Hey Giovanni. Was traveling this week, so only getting to answer your question now. The section you're referring to is as follows I believe:
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Passive funds create a problem because they purchase stocks regardless of price when they receive new investments, as Bloomberg’s John Authers explains. Ultimately, “Passive decreases the inelasticity of a stock as it grows in market cap,” Simplify’s Michael Green shares. “Lower inelasticity, more extreme price response to the same volume of flow.”
As a company's value increases, passive funds buy more of its stock, increasing prices. This trend is particularly concerning in the technology sector, where the flow of funds into passive investments pushes those stocks even further from value, stoking bubble fears.
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So, my take on the elasticity discussion is as follows.
When passive funds put more money into a stock that's already getting a lot of attention (e.g., Tesla’s inclusion in the S&P 500) and its price is going up because of active managers, the elasticity of the price mechanism shows how much the stock price will change. If the stock price has high elasticity, it will go up a lot when passive funds buy more, which can make a bubble in the stock's price even bigger.
In other words, as passive funds grow and continue to invest, the individual stocks become more sensitive to price movement.
Bloomberg's John Authers said this morning:
"Each new slug of money gets invested at the fresh market weight. If some managers are growing excited by Nvidia Corp. and pushing up its price, then passive funds will also be obliged to buy more of it with their new inflows, thus inflating a bubble."
Oppositely, if money started flowing out of index funds, the market distortions caused by their buying behavior would likely be reversed. This reversal would involve the largest stocks being sold off the most as investors redeem their shares. In anticipating these redemptions, active managers would likely sell off their holdings in large-cap companies in advance to avoid losses.
So, in conclusion, the elasticity of the price mechanism in the context of passive investing can contribute to both price inflation and price correction in the market of individual stocks that make up the passive fund.
Great job Renato!
Compelling analysis on passive investing
Thank you, Giovanni! I am honored.
Renato can you explicit the elasticity òf price mechanism? I know the microeconomic concept. Many thanks
Hey Giovanni. Was traveling this week, so only getting to answer your question now. The section you're referring to is as follows I believe:
--
Passive funds create a problem because they purchase stocks regardless of price when they receive new investments, as Bloomberg’s John Authers explains. Ultimately, “Passive decreases the inelasticity of a stock as it grows in market cap,” Simplify’s Michael Green shares. “Lower inelasticity, more extreme price response to the same volume of flow.”
As a company's value increases, passive funds buy more of its stock, increasing prices. This trend is particularly concerning in the technology sector, where the flow of funds into passive investments pushes those stocks even further from value, stoking bubble fears.
--
So, my take on the elasticity discussion is as follows.
When passive funds put more money into a stock that's already getting a lot of attention (e.g., Tesla’s inclusion in the S&P 500) and its price is going up because of active managers, the elasticity of the price mechanism shows how much the stock price will change. If the stock price has high elasticity, it will go up a lot when passive funds buy more, which can make a bubble in the stock's price even bigger.
In other words, as passive funds grow and continue to invest, the individual stocks become more sensitive to price movement.
Bloomberg's John Authers said this morning:
"Each new slug of money gets invested at the fresh market weight. If some managers are growing excited by Nvidia Corp. and pushing up its price, then passive funds will also be obliged to buy more of it with their new inflows, thus inflating a bubble."
Oppositely, if money started flowing out of index funds, the market distortions caused by their buying behavior would likely be reversed. This reversal would involve the largest stocks being sold off the most as investors redeem their shares. In anticipating these redemptions, active managers would likely sell off their holdings in large-cap companies in advance to avoid losses.
https://www.bloomberg.com/opinion/articles/2024-02-16/passive-investing-resistance-round-ii-where-price-discovery-survives?sref=TBDibEcD
So, in conclusion, the elasticity of the price mechanism in the context of passive investing can contribute to both price inflation and price correction in the market of individual stocks that make up the passive fund.
Please let me know if these thoughts make sense.
It's clear Renato.
Very similar to the microeconomic concept.
It makes perfectly sense.
Many thanks.
Talk to you soon