[xivzgrev]

What if the rise in index funds is a bubble on its own?

It's massive and increasing amounts of money that is not price sensitive and keeps growing. There's an underlying bubble message: "the stock market always bounces back, so keep plowing your money into it even when it's down".

Apparently passive funds are 60% of mutual funds / ETFs now https://www.avantisinvestors.com/avantis-insights/has-passiv...

Even more insidious is that this is in part driven by retail who are not paying attention. It's literally the definition of passive, hands off

So at some point, valuations will become increasingly disconnected from fundamentals. Active players will notice and find some way to take advantage. Passive yields will eaten. But at what point will the scales tip and people decide it's a sham and there are better places to park your money? That's when a huge bubble will collapse.

I don't know. Honestly don't know if that will ever happen because I'm not sure what a better investment for average Joe would be than a passive broad stock market index.

[dasil003]

I've been invested largely in US index funds for a while now, and I've definitely thought about this. My conclusion is S&P 500 is too big too fail, everyone with various forms of power in the US (economic, political, etc) are incentivized to keep the music going. Sure it feels unsustainable, but there is no way going active can help me—I don't have enough access to the right people, and even if I did, it's better as a hedge strategy. Someone who has a billion dollars can easily pace a bunch of $10M bets on long-shot hedges that will mint a fortune when the music stops. Theoretically I could do something similar at smaller scale, but the people smart enough to have credible strategies are not talking to me, and even if they did I don't have the expertise to judge the advice (the super rich don't either, but at least AUM volume is some signal of competence).

[YZF]

The S&P 500 can and will crash at some point. It has and it will. That's part of the lifecycle of market psychology. We go through cycles of over valuation and under valuation. It's true there are many forces with interest in keeping the markets up but there have always been and it's always crashed because once the psychology changes there is no amount of intervention that can keep the market up.

If you are invested for the long term then just don't think about it. If you want to diversify a little then go for it - slowly. Also keep in mind your US index fund is full of international companies anyways.

[y-c-o-m-b]

I'm along the same lines of thinking. I got most of my funds in SGOV (I manually did t-bills for a while but too lazy to keep it going).

> there is no way going active can help me—I don't have enough access to the right people

It really comes down to this realization. Without access to what all these billionaires and their companies have access to, I just feel like a pawn with everything to lose.

[r_lee]

It absolutely is.

With the rise of ETFs and 401ks people are incentivized (literally) by the US Gov to put their money in the S&P500

And the "instead of picking a needle in the haystack, just buy the whole haystack" only works if there is actual stock picking going on and you get to ride that, but now when there's so much passive investing, it's just everybody buying the haystack, even if there is no needle

Like with the ETFs and 401ks, they will happily buy as much NVDA at its ATHs, it's quite literally massive liquidity feeding orders all the time, coming from retail's monthly paychecks

[solatic]

US stock market index funds will crash when the US stock market crashes. That will require very large sums of capital to decide to move away from US capital markets. To give an idea of how much money would need to move - VTSAX alone is about $2.1 trillion, with hundreds of billions of dollars of shares of each Mag7 stock.

You basically need the world to decide that EMEA/JAP markets are collectively stronger than the US stock market, and to collectively move their capital outside the US to be deployed in EMEA/JAP. Moves away from Mag7 to US value stocks will be captured by the US stock market index funds; moves into commodities will be seen as opportunities to buy the dip before a market rebound. You can view attempts by US private equity to purchase real estate as attempts to hedge against overvaluation in US markets, but if the US has another Great Depression, those real estate purchases won't be able to fetch high rents or prices anyway.

In short, just follow the normal advice, which is not to put all your money into US domestic stocks, but to also purchase foreign stock market index funds, which help to hedge against the risk of the entire US stock market crashing. In the long run, US index funds are still a good investment - US courts still are quite powerful to settle contract disputes, the US does not have capital flight controls, and American business culture is still one of the hardest working, greediest forces on the planet - a Great Depression v2 would not change that.

[YZF]

All assets are correlated. When the stock market inevitably crashes, and it will, we just don't know when, so will other world stock markets. And the cycle will repeat.

Capital is not going to "move away from US capital markets" because those markets tend to over-perform and will likely still over-perform. What companies are you investing in that are not nVidia, Google, Amazon, Meta, Apple, Open-AI, Anthropic etc. etc.?

It's really hard to predict market crashes. I think it makes sense to be more cautious but also that's what could have been said a year or 2 or 5 years ago, in which case you would have missed a lot of potential gains.

[state_less]

> US stock market index funds will crash when the US stock market crashes. That will require very large sums of capital to decide to move away from US capital markets. To give an idea of how much money would need to move - VTSAX alone is about $2.1 trillion, with hundreds of billions of dollars of shares of each Mag7 stock.

I'd like to make a technical note about markets because I see this mistake repeated in the comments. The money doesn't have to move out of the US markets to somewhere else for the stock market to crash. It only requires a destruction of confidence. For a hypothetical example, suppose the S&P 500 closes at 7000 on a Friday, and everyone loses confidence in the S&P 500 over the weekend (for whatever reason). The market can open on Monday 3500 with not a share traded before the open (no money was moved out of the market), and investor portfolio values are now cut in half. Since confidence is broken, nobody buys the dip, and the market closes Monday down to 3000.

It's an extreme example, but it's worth understanding the fundamental underpinnings. The markets are a confidence game. Sometimes we forget because we have good reason to be confident (e.g. in the S&P 500) and so it fades into the background that something like this could even happen, but it's not hard find these sorts of events in history.

[solatic]

You are correct, but only insofar as destroying paper value. If investors have a firesale because the market would prefer to realize whatever value might be rescued, even at a loss, but the proceeds of the sale stay inside the US, then that capital is more likely to be reinvested in the US once investor confidence returns. This is the underlying reason why most long-investors should continue to hold their positions despite short-term losses. The fact that NVDA has a $4.6T market cap, as a product of about 24 billion shares multiplied by about a $190/share price, does not mean that the market believes that all 24 billion shares could be sold for that $190/share price. That is a convenient fiction that falls apart when investor confidence bursts, but that does not in and of itself truly represent value destruction (Nvidia employees will still wake up the next day and go to work), at least not until second-order-effects kick in (e.g. Nvidia employees leave because their RSU packages are no longer competitive compensation). People who stay long in the stock market can wait for investor confidence to return, in which cash is reinjected into the stock market, and the losses in diversified portfolios are not realized. If the S&P 500 investor takes a 50% hit in a crash, decides to hold, then the S&P 500 rises by 140% in the next two years, then the investor who held will still realize a nice return.

The way in which that narrative does not happen is if the capital leaves entirely to be locked up in other investments; in the context of index funds which would anyway rebalance to rise with those other investments, if the capital leaves for other countries, to investments that are not covered by the index funds.

[YZF]

Correct. The price of the market is the price people are willing to pay. It is not directly related to the move of capital. That said prices are also a function of supply and demand, if there is no demand (e.g.) for US stocks then it is more likely price will go down. If everyone wants to sell US and buy Europe, e.g. because they think the European competitors to Apple, Google, Amazon, nVidia and such will outperform, then presumably the prices at which those companies trade will trend down.

[xivzgrev]

Related thought: maybe the rise in passive is a permanent buoy for positive market sentiment

In the past bad news led to jumpiness and people getting out, including retail. Now you have a massive amount of money that keeps going. So if you jump out..you see that so much money continues to plow in, and price starts going back up. So you come back in so you don't miss out. And on we go.

I think it's very possible passive investing is changing the dynamic, where downturns are more muted. It's overall a good thing but again, as I said above, it feels like it's setting up an even bigger ruin down the road

[tonfa]

I don't even think it's about active vs. passive index funds.

Even if people were to do active bets on equity, what matters is the amount of money flowing in the asset class, so as long as there's an infinite stream of long investments into equity (due to 401k, etc.), the prices will rise.

You'd need people to actively balance their allocation between asset classes rather than stock X vs Y to counter those equity bubbles, but I don't think it's happening (and equity becomes too big to fail given the link with things like pension in the US).

[panarky]

If equities are "too big to fail" then governments will do everything in their power to ensure prices continue to go up.

If the right price for equities is 30% of their current value, and if achieving that price means the regime will fall in the next election (or sooner due to civil disorder), then the regime will not allow that to happen.

A regime that controls its own currency has nearly unlimited power to prop up whatever asset classes it wants to, from bonds to equities to housing.

Doing that has consequences like inflation which people don't like, and could cause them to vote the bastards out. But the regime could also print even more money for direct deposits into voters' bank accounts before an election.

So it seems like equities have limited downside until there's a regime change.

[dash2]

In theory this could be true. Is the US government actually doing anything specifically to prop up equity values?

[coryrc]

The federal reserve has 7x the assets it had in 2009: https://www.federalreserve.gov/monetarypolicy/bst_recenttren...

[CamelCaseName]

Okay, but this shows that they made massive acquisition in 2020 (presumably at the bottom of the market in response to COVID) and are now unwinding

[dash2]

How much of that is shares as opposed to treasuries, MBS etc?

[panarky]

When the Fed purchases bonds, that reduces interest rates, and lower rates make asset prices go up.

The Fed purchases the bonds with cash created out of thin air with a journal entry. That newly created cash is used by private actors to purchase assets, which makes asset prices go up.

The Fed could purchase equities directly, but it doesn't have to own them to influence their prices.

[variadix]

This is a fundamental misunderstanding of why index funds are effective. Being over invested into U.S. equities is a risk if you hold outsized U.S. index funds (esp. if you have a large allocation in the S&P500, you do not own the market portfolio), but there are other risks being invested into foreign equities as a U.S. investor.

[bluecalm]

>>That's when a huge bubble will collapse.

Maybe there will be a "huge bubble" in the future but it doesn't look that huge right now. Forward P/E for S&P500 is about 22. That is 4.5% yearly return even if there is no growth beyond 2026. This is also real growth as earnings raise with inflation so nominal expected return is about 7% even if there is 0 growth beyond 2026.

Meanwhile risk-free rate (basically short term government bonds) is around 3.5% per year right now (nominal). That 7% is quite pessimistic as some "net growth" (growth - costs of generating it) is expected beyond 2026 and you can only get 3.5% "risk-free" I am not sure why people call current valuations crazy or what their expectations for "fair valuations" are. Equity risk premium seems to be still above 4%. Maybe that's on the low side but far away from bubble territory, let alone "a huge bubble".

[dgb23]

I think the almost opposite is the case.

Passive, (especially global) index funds doing so well and outperforming the vast majority of actively managed, general funds () is not a given, but they point to a different problem.

It means that most actively managed funds are still overpriced (fees), don't deliver efficient price discovery, and in some cases destabilize the market by making consistently wrong bets.

That's not the fault of index funds. In fact they make it easier for high performing investors who have deeper insights.

There are plenty of funds that don't compete on just on beating the index, but have other goals.