When a Few Stocks Carry the Market

A company’s stock can double even if its profits don’t budge. Your S&P 500 fund could then put nearly twice as much of your next $100 contribution into that stock.

Eventually, that creates the environment for a major correction.

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The Pitfalls of Passive Investing

I own index funds. I like owning a piece of hundreds of companies without spending my evenings listening to CEOs explain why a bad quarter was actually a good one.

When I talked to Michael Green on my podcast, I asked what happens when millions of us make that same choice every payday…

An S&P 500 fund puts more of each new dollar into the companies worth the most on the stock market. 

Say the stocks in an index are worth $1 trillion. One company makes up $100 billion of that, or 10%. So $10 of every $100 buys its stock. If that stock doubles while the rest stay flat, the company now makes up $200 billion of a $1.1 trillion index. The fund puts about $18 of your next $100 contribution into that same stock.

The fund allocates more of your money to the stock that has risen, even if profits haven’t grown.

N.B. Nvidia currently accounts for about 7% of the entire S&P 500.

If enough money follows that rule, the buying can push the price up again, and again… fundamentals be damned.

In an S&P 500 fund, the more valuable a company becomes, the bigger the bet the fund makes on it.

As Green put it, “passive investing is anything but passive.” 

A fund can own hundreds of stocks and still lean hard on just a few. The more room the biggest stocks take up, the more they can move the whole index. Green worries about what happens if the buying slows or gives way to selling. The stocks that did the most to lift the index can do the most to drag it down.

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What Happens if Stocks Tank?

A big enough drop can reach well beyond the market. When retirement savings shrink, some families put off buying a car or fixing up the house. Stores feel it in their sales. If lenders pull back at the same time, businesses can have a harder time borrowing to buy inventory or pay suppliers. Then you see unemployment rise… then you see a recession.

That’s why Green expects the Fed to feel pressure to step in early if we see a significant stock market correction. The entire American economy is now financialized, with more and more of it relying on Wall Street.

An index fund can own hundreds of companies. But when a handful of stocks take up a big share of the fund, a drop in those stocks can hit retirement accounts across the country. If enough families cut back on spending, businesses feel it too. That’s the danger when millions of passive investors are all leaning on the same few stocks.