SpaceX Just Got Fast-Tracked Into Your Portfolio

You are talking several, you know, billions, tens of billions of dollars that are ultimately going to flow into these investments. The big winners there are those who are seeking liquidity, the insiders who are actually looking to sell shares, and that unfortunately I think contributes to the general perception that the stock markets are really not set up for the average investor at this point. Although we're thrilled to see them move higher given our participation through things like 401ks, it's a little bit of a slap in the face to see somebody become the world's first trillionaire on the basis of manipulating an index that we were all told we could trust.

Well, I mean, unfortunately, I think this is the logical conclusion of America's shift towards passive index investing. Rather than have a choice being made by an individual or by a portfolio manager, we now have choices that are being made simply by the index, which has an obvious incentive to get companies public, get them listed on the NASDAQ, offer NASDAQ inclusion as a component of that, in order to get the listing on the NASDAQ index as compared to the New York Stock Exchange or other exchanges they could potentially have listed on. So we understand why this is occurring, or we have a very strong sense for why this is occurring. It is an opportunity to effectively exploit the index position to bring the company public, get it listed, drive the capacity for insiders to sell shares, and ultimately create liquidity for those inside investors. As to whether or not that's a good idea, obviously, I think it is not, from the tone that I'm using. I think it is candidly quite manipulative. We have allowed index investing to receive special treatment under the law, in which it does not have the same requirements that active management has for fiduciary standards or suitability standards. If I run a strategy that says I'm going to do X and I suddenly unexpectedly change that, my investors are allowed to sue me. We are by and large protected from that in the index world as long as the index methodology has changed rather than simply the inclusion of a new stock. In this case, they published their intent to do this in advance of the listing. It was open for comment period. My understanding is the comments were almost universally negative. I certainly contributed several of those myself. It was much like Chicago. I voted twice and often even after I had died. But the simple reality is that they were intent on doing this. It's a profitable decision. It draws attention and gets us discussing the NASDAQ 100 or the QQQ ETF, which is part of the objective as well. And now we're confronted with a scenario in which funds can actually be invested in under the idea that they are passive, that they receive special treatment under the law, and yet they've exposed themselves as not at all being passive. It's the logical conclusion of what you would expect. Eventually, we'll figure out how to manipulate anything to generate profits.

Well, when you highlight that it is in the neighborhood of 1.4 trillion that is tracking it, and it is roughly a 1% weight, although it is receiving additional weight because of the float multiplier that is being used, you are talking several, you know, billions, tens of billions of dollars that are ultimately going to flow into these investments. The big winners there are those who are seeking liquidity, the insiders who are actually looking to sell shares. Whether those are investors who invested during its private period or whether those are employees who have waited for liquidity, the answer is it's the insiders. And that unfortunately I think contributes to the general perception that the stock markets are really not set up for the average investor at this point. Although we're thrilled to see them move higher given our participation through things like 401ks, it's a little bit of a slap in the face to see somebody become the world's first trillionaire on the basis of manipulating an index that we were all told we could trust.

I think there's definitely some truth to that. I think, you know, what we need to remember is that passive was never passive by its own definition. The definition of a passive investor is somebody who never buys or sells. That makes sense to many individual investors who, through their 401k, are quote-unquote buy and hold. But that first step, the buy, actually is a really critical component because you are contributing cash to the portfolio that causes the portfolio to need to be rebalanced. That causes trading and influences prices. Over the last five to seven years, we've learned an extraordinary amount about the influence of passive investing. My work suggests that the impact of passive strategies is rising the S&P, increasing the S&P by nearly 18% a year. Now, I know that sounds like an astonishing number given that the S&P was only up 15% last year. So we're actually looking at an index that overall probably would have declined had we not chosen to invest this way. We decided to do this because we thought that it simplified the process. It did simplify the process for average investors. It also simplified the process of taking advantage of those investors, as we have just seen.

I've been doing research and reporting and writing on this for well over a decade now. Sometime around 2016, the formative literature and the awareness began to grow that there was an impact from passive investing, which had always been presented as effectively a not meaningful impact on the market. Even today, you will hear Vanguard and others talk about the small fraction of trading that is involved in passive trading. Those are simply misrepresentations. Unfortunately, what they consider is what's called the organic trading. It excludes all of the flow characteristics that I just walked you through. So when we look at what's happening in the markets today, we have about a trillion dollars that is flowing into index funds. We have somewhere in that neighborhood that is actually leaving the discretionary active community. My lament is not about the active community. It's about the impact that has on the markets. We're destroying the process of price discovery. You asked, is it the right price for SpaceX? The reality is nobody knows, and nobody bothered to look at it, and everyone who has has come to the conclusion that it's fantastically overvalued. In fact, it really shouldn't even be called SpaceX. It should be called xAI because three-quarters of the expected value in most of the forecasts are tied to its money-losing, nonprofitable, and lagging AI business. Why that justifies such an extraordinary multiple in valuation is somewhat beyond me. But once you declare it into the index at those levels, the index accepts that the last price was right. And that's really the key of passive. It passively accepts the price. And so when you involve them in the process of listing in this manner, you are structurally changing outcomes.

I don't think so. I think actually the next chapter is we will see more of this type of manipulation. There are many, many publicly traded or privately held companies that would love to list under these types of conditions and to receive the multiplier. My hunch is that we will actually see that exploitation and a repeat of the late 1990s IPO boom before we see anything resembling the outflow type components that you're highlighting.

Well, ultimately, I want to be clear for an investor into the NASDAQ 100 or into any index like the total market indices that have already included SpaceX because of its size in their indexes. Ultimately, whether it turns out to be a good investment or a bad investment is not going to be all that material. It is a relatively small fraction of the index. So even if it went to zero, the ultimate impact on the index investor would be largely negligible. The downside is actually what's happening from a societal framework. This is an enrichment tool that allows corporate executives and insiders to dump shares onto an unsuspecting public. And the last thing I would highlight, Ed, is just that I think you're giving people by and large too much credit. I think this audience very well may be aware of what you're discussing, but the really critical changes were made in 2006 when we created what's called the Pension Protection Act. We switched our retirement system of 401ks from what's called an opt-in framework, in which they had to choose to participate, into what's called an opt-out framework, where they had to choose not to participate. That exploded the number of people who held 401ks. It climbed from around 25% to today it's around 65%. It radically reduced the investment choices that most people are exposed to. And candidly, I would argue that most people are sleepwalking through this process, not really aware of what they're investing in or why they're investing in it. They're simply doing as they are told. That can be a good thing. It can also be a bad thing if everybody starts doing what they're told, as we are seeing. It creates the distortions that we are experiencing as markets become increasingly disassociated from fundamentals. So should this be happening? No. But we made a choice to do it this way. And this is, I said at the very beginning, is likely the logical conclusion. We will figure out a way to exploit this phenomenon and turn it into profits for those who are highly incentivized to create those profits.