What If The Automatic Stock Buying Stops?
Submitted by QTR's Fringe Finance
My readers know that for the last couple of years I’ve repeatedly warned about the “passive bid” in markets. By that I mean the constant, automatic buying of stocks driven by retirement plans, ETFs, and other systematic investment programs.
This bid isn’t discretionary. It doesn’t ask whether valuations are reasonable and it doesn’t care whether earnings justify prices. It simply asks one question: did money flow in? If the answer is yes, it buys. It buys regardless of valuation, regardless of timing, and regardless of fundamentals.
This dynamic has created a market that behaves very differently from the one investors grew up with. Instead of price discovery driven by valuation and earnings expectations, we increasingly have price formation driven by flows.
And now one recent data point hints that this dynamic may be changing.
According to Vanguard data cited by the WSJ, a record 6% of workers in Vanguard administered 401(k) plans took hardship withdrawals last year, up from 4.8% in 2024 and roughly 2% before the pandemic.
Hardship withdrawals have now risen for six straight years. The median withdrawal was $1,900 and the most common reasons were avoiding foreclosure or eviction and covering medical expenses.
In isolation, that is not a market moving number. But what it represents is worth paying attention to. Because retirement accounts, which have become the backbone of passive investing, are increasingly doubling as emergency financial backstops.
For years I have argued that the market is being structurally bid higher by passive investment flows. Retirement plans, target date funds, ETFs, and automated investment programs buy stocks consistently month after month. These programs operate on autopilot. The result is a forced buyer in the market.
When contributions arrive, the funds buy the underlying securities, typically weighted by market capitalization. That means the largest companies receive the most buying pressure. This helps explain why a small group of mega cap stocks has dominated market performance. The so called Magnificent Seven, Tesla, Meta, Amazon, Apple, Microsoft, Netflix, and Google, have dramatically outperformed the broader market in recent years because of the passive bid, in my opinion.
At the same time, market breadth has often been remarkably weak. The number of advancing stocks has frequently lagged even as major indexes push to all time highs.
In other words, indexes have been rising while much of the market has moved sideways or lower. That is what happens when capital flows are allocated by size instead of value. It’s also why if I needed to start buying the S&P regularly to invest, today I’d prefer something like the equal weighted Invesco S&P 500® Equal Weight ETF (RSP) as opposed to a weighted ETF like State Street SPDR S&P 500 ETF Trust (SPY).
Regardless, for a long time the biggest question in my mind was not how passive flows drive markets higher. It was what happens if those flows slow or reverse...(READ THIS FULL ARTICLE HERE).