Is Passive Investing Toxic?

I can analyze the economy in specific detail for endless articles, but the health of the economy has had declining relation to the stock market returns lately. I calculated the correlation between quarterly GDP and the S&P 500 from 2008 to 2016. The correlation coefficient is 0.973 which signals there’s very high correlation between the two variables. However, you look at the data from 2014 to 2016, which is the time when the economy has been weak while stocks rallied, the coefficient of correlation has dropped to 0.819. It’s not surprising because investors aren’t buying stocks because of the strength of the economy. They’re buying index funds because that’s the hot trend brought about by low interest rates and historical active management underperformance. I think the most likely way for this trend to reverse is poor stock performance. When an investor is buying something he/she has no knowledge of he/she has a very low risk tolerance. A 10% correction could start a snowball effect as the money pushed into passive management gets taken out.

I would argue passive investing isn’t investing at all. It’s mindlessness. The reason why I have gone from liking the passive investing strategy to hating it is because of its increased popularity. As like when most things become popular, its original intent has been distorted. Investing in passive ETFs such as the S&P 500 index fund made sense because mutual funds had been shown to miss their benchmark. 67% of active management funds have missed their benchmark and 86% have missed their benchmark when you include the liquidated funds. The S&P 500 usually rewards investors over time if they buy and hold assuming they don’t buy the market near the top. The problem with this basic analysis is it became popular which has made it no longer relevant. It’s common sense that if everyone buys any asset, not only is the alpha long gone, but the returns become negative.