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We want to expand on something that we hinted at and it?s about ?indexing? and the myth that the market only goes up, so therefore you should buy and hold. First, if we asked you what the biggest single business on earth is, we?d bet that not many would pick the stock market. But trust us it is. The daily trading of just one popular stock is often a significant percentage of the entire daily GDP in dollar terms. It?s huge and with more than half of our population investing in the market through 401K?s, or even your insurance company investing behind the scenes, you are indeed involved.

When you are talking about an industry that exchanges billions upon billions of dollars worth of goods every day, you are indeed talking big business. Look at WMT. They sold a billion and a half dollars worth of goods on Black Friday. Wow. Well the NYSE did a billion and a quarter shares of stock swapping. And each of those shares cost between 5 and 100 dollars. The dollar amount is staggering. So, since stocks are the biggest business on earth, don?t you think the biggest and brightest minds have come up with all the tricks of the trade to keep it growing? You bet.

Indexing was one of their biggest corrupt inventions. Why? Well along with the fact that they reshuffle the index?s (there have been 27 changes to the DOW) so they can discard ?bad poor performing companies and put in winners?, there is the problem of weighting that comes into view. When an index is weighted so that company A is more important than Company B and that more important than company C, where do you think the bulk of the money that comes to an index fund will go? To company A of course. It doesn?t matter that Company B might be better, or that company C might be growing faster, the money will go to company A first, then b, then c.

So, is it any wonder why the well known names get so bloated? Is there any wonder why P/E?s get so excessive? Every person that ?puts? his money in an index fund is primarily buying that first most heavily weighted stock, first. So, indeed, that stock pretty much ?has? to go higher in time simply because every person that puts in a buck in an index, is sending a portion of it to buy that company. Now, with a portion of everyone?s dollars going to the heavyweights of an index, and in a good year an index can indeed move 40%, there are a ton of money managers that get paid to ?beat the index?. Well how can they do that? By buying smaller riskier stocks. They know that if they can create some excitement in a low float, small or micro cap, that thing can catch fire and double, or triple. They need those doubles and triples to beat the index?s or they get fired for under performance.

So, when the index?s are getting big money inflows, they roar higher. They have to. The small caps fire up so that hedge funds and private money managers get to fire them up and beat the indexs. But because of the weighting involved with indexing, what we often see is grotesque imbalances. Tiny companies with little hopes of ever really doing anything special are bid up, trading at 100 times sales. The individual investor sees the excitement and wants in, but he generally has no idea why he?s buying the darned thing. When the index funds run out of steam, the smaller issues then become targets for serious selling. The run will end as badly as others have for them with precipitous drops. This is what indexing has done for the market, it?s created a boom/bust cycle for smaller issues that is out of the scope of reality. They rarely end well.

This article courtesy of http://www.liability-insurance-central.com.
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