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Michael Burry believes that passive and blind investing into index funds is destroying the proper functioning of a market based on valuations, earnings, and fut

Michael Burry believes that passive and blind investing into index funds is destroying the proper functioning of a market based on valuations, earnings, and future cash flow. True value is no longer priced in based on fundamentals. Another signal of a bubble. Here's my issue: indexing isn't a single stock or bond - it's compromised of companies who got large because other more active investors already analyzed their fundamentals and found them worth investing in. Passive investing provides inertia to markets, but it isn't totally divorced from them. Companies that have a dramatic fall cough Meta cough will get punted, and the passive investors will only get their feathers singed. It's kinda parasitic I guess of the average indexer like me, but I'm giving up wild gains for a long term commitment to perhaps being a little later to the party than guys like Burry. If the entire index crashes, like, 95%+, we are gonna have MUCH bigger problems globally than people losing their retirement accounts. You're talking about enough companies failing because of the interlocking economy.

TedDoesntTalk 4y ago
Ok, but what about the point in the article about the underlying not being traded in 96% of the index trades? Isn’t this hiding valuation, liquidity, or some other aspect of the underlyings?
- lr4444lr 4y ago
  The premise to this section strikes me as begging the questiom: All stock prices move based on supply and demand not theories and strategies. Well, why do people demand a given stock? One word: dividends. This may seem obvious (or not!) But Robert Schiller in a MOOC some years back made this basic truth clear to me: if a company would hypothetically never pay a dividend, no investor would ever want it. Stocks do not need to trade in large volumes to bring people profit and be desirable. They just need to bring dividends, either now or in the future.
  - WastingMyTime89 4y ago
    You can buy to hold thinking the business will grow. People buy to make money. They don’t care if it comes as dividends or raise in the share price.
    - lr4444lr 4y ago
      Right. But the person they sell to at some point down the trading line has to believe dividends will be forthcoming. Foreclose all possibility of that, and no one would want stock.
      - WastingMyTime89 4y ago
        Or that it will keep growing. Or they want a majority in the company. Stock is ownership.
        ac29 4y ago
        But no company can grow faster than the overall economy forever. At some point spending profits on attempted growth is a waste of money that could've been returned to shareholders (see: Zuckerberg, Mark and the billion dollar quest for the virtual legs).
  - tjs8rj 4y ago
    Why would they never buy it? Art, crypto, NFTs, etc never pay dividends and have markets for them
    - kqr 4y ago
      Dividends are sufficient, but not necessary!
      - tjs8rj 4y ago
        OP said “if a company would never offer a dividend, an investor would never buy it”
  - smachiz 4y ago
    That's only true if they're not in a rapid growth phase. There are other ways to make money from stocks - and stock appreciation is likely a bigger driver to the average investor (and most pro investors).
  - Kinrany 4y ago
    If a stock was worth 0 because of never paying any dividend, anyone could buy it all, liquidate the company and profit.
- MuffinFlavored 4y ago
  What's the alternative? Some people have extra cash, and they are willing to risk it in hopes of return. Is it going to consequentially drive valuations higher than they've ever been compared to history? Sure. But isn't that more of a paradigm shift than a "bubble that may one day pop"? With more and more people having easier access to investing in index funds... why would it ever go backwards? You'd need people to be sick and tired of risking their money and not having anything to show for it (aka no/poor returns).
huhtenberg 4y ago
Just a nitpick - > it's compromised of companies... it comprises companies...
- lr4444lr 4y ago
  No, it's "comprised of companies", or "companies comprise [the index]". But I promise you it was phone autocorrect that messed me up there.
  - huhtenberg 4y ago
    Nope, it's a very common mistake to tack on "of" after "comprise". "To comprise" == "To consist of". https://www.merriam-webster.com/dictionary/comprise https://www.merriam-webster.com/dictionary/comprise
    - lr4444lr 4y ago
      I'm not saying this to try to patch things up with up with you, (because I want my grammar to be correct and will admit a mistake) but it seems the transitivity of the verb is neither as cut and dry as either of us thought. From the link above: Although it has been in use since the late 18th century, sense 2 is still attacked as wrong. Why it has been singled out is not clear, but until comparatively recent times it was found chiefly in scientific or technical writing rather than belles lettres. Our current evidence shows a slight shift in usage: sense 2 is somewhat more frequent in recent literary use than the earlier senses. You should be aware, however, that if you use sense 2 you may be subject to criticism for doing so, and you may want to choose a safer synonym such as compose or make up. I'll probably avoid using the word altogether in the future if it's so contentious.
gpsx 4y ago
I didn't see this said in the article explicitly but if the index funds start selling rather than buying, stocks like Apple will probably be OK, but some other stocks that have been propped up by the index funds may have no bid and they can crash. This of course leads to more people exiting those stocks and potentially a vicious spiral. I supposed this could also effect the whole index.
scoofy 4y ago
I think a big part of the point he's making is tracking error. Your index fund is not the index. It's a fund that attempts to track the index. Many S&P500 funds have a very good benchmark so far, but that needn't be the case in periods of extreme volatility when things like counter-party risk come to bear on moving in and out of large positions. You look at that tracking index of VOO: 0.02 https://screener.fidelity.com/ftgw/etf/goto/snapshot/keyStatistics.jhtml?symbols=VOO https://screener.fidelity.com/ftgw/etf/goto/snapshot/keyStat... That's very good, but it's not nothing. If liquidity really crunches, that could theoretically skyrocket. Wouldn't be the end of the world likely, but you could see some non-negligible losses as MASSIVE funds have to move 60% of their portfolios, and all the other traders know it. It could basically put passive investors on the wrong side of the GME nonsense. Not saying it's really plausible, but it could theoretically happen if the markets moved so fast that spreads effectively stopped trading for long periods.

TedDoesntTalk 4y ago

Ok, but what about the point in the article about the underlying not being traded in 96% of the index trades? Isn’t this hiding valuation, liquidity, or some other aspect of the underlyings?

lr4444lr 4y ago
The premise to this section strikes me as begging the questiom: All stock prices move based on supply and demand not theories and strategies. Well, why do people demand a given stock? One word: dividends. This may seem obvious (or not!) But Robert Schiller in a MOOC some years back made this basic truth clear to me: if a company would hypothetically never pay a dividend, no investor would ever want it. Stocks do not need to trade in large volumes to bring people profit and be desirable. They just need to bring dividends, either now or in the future.
- WastingMyTime89 4y ago
  You can buy to hold thinking the business will grow. People buy to make money. They don’t care if it comes as dividends or raise in the share price.
  - lr4444lr 4y ago
    Right. But the person they sell to at some point down the trading line has to believe dividends will be forthcoming. Foreclose all possibility of that, and no one would want stock.
    - WastingMyTime89 4y ago
      Or that it will keep growing. Or they want a majority in the company. Stock is ownership.
      - ac29 4y ago
        But no company can grow faster than the overall economy forever. At some point spending profits on attempted growth is a waste of money that could've been returned to shareholders (see: Zuckerberg, Mark and the billion dollar quest for the virtual legs).
- tjs8rj 4y ago
  Why would they never buy it? Art, crypto, NFTs, etc never pay dividends and have markets for them
  - kqr 4y ago
    Dividends are sufficient, but not necessary!
    - tjs8rj 4y ago
      OP said “if a company would never offer a dividend, an investor would never buy it”
- smachiz 4y ago
  That's only true if they're not in a rapid growth phase. There are other ways to make money from stocks - and stock appreciation is likely a bigger driver to the average investor (and most pro investors).
- Kinrany 4y ago
  If a stock was worth 0 because of never paying any dividend, anyone could buy it all, liquidate the company and profit.
MuffinFlavored 4y ago
What's the alternative? Some people have extra cash, and they are willing to risk it in hopes of return. Is it going to consequentially drive valuations higher than they've ever been compared to history? Sure. But isn't that more of a paradigm shift than a "bubble that may one day pop"? With more and more people having easier access to investing in index funds... why would it ever go backwards? You'd need people to be sick and tired of risking their money and not having anything to show for it (aka no/poor returns).

huhtenberg 4y ago

Just a nitpick - > it's compromised of companies... it comprises companies...

lr4444lr 4y ago
No, it's "comprised of companies", or "companies comprise [the index]". But I promise you it was phone autocorrect that messed me up there.
- huhtenberg 4y ago
  Nope, it's a very common mistake to tack on "of" after "comprise". "To comprise" == "To consist of". https://www.merriam-webster.com/dictionary/comprise https://www.merriam-webster.com/dictionary/comprise
  - lr4444lr 4y ago
    I'm not saying this to try to patch things up with up with you, (because I want my grammar to be correct and will admit a mistake) but it seems the transitivity of the verb is neither as cut and dry as either of us thought. From the link above: Although it has been in use since the late 18th century, sense 2 is still attacked as wrong. Why it has been singled out is not clear, but until comparatively recent times it was found chiefly in scientific or technical writing rather than belles lettres. Our current evidence shows a slight shift in usage: sense 2 is somewhat more frequent in recent literary use than the earlier senses. You should be aware, however, that if you use sense 2 you may be subject to criticism for doing so, and you may want to choose a safer synonym such as compose or make up. I'll probably avoid using the word altogether in the future if it's so contentious.

gpsx 4y ago

I didn't see this said in the article explicitly but if the index funds start selling rather than buying, stocks like Apple will probably be OK, but some other stocks that have been propped up by the index funds may have no bid and they can crash. This of course leads to more people exiting those stocks and potentially a vicious spiral. I supposed this could also effect the whole index.

scoofy 4y ago

I think a big part of the point he's making is tracking error. Your index fund is not the index. It's a fund that attempts to track the index. Many S&P500 funds have a very good benchmark so far, but that needn't be the case in periods of extreme volatility when things like counter-party risk come to bear on moving in and out of large positions. You look at that tracking index of VOO: 0.02 https://screener.fidelity.com/ftgw/etf/goto/snapshot/keyStatistics.jhtml?symbols=VOO https://screener.fidelity.com/ftgw/etf/goto/snapshot/keyStat... That's very good, but it's not nothing. If liquidity really crunches, that could theoretically skyrocket. Wouldn't be the end of the world likely, but you could see some non-negligible losses as MASSIVE funds have to move 60% of their portfolios, and all the other traders know it. It could basically put passive investors on the wrong side of the GME nonsense. Not saying it's really plausible, but it could theoretically happen if the markets moved so fast that spreads effectively stopped trading for long periods.