In 1879, a young New York journalist named Charles Dow laid the foundation for the Dow Jones Index by publishing a daily list of stocks traded on the Wall Street Stock Exchange. Little did he know that his creation would one day lead to the development of exchange-traded funds (ETFs) and herd mentality in the stock market.
Fast forward to the 1990s, when Wall Street started producing investment products based on major stock indices. ETFs quickly gained popularity among hedge funds and are now considered central to stock markets. However, their popularity has led to concerns about market volatility and potential bubbles due to herd mentality in investors.
According to Chief Economist Alex Zabrzynski from Meitav Investment House, the concept of a “perfect market,” where all relevant information is reflected in the price of a share, is being questioned due to passive investments through ETFs. The massive flow of funds into ETFs has influenced stock prices, resulting in a trend where large stocks become increasingly overvalued compared to smaller stocks. This distortion in the market could potentially lead to increased market volatility and concentration of gains in just a few large stocks.
As small stocks struggle to compete with large stocks during market upswings under ETF control, investors must consider whether this shift will have long-term sustainability implications for their investment strategies. While passive investments may benefit larger companies during rising markets, they leave them vulnerable during declining markets.
