The passive issue returns... Folks don't know what they're investing in... The cubic volatility threshold... That threshold could arrive faster than you think...
There's no way to confidently predict an extreme, unlikely event like the stock market going to zero...
And regular readers know that I (Dan Ferris) don't make predictions.
However, the market falling to zero isn't as far-fetched an idea as most folks would like to believe. And that could put a lot of investors at risk.
Before we move on, just know that I'm not recommending you sell all your stocks and bonds so you can buy guns, gold, and groceries and head to an off-the-grid cabin in the Idaho wilderness.
I simply want to tell you about a risk in the stock market. It's one we've talked about before, but not many people consider...
Passive investing is distorting the pricing mechanism of the stock market...
Passive investors buy stocks mindlessly – often in their 401(k)s – without any regard for business or economic fundamentals. The most popular choices are equity-index funds and target-date funds.
These investments are on autopilot, and investors might even forget that they're putting some percentage of their earnings into the stock market every time they get paid. They simply buy stocks and forget they own them for decades, unaware of what they even own.
In the case of target-date funds, investors buy stocks and bonds in various percentages, with the mix changing over time. The idea is to funnel assets into less risky investments as the employee's retirement date approaches.
Many folks probably don't even know they have a 401(k), let alone where the money is going...
Today, employees are often automatically enrolled in 401(k)s. They can decline to participate, but if they do nothing, they'll be enrolled, with contributions deducted from their pay and put into prechosen investment choices (which employees have the right to change).
So passive investors are putting billions of dollars per week into the stock market – completely unaware of where those dollars are going or that they're going there at all.
It's weird to think about, but that's the world we live in. Billions of people around the world depend on governments to support them in a mind-boggling array of different ways – from income payments or tax credits to corporate subsidies and tax breaks for businesses.
We're accustomed to being taken care of in this modern world of high living standards, abundant wealth, and ubiquitous wealth-redistribution schemes. The obliviousness of 401(k) account holders is just another symptom of our loss of agency and self-reliance.
I believe people around the world have misplaced their trust in governments. Maybe you disagree. But I think it's easy to see that investors have misplaced their trust in the market by putting all their retirement funds there.
Passive investing turns the market into a retirement utility...
But that's not what markets are designed to do. They're designed to ingest unfathomably complex myriad information and adjust asset prices accordingly, with folks buying and selling.
When you turn it into the automatic destination for billions of dollars of savings each week, you change things. The more money that pushes into the market with zero regard for that information, the less meaning market prices have. They're no longer a reflection of knowledgeable investors' decisions.
In an abstract of an upcoming paper called "Passive Fragility," Stephan Sturm of Worcester Polytechnic Institute, Mike Green of Simplify Asset Management, and Hari Krishnan of SCT Capital Management raise the alarm about the passive share of the U.S. stock market:
[T]he implications of our model should be a cause for significant concern. Once the passive share crosses a threshold, index volatility is expected to increase at a cubic speed, which may lead to much faster boom and bust cycles in the market... a higher threshold of passive share may spell disaster. Here, the major indices have a positive probability of hitting 0 before rebounding, over any finite time interval.
One of the authors' key findings is that passive investments could increase the market's volatility cubically (as in 2 times 2 times 2 equals 8).
Let's assume the S&P 500 Index's volatility is 15%. So in any given year, if you start at 100, the market would, on average, end the year anywhere between 85 and 115.
If you square that (as in 2 times 2 equals 4), volatility becomes 225%. So in any given year starting from 100, the market would land anywhere from 0 (since it can't go to minus 125) to 325.
It would become far more likely to see the market drop as much as 95% in a given year or soar as much as 10 times. It would be a market of constant melt downs and melt ups. In other words, it would be absolute chaos.
Now, assume the authors are correct and volatility increases cubically. That would be 3,375%. At that level, there would only be a small probability that the market wouldn't hit zero in a given year. Compounding would go out the window. Folks would sell all their equities if they could get just a penny for them.
According to the authors, these nightmarish conditions depend on passive investing hitting a critical threshold.
But we don't know what the authors believe that level is yet, since the full paper hasn't been published.
Right now, various folks estimate passively held investments make up between 53% and 60% of the U.S. stock market.
If things continue as they are, that number will soon approach 71%. That's the percentage of Americans who prefer passive investing, according to a Gallup poll.
It makes sense that volatility will rise with more passive investing...
It means that a smaller and smaller portion of the market is actively traded. The market itself would become the rough equivalent of a closely held company with a small group of shareholders holding a large portion of shares that don't trade.
If a $1 billion-market-cap company is 95% closely held by its founders, that means only 5% of the shares trade. So it's not really a $1 billion-market-cap company to the stock market. It's a $50 million-market-cap company, and it will likely be a lot more volatile than the average $1 billion company.
It's the same with the overall market. Imagine if 71% of the S&P 500's $61 trillion market cap was held by passive investors' retirement accounts. That would leave just 29% of the market, about $17.7 trillion, left to actively trade.
The market wouldn't be nearly as deep and liquid as everybody assumes. Trading would become more difficult, perhaps with wider bid/ask spreads and greater volatility.
If the market's pricing mechanism is off with passively held stocks between 53% and 60%, and volatility goes nuts at some level between 60% and 71%, then market prices could become completely disconnected from any notion of their underlying fundamental value sometime in the next few years.
This is one of those times when widespread agreement that an asset is safe turns it into toxic waste. The same thing happened in the housing bubble leading up to the 2008 financial crisis.
You often heard folks back then saying that U.S. home prices had never fallen (which was false) or that they hadn't fallen in so long it didn't matter (which turned out to be false).
According to the S&P Cotality Case-Shiller U.S. National Home Price Index, U.S. home prices peaked in July 2006 (two full years before the crisis arrived) and didn't hit bottom until February 2012.
Everybody agreeing that something is a great investment is not a good sign. Everybody agreeing that they'll shove every dollar of their retirement savings into one investment suggests a lot of folks are signing up for a rough retirement.
The big volatility threshold could arrive faster than you think...
Xavier Gabaix of Harvard University and Ralph Koijen of the University of Chicago wrote a working paper that's making the rounds among hedge funds. As the Economist recently reported:
[The paper] contradicts the textbook argument that money flowing into stocks should barely raise prices, since if it did, demand would fall and return prices close to their starting level. In fact, the paper's authors find that stockmarket demand is not "elastic" in this way. It is inelastic, and does not fall much as share prices rise. As a result, an investor who buys $1-worth of stocks using fresh cash (or the proceeds from selling other assets such as bonds) pushes up aggregate market value by $3-8.
In other words, 401(k) contributions push market prices up and, I would argue, eventually down a lot more than the amount of the contributions themselves.
Hopefully, this threshold is many years away, and its arrival comes in spurts... giving us all time to sound the alarm and prepare for the worst.
We have various ways of handling market downturns, but the big indexes going to zero – even for a split second – would be magnitudes worse than a 30% or 50% drawdown. The S&P 500, Nasdaq, or Dow Industrials hitting zero would horrify millions of people. Folks would sell their stocks for whatever they could get – which would be nothing or nearly nothing in most cases.
It's hard to wrap your head around such a scenario actually playing out. But some very smart folks have been talking about this sort of thing (though perhaps with a less horrific outcome) for years now, even with markets in spitting distance of new all-time highs.
So how do you prepare for this?
Hard assets in your physical possession would be a good start. So would a large stash of readily available cash, though I suspect a large stash of cash in a brokerage account might not be as accessible as you like in this type of crisis.
Bitcoin is another option, though it's now tied to the stock market through exchange-traded funds. So it might become volatile... But that's pretty normal for an asset that has had 80% and 90% drawdowns over the years.
Hopefully precious metals, cash, and other non-stock market assets will take care of us. But the truth is, there's simply no sure-fire way to prepare for such an extreme event.
Again, the market going to zero is unlikely. But if there's even a small chance it could happen (and I think there is), it's worth thinking about how you should position yourself today.
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In today's mailbag, feedback on Digest Editor Corey McLaughlin's thoughts about the origins of inflation he shared in yesterday's mail... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"Nicely done, Corey. I'm an alter cocker as we say [a Yiddish phrase referring, often with affectionate exasperation, to an older person], and this was the first time I have read that events in 10th-century China are responsible for inflation. Always enjoy your work, keep it up." – Subscriber Sherwin R.
"You write in part about 'two key moments in the "printing money" timeline... One is "the day the dollar died" on August 15, 1971 when President Richard Nixon took the U.S. off the gold standard for good.'
"I would add, 'and every day after that, when the government did not fix that prior mistake'.
"And I have a very concrete example of fixing mistakes. Let's say you make a bad stock pick, and it goes down, and is trending down.
"Every day you chose to not honor a stop, not sell, is another day with a bad decision. You can't just blame your former self for that mistake as if it were cast in stone and unfixable. Furthermore, the cumulative impact often gets worse and worse. Just some thoughts..." – Stansberry Alliance member John W.
Good investing,
Dan Ferris
Medford, Oregon
February 27, 2026
