Precursor To Mayhem? All-Important Passive Capital Flows Are Faltering | Mike Green

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**Michael Green** (0:37)
There's actually some evidence that the giant mindless robot is flattening out a little bit. So we're actually seeing combined flows across mutual funds and ETFs begin to flatten out and actually potentially turn down.

**Adam Taggart** (0:55)
Welcome to Thoughtful Money. I'm its founder and your host, Adam Taggart. When you're uncertain, it's said you should seek the counsel of those smarter than you. Well, amongst the many experts I interview on this channel, Michael Green is definitely in the top cohort intellectual horsepower-wise. Mike's the portfolio manager and chief strategist at Simplify Asset Management, and today, we'll tap his latest thinking on the stock market, the labor force, the economy, and where the new administration's policies may be taking us. Mike, thanks so much for joining us today.

**Michael Green** (1:28)
It's always a pleasure, Adam. Thank you.

**Adam Taggart** (1:30)
Hey, thank you. Well, look, my friend, let's just get into it. Lots to talk to you about, but for better or worse, Mike, you're known amongst my audience as the passive capital flows guy, the giant mindless robot guy. We're talking here with stocks back at all-time highs. So I'm guessing you're going to say there's really nothing wrong right now with the giant mindless robot, meaning he's just doing fine.

**Michael Green** (1:57)
Well, it's interesting. There's actually some evidence that the giant mindless robot is flattening out a little bit. So we're actually seeing combined flows across mutual funds and ETFs begin to flatten out and actually potentially turn down. I associate that with the increase in unemployment that we have seen. But currently, that is being offset by the fact that we're still largely firing active managers and hiring passive managers. And if you remember prior discussions we've had, there's effectively just a different multiplier associated with those two. You put money in with an active manager, they can behave like I do on occasion, which is say, thank you very much for the cash. I'm going to use that to build up reserves so that I can buy things when they're more attractive. That has obviously zero multiplier in terms of the stock market, if that's what occurs. If on the flip side of it, you send it to an S&P 500 fund or a total market fund, a passive index fund, in other words, that money is immediately going to be deployed, and it will be deployed to buy the largest stocks in the highest proportion. Those are also the least elastic stocks. Again, that's the economic term that describes how supply and demand react to price. In stock market terms, we invert that and basically say, how does price respond to changes in supply and demand? Inelastic stock is one that has no real substitutes. It has very little capacity to absorb that additional inflow relative to the quantity of capital that's being put to work on it. And so its price behaves with a very, very high multiplier. When I do the math between those two, typically if you're giving money or taking money away from an active manager, the multiplier is about two. So you give me a dollar, I go buy some stocks. The impact on the aggregate market cap is roughly a $2 increase in the market. If you give it to a passive fund at this point, my numbers are saying somewhere between $17 and $20 worth of multiplier. As long as the ratio between active and passive does not exceed that threshold, effectively where you'd begin to see permanent negative impacts, you're unlikely to see the real event that I'm concerned about. But we are starting to see that weekend. If unemployment begins to rise further or if Americans become more concerned about the potential for investing in the stock market or far more important actually in today's world, if Europeans, international investors, etc., decide that they're going to send far fewer of their investment dollars to the United States, that could lead to a change in what we currently think of American exceptionalism, the outperformance of the US stock market. We got a taste of that in the February to April time period in which there's a brief flurry of activity from Canadian pension plans, from European sovereign funds, etc., where they started to reallocate away from the United States. But I think it's really important for people to recognize that that entire narrative has largely stopped. The US stock market has outperformed significantly off of the April lows. It was one of the first in the world to make new all-time highs. It was, of course, led by those large inelastic stocks that we think of as the MAG7, the largest components of the S&P 500