Subject: Re: Control Panel: Sticking the soft landing, “Soonico
I took Jim to be referring to index funds.

Yes, but also all fixed allocation funds.

There was a recent research paper on this, which I found very much worth pondering. I'm not sure I swallow it all without more pondering for the simple reason that their conclusions are astounding, but definitely worth looking up.

In Search Of The Origins Of Financial Fluctuations: The Inelastic Markets Hypothesis, by Gabaix and Koijen.

A poor summary of some of their thinking:
If an equity fund or a fund with a fixed equity percentage mandate gets new money in, they MUST buy more stock, and they are completely price insensitive when they do so. That much is obvious.

If this class of fund comes to dominate markets, who are the willing sellers to them who think prices have become too high? Actual humans who value and own individual stocks are vanishingly rare, so statistically they have to buy from another such fund. It can't be an equity fund, as they have to remain fully invested. (It could be a mutual fund or managed portfolio that is allowed to increase cash allocation, but even they have limits, and they are fading as a factor) So prices probably have to rise sufficiently for some other fixed allocation fund or "closet fixed allocation" portfolio to be above their target equity allocation due to price movement. So prevailing prices go up: if the bid doesn't go up, the allocation doesn't get above target, and nobody will sell. The authors estimate that in recent years each dollar of new money into equities (not from the sale of other equities, but new to the equity world) drives up aggregate global market cap by around $5 (!).

They note that this process could go into reverse. If there are net *withdrawals* from the equity world...shares being sold where the proceeds are not going into other equities...it could become a negative feedback loop. Fixed allocation funds can't be buyers until prices fall enough that their equity allocation is below target.

This is all obviously at odds with my prior post that supply and demand generally don't matter for purely financial assets : ) There is still an infinite demand for free money, perhaps setting a lower bound when prices get below consensus value, but there isn't much (enough) elasticity in the other direction lately: there seems to be a structural shortage of people who own stocks and are willing to sell them when they're plainly trading for more than they think they're worth. At least for times like this of "new" money steadily going into equities without regard to price.

Jim