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Strategies & Market Trends : MDA - Market Direction Analysis -- Ignore unavailable to you. Want to Upgrade?

To: j.o. who wrote (33787)	11/19/1999 5:23:00 PM
From: Christine Traut	Read Replies (1) \| Respond to of 99985

j.o. Thanks for taking a look at the Daniel Akst article. But I'm still confused. Here is what I think he is saying. When a very small percentage of people use index funds, they can successfully 'ride' the work of your well-paid analysts and benefit from owning the market as a whole. The work of evaluating the worth of companies such as Microsoft goes on - as analysts and individual traders figure out how much they are willing to pay for a particular stock. When many people index, so that a large percentage of total money in the market just buys an arbitrary list of stocks, those stocks get inflated. At the time Akst wrote the article in August of 1997, 17% of new money was going into index funds. I'll bet that the curve has gone straight up since then. When I put 1,000 into Vanguard S&P 500, there is no active manager saying, 'I wonder if this is a good time to buy the index'. Some computer program just buys this index. This is hardly a market judgment on the value of these stocks. So part of the bubble in this market is that <Index investing ... makes markets less efficient by distorting the price of companies lucky enough to be included in the chosen indices> Market capitalization weighting further distorts this effect. Add to that the fact that managers who want to 'beat the index' are almost forced to buy the largest component companies. This means that some significant percentage of funds buying a stock like Microsoft (or Intel or Cisco) do so not on any true judgment of its worth but simply because it is on an index list. I find the inflationary effect logic quite compelling. The growing popularity of index funds inflates any company that is on an index and particularly inflates the largest ones. By the way, under this theory, Microsoft has really tanked badly since Judge Jackson's findings of fact. The new money pouring into index funds is propping it up - so treading water around 85-87 is a lot worse than it looks.