7 ms·

As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion.

by cs702 8y ago

As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion. When passive funds as a group have net outflows, all their holdings must be reduced in roughly the same proportion. But passive funds as a group cannot reduce their holdings by selling stocks to each other! It's impossible to take water out of a boat by scooping water from one spot and pouring it back into the same boat in some other spot! Therefore, to reduce holdings, passive funds (or their broker-dealers) necessarily must find other -- i.e., non-passive -- buyers willing to take those stocks at some market-clearing price. Alas, everyone else, in the aggregate, also owns the same stocks in the same proportion. Potentially, this can produce temporary imbalances between passive net sellers and non-passive net buyers that get corrected via declines in price. Passive net sellers, being price agnostic, do not care; they're on automatic.

module0000 8y ago
>> As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion. THIS. This is how it works. They also have similar basis prices for their positions, and similar pain thresholds. It's not a big surprise that when Institution XYZ reaches its' pain threshold and stop loss orders are used, a few more dozen Institution ABC, DEF, and GHI hit theirs also! This looks like a "huge selloff" on a chart, but it's just the same event being experienced by multiple institutions near the same point in time. tldr: it looks like a herd because it is a herd.
- ajross 8y ago
  How is that any different from previous bear markets? I swear I remember reading the same analysis in 1987 after the crash. Human behavior (even human-programmed behavior) is pro-cyclic. Everyone wants the same stuff and makes the same decisions with the same input. I don't see anything notable about this market cycle as compared with previous ones at all, only the jargon is changing.
  - module0000 8y ago
    It's not any different other than the speed it happens at. 20 years ago it would have taken minutes/hours for some of the drops we've seen to materialize. Now you can watch the NQ drop 100 points in less than 5 minutes, 20 years ago that would have taken hours, possibly all day. People had to wait on quote services via satellite, telephone calls to their floor traders, or actually be in the pits during the selloffs. Now it only takes us a couple seconds to connect our device of choice to our trading platforms. Market makers stop providing liquidity during these sell-offs much faster than they could 20 years ago.
    - JumpCrisscross 8y ago
      > 20 years ago it would have taken minutes/hours for some of the drops we've seen to materialize. Twenty years ago was 1998. Ten years before that, Black Monday was faster and more vicious than anything we've seen since. It remains "the largest one-day percentage decline in the DJIA" [1]. [1] https://en.wikipedia.org/wiki/Black_Monday_(1987) https://en.wikipedia.org/wiki/Black_Monday_(1987)
      - module0000 8y ago
        Black Monday is the edge case
  - jm__87 8y ago
    Not really sure what your point is. Cycles always happen for the same technical reason - more buyers than sellers lead to rising prices and more sellers than buyers lead to falling prices. Understanding what leads to these imbalances in buying and selling is the more interesting and more difficult part and the details tend to be a bit different for every cycle. Most people find these details interesting and for some people, it is their job to understand these details. The abstract idea that herd behavior is what moves markets is not that useful unless you understand exactly which herds are moving which markets and how they make their buying and selling decisions.
    - 8y ago
- JumpCrisscross 8y ago
  > They also have...similar pain thresholds Passive funds have no pain thresholds which force them to sell. Investors in them may. But that’s a difference in how individual investors’ risk tolerances are abstracted to broad market pricing, not a change in those risk expressions themselves.
  - module0000 8y ago
    I disagree, I'd argue that exactly 4 times a year, passive funds must sell, and must buy again. Contract expiration dates cause huge volumes of activity from so-called "passive" funds. The seconds, minutes, hours, and (occasionally) days that elapse between rolling out from current month to forward month contracts are all about the fund managers pain threshold. The exception to this rule is if your fund has governance specifying that rollovers have to happen ASAP(as in, as each <N> contracts are sold from the current month, <N> forward month contracts must be bought before repeating the process), which is not common. edit: Sometimes I'm blinded by the part of "market" I operate within, which is the commodity futures market. I could be(and likely am) completely wrong when you apply this to the securities market, which I am less familiar with.
nostrademons 8y ago
A lot of the attention on the stock market is focused on the short term (i.e. panic sells or a flight to safety in reaction to quick emotional events), but I wonder what happens when this dynamic plays out in the long term. Right now, the pool of people putting money into the market has been steadily increasing as Millenials enter the workforce. Boomers are retiring, but not really in large numbers yet, so the overall number of folks saving for retirement has been continually increasing since Boomers started entering their prime earning years in the early 1980s. However, the peak of the Boomer years will soon start entering retirement soon (~2020) while the early Boomers are starting to die off. And the generation after Millenials - who will start comprising the workforce in 2020 - is much smaller than the Millenial generation. There are fundamental issues with demographics that can't be papered over by financial engineering: a smaller working-age population supporting a larger dependent population (absent massive technological advancement in care) = lower standard of living for everyone. Demographically, this would play out as a generation-long bear market, but markets tend to correct as soon as everyone adjusts their expectations for the future. That implies a sudden and massive crisis at some point with stock market levels correcting to the yields and prices of the 1970s, adjusted for inflation. That would imply an S&P 500 of about 370 (down ~95%) and interest rates in the 10% range.
- cs702 8y ago
  In such a horrific scenario, I imagine the stocks of companies with low-duration free cash flows (i.e., generating profits in the near future and trading at reasonable multiples of those profits) would hold up the best, because they can pay greater dividends, buy back more shares, be more likely to go private at a premium, etc. As for the stocks of companies with high-duration cash flows (i.e., companies for which the majority of profits lies far in the future, trading at optimistic multiples of those distant profits)... I imagine they would suffer the worst declines. However, I agree with JumpCrisscross (https://news.ycombinator.com/item?id=18763124 https://news.ycombinator.com/item?id=18763124) that such a horrific scenario is unlikely.
- JumpCrisscross 8y ago
  > a smaller working-age population supporting a larger dependent population (absent massive technological advancement in care) = lower standard of living for everyone On average, assuming nothing else changes. In reality, we have the levers of immigration and workforce utilization (e.g. making it easier for ex-felons or non-violent drug convicts to re-enter the workforce) to juice labour inputs. And we have education and R&D to juice productivity. On top of that are random factors like natural resource utilization, falling energy and material intensities of GDP, et cetera. > That would imply an S&P 500 of about 370 (down ~95%) and interest rates in the 10% range One cannot so neatly connect demographics to interest rates, let alone the S&P 500. Demographics map to certain consumption sectors (e.g. durables) very well. They map to others (e.g. luxury or entertainment products) quite badly. To illustrate one of the many confounding variables between demographics and stock prices, consider what a small shift in asset allocations in a single generation from real estate to equities would do to prices.
gcb0 8y ago
passive funds hold a disproportionate amount of sp500 like indexes. if that was the only explanation, those would have to fall always much more in price than all the rest.
chiefalchemist 8y ago
That almost sounds like a Ponzi Scheme, of sorts Realize it doesn't meet the true technical definition, but more the idea of passing the buck (so to speak) and someone getting hit pretty hard, in an inevitable / unavoidable sorta way. Also, because this also (to me) feels less like investing and more like a timing game.
pixl97 8y ago
> It's impossible to take water out of a boat by scooping water from one spot and pouring it back into the same boat in some other spot! But you can balance a boat and keep it from tipping over that way.

by cs702 8y ago

module0000 8y ago

>> As the article points out, passive funds, which have become a dominant force in the stock market, own the same stocks as everyone else in the same proportion. THIS. This is how it works. They also have similar basis prices for their positions, and similar pain thresholds. It's not a big surprise that when Institution XYZ reaches its' pain threshold and stop loss orders are used, a few more dozen Institution ABC, DEF, and GHI hit theirs also! This looks like a "huge selloff" on a chart, but it's just the same event being experienced by multiple institutions near the same point in time. tldr: it looks like a herd because it is a herd.

ajross 8y ago
How is that any different from previous bear markets? I swear I remember reading the same analysis in 1987 after the crash. Human behavior (even human-programmed behavior) is pro-cyclic. Everyone wants the same stuff and makes the same decisions with the same input. I don't see anything notable about this market cycle as compared with previous ones at all, only the jargon is changing.
- module0000 8y ago
  It's not any different other than the speed it happens at. 20 years ago it would have taken minutes/hours for some of the drops we've seen to materialize. Now you can watch the NQ drop 100 points in less than 5 minutes, 20 years ago that would have taken hours, possibly all day. People had to wait on quote services via satellite, telephone calls to their floor traders, or actually be in the pits during the selloffs. Now it only takes us a couple seconds to connect our device of choice to our trading platforms. Market makers stop providing liquidity during these sell-offs much faster than they could 20 years ago.
  - JumpCrisscross 8y ago
    > 20 years ago it would have taken minutes/hours for some of the drops we've seen to materialize. Twenty years ago was 1998. Ten years before that, Black Monday was faster and more vicious than anything we've seen since. It remains "the largest one-day percentage decline in the DJIA" [1]. [1] https://en.wikipedia.org/wiki/Black_Monday_(1987) https://en.wikipedia.org/wiki/Black_Monday_(1987)
    - module0000 8y ago
      Black Monday is the edge case
- jm__87 8y ago
  Not really sure what your point is. Cycles always happen for the same technical reason - more buyers than sellers lead to rising prices and more sellers than buyers lead to falling prices. Understanding what leads to these imbalances in buying and selling is the more interesting and more difficult part and the details tend to be a bit different for every cycle. Most people find these details interesting and for some people, it is their job to understand these details. The abstract idea that herd behavior is what moves markets is not that useful unless you understand exactly which herds are moving which markets and how they make their buying and selling decisions.
  - 8y ago
JumpCrisscross 8y ago
> They also have...similar pain thresholds Passive funds have no pain thresholds which force them to sell. Investors in them may. But that’s a difference in how individual investors’ risk tolerances are abstracted to broad market pricing, not a change in those risk expressions themselves.
- module0000 8y ago
  I disagree, I'd argue that exactly 4 times a year, passive funds must sell, and must buy again. Contract expiration dates cause huge volumes of activity from so-called "passive" funds. The seconds, minutes, hours, and (occasionally) days that elapse between rolling out from current month to forward month contracts are all about the fund managers pain threshold. The exception to this rule is if your fund has governance specifying that rollovers have to happen ASAP(as in, as each <N> contracts are sold from the current month, <N> forward month contracts must be bought before repeating the process), which is not common. edit: Sometimes I'm blinded by the part of "market" I operate within, which is the commodity futures market. I could be(and likely am) completely wrong when you apply this to the securities market, which I am less familiar with.

nostrademons 8y ago

A lot of the attention on the stock market is focused on the short term (i.e. panic sells or a flight to safety in reaction to quick emotional events), but I wonder what happens when this dynamic plays out in the long term. Right now, the pool of people putting money into the market has been steadily increasing as Millenials enter the workforce. Boomers are retiring, but not really in large numbers yet, so the overall number of folks saving for retirement has been continually increasing since Boomers started entering their prime earning years in the early 1980s. However, the peak of the Boomer years will soon start entering retirement soon (~2020) while the early Boomers are starting to die off. And the generation after Millenials - who will start comprising the workforce in 2020 - is much smaller than the Millenial generation. There are fundamental issues with demographics that can't be papered over by financial engineering: a smaller working-age population supporting a larger dependent population (absent massive technological advancement in care) = lower standard of living for everyone. Demographically, this would play out as a generation-long bear market, but markets tend to correct as soon as everyone adjusts their expectations for the future. That implies a sudden and massive crisis at some point with stock market levels correcting to the yields and prices of the 1970s, adjusted for inflation. That would imply an S&P 500 of about 370 (down ~95%) and interest rates in the 10% range.

cs702 8y ago
In such a horrific scenario, I imagine the stocks of companies with low-duration free cash flows (i.e., generating profits in the near future and trading at reasonable multiples of those profits) would hold up the best, because they can pay greater dividends, buy back more shares, be more likely to go private at a premium, etc. As for the stocks of companies with high-duration cash flows (i.e., companies for which the majority of profits lies far in the future, trading at optimistic multiples of those distant profits)... I imagine they would suffer the worst declines. However, I agree with JumpCrisscross (https://news.ycombinator.com/item?id=18763124 https://news.ycombinator.com/item?id=18763124) that such a horrific scenario is unlikely.
JumpCrisscross 8y ago
> a smaller working-age population supporting a larger dependent population (absent massive technological advancement in care) = lower standard of living for everyone On average, assuming nothing else changes. In reality, we have the levers of immigration and workforce utilization (e.g. making it easier for ex-felons or non-violent drug convicts to re-enter the workforce) to juice labour inputs. And we have education and R&D to juice productivity. On top of that are random factors like natural resource utilization, falling energy and material intensities of GDP, et cetera. > That would imply an S&P 500 of about 370 (down ~95%) and interest rates in the 10% range One cannot so neatly connect demographics to interest rates, let alone the S&P 500. Demographics map to certain consumption sectors (e.g. durables) very well. They map to others (e.g. luxury or entertainment products) quite badly. To illustrate one of the many confounding variables between demographics and stock prices, consider what a small shift in asset allocations in a single generation from real estate to equities would do to prices.

gcb0 8y ago

passive funds hold a disproportionate amount of sp500 like indexes. if that was the only explanation, those would have to fall always much more in price than all the rest.

chiefalchemist 8y ago

That almost sounds like a Ponzi Scheme, of sorts Realize it doesn't meet the true technical definition, but more the idea of passing the buck (so to speak) and someone getting hit pretty hard, in an inevitable / unavoidable sorta way. Also, because this also (to me) feels less like investing and more like a timing game.

pixl97 8y ago

> It's impossible to take water out of a boat by scooping water from one spot and pouring it back into the same boat in some other spot! But you can balance a boat and keep it from tipping over that way.