fund like Millennium or Balyasny, who are quick to buy or sell based on any arrival of new information, resulting in huge volatility. If you’re wondering why it has become so difficult to make money picking stocks, this is why. Indexing is the culprit.

Ackman is not the first to say this—Michael Green has been saying it for some time. And I’ve observed distortions in the market for years, which I also chalked up to indexing, but I couldn’t quite articulate what was going on. I have my own quibbles with indexing, which I wrote about in a recent book, that have nothing to do with equity market microstructure.

These days, I am not trading a lot of stock. To the extent that I own any stocks, they are primarily overseas. Besides, only about 10 of them are going up, and the rest of them are going down. I am more interested in bonds and gold and other stuff. I write a few newsletters, which mostly pick stocks, and I have not been picking many stocks lately.

Arguments Against Indexing

I will tell you a little about my arguments against indexing, and they have nothing to do with the fact that you are getting the “average” return, which is how most of the arguments go. 

The returns are great. The volatility, not so much. Indexing has become so popular that people who probably have no business investing in the stock market are now in index funds, which they think are conservative and “safe.” I hear this all the time: Index funds are conservative and safe. Really? The stock market is safe? It wasn’t so long ago when people thought that investing in the stock market was nuts. You put it in an index fund wrapper with “Vanguard” tattooed on it and it achieves a veneer of respectability. 

I know many people who are Bogleheads. They tend to not be very introspective. After all, if you are 50, the last time that the stock market ran into trouble was when you were 32, which was probably before you started investing, and even if you had been investing, the consequences were not too serious because you were young and there was less at stake.

If you have millions of dollars in index funds, and 2008 happens all over again, you are going to lose millions of dollars, which is not going to be fun. You might find this foreign and incomprehensible, but it absolutely can happen, and I’d say that we are a lot closer to the next crisis than we are to the last one. Murphy’s Law being what it is, it will probably happen right before the 2028 election.

Mass Psychosis

My friend Eric Balchunas recently wrote that the stock market has become a public utility of sorts, and that it is too big to fail because people now have their live savings in it, and the effect of a stock market crash on consumption (and mental well-being in general) would be too terrible to contemplate, so the authorities will do whatever it takes to prevent that from happening. That is a pretty good take. Under the never let a good crisis go to waste maxim, I wouldn’t be surprised if  the Federal Reserve does QE for stocks in the next crisis. There is precedent for it—the Bank of Japan did it in 2012. Just marinate on that for a moment.

Then, of course, you have the Trump accounts, which are naturally invested in the S&P 500, at peak valuation. Get all the little kids into the stock market at the highs, into the Greatest Wealth-Generating Machine in History™. We are all Bogleheads now, from Trump on down. Mass psychosis. Kind of funny that the guy who could have been a billionaire many times over from this mass psychosis chose not to make any money off it. I find the whole thing to be very, very funny.

In the beginning, index funds were sold as instant diversification. Write one check, you get exposure to 500 stocks, and you are diversified. Those diversification benefits disappear if 150 million people are doing the same thing. You don’t own 500 stocks—you own a security, which happens to be the most consensus security in the world. In the old days, you would have runs on banks. What would a run on the stock market look like? Well, we actually saw it in 2020 during the pandemic—down 35% in a month. That’s what happens when everyone sells SPY all at the same time.

DirtCon

Enough out of me. I have The Daily Dirtnap Conference in Nashville this week—the seventh iteration of the conference and the first one in a big-boy venue. There will be about 130 people in attendance, plus speakers. Pics or it didn’t happen. Follow Tars on X; he’ll keep you posted. You should really come to the next one.

Also, a photograph of me in action, playing at the legendary Do Not Sit on the Furniture last week in Miami Beach, Florida. It was sublime.

Poll

Appreciate your participation last week… it was a close one.

Dumbest Thing I Saw This Week

The FIRE (Financial Independence, Retire Early) movement strikes again. These are, without a doubt, the dumbest people you will come across in personal finance.

I mean…

I wrote about FIRE here a couple years ago.

Oxygen thieves.

Jared Dillian, MFA