Will Future Recessions be Prevented by the Large Amount of Passive Index Funds and ETFs?

Question

According to this article from CNBC:

Passive investing, made up of funds tracking market barometers, has now taken over nearly half the stock market as more investors shun stock-pickers and flock to index funds.

If this literally means that half of all stocks on the market are owned through index funds and ETFs, then there must be an increasing built-in resistance to recessions in the market. If stocks from many companies start falling for whatever reason and active traders/funds are selling loads of stocks, most regular people with a 401(k) aren't going to move out of index funds because it's easier to do nothing and people don't want to lock in losses. In this case, the market wouldn't fall nearly as far as it did in the past, making for a quick recovery.

Does this mean that, in the future, there will be no more Great-Recession-level market crashes?

Answer 1

I think that some of your conclusions are wrong.

Apart from the fact that market crashes are rare (1929 and 1987), bear markets occur because of a recession. They aren't causal.

The majority of trading today is institutional. When earnings start to contract in the early stage of a recession, the big boys will sell off holdings regardless of whether they are individual stocks or ETFs. The smaller group, aka 'regular people', aren't a monolithic group. Many will run for door as well. Fear drives selling.

If you lived through the 2008 GFC as an investor, when the likes of Bear Stearns, Lehman Brothers and many other investment and commercial banks were collapsing and your portfolio was disappearing before your eyes (S&P down 50%), would it have mattered to whether you owned those stocks individually versus in an ETF that was collapsing? You either dug in or you sold. More practically, if you were 5, 10 or 15 years away from retirement, would it be 'easier to do nothing' or better to sell and safeguard your retirement? There are a variety of reasons for selling, regardless of the existence of ETFs.

There will always be recessions and there will be plenty of sellers. How 'Great' they will be will depend on the severity of the events leading up to them.

Answer 2

active traders/funds are selling loads of stocks

Every trade has both a buyer and a seller. Limited liquidity magnifies the market impact of an order.

people don't want to lock in losses

In some circumstances, there are tax advantages to realizing losses. Some people also panic sell to limit their losses. Others own shares with borrowed money and are forced to sell.

Finally, think about how much more difficult (and expensive!) it is to sell your home than it is to sell stocks. Yet, homes were far from immune during the crisis.

Answer 3

The part article of the article slightly misstates its own earlier statement

According to this article from CNBC:

Passive investing, made up of funds tracking market barometers, has now taken over nearly half the stock market as more investors shun stock-pickers and flock to index funds.

If this literally means that half of all stocks on the market are owned through index funds and ETFs

I don't think it does mean that. The article itself is slightly unclear, but I think what it's saying is that of all the money in equity-based funds, 45% of it is in passive funds rather than active funds.

It doesn't say anything at all about overall equity ownership - all the directly-owned shares are not part of this calculation.

Answer 4

Frame Challenge

half of all stocks on the market are owned through index funds and ETFs, ... most regular people with a 401(k) aren't going to move out of index funds

"Type of fund" (active or passive) is orthogonal to "type of account" (taxable or tax-favored).