Carson Block: Passive buying fuels price feedback loop

Carson Block, founder of Muddy Waters Research, warns that automatic, price‑inelastic buying by passive funds is creating a feedback loop that can affect how stocks are priced. He uses SpaceX’s rapid inclusion in the Nasdaq‑100 as an example of demand driven by index rules rather than company valuation.

Block describes the mechanics: when passive funds receive inflows they must buy the stocks in their benchmarks, so their demand does not fall as prices rise. Those purchases reduce available supply, which can push prices higher and attract further passive inflows. He adds that share buybacks can further shrink the free float and increase the effect on prices.

SpaceX reached the Nasdaq‑100 15 days after its public debut. Its inclusion obliges index trackers to buy the stock regardless of market price. Block notes that more than $800 billion in retirement assets track that index, meaning a large pool of capital will flow into any company added to the benchmark.

Market‑cap weighting directs larger allocations to the biggest companies, concentrating structural demand in those names. A 2021 paper by Lucian Bebchuk and Scott Hirst estimated that the three largest index managers together own a median of about 22% of shares in S&P 500 companies, a level that can magnify the impact of index flows.

A June chart showed that, among the largest 1,000 U.S. companies, 108 stocks in 2026 had a negative beta to the S&P 500 compared with 18 in 2025. That change reflects a rising number of firms moving separately from broad market swings while a smaller group of mega‑caps increasingly drive index returns.

Leveraged ETFs add another layer. Michael Green, portfolio manager and chief strategist at Simplify, explains: “These daily requirements mean that stocks experience extreme buying pressure from flows in ETFs. This drives prices higher, which requires more buying on the rebalance. If enough shares are not available, the fund must buy call options, driving both implied volatility and prices higher.”

Hedge funds and active traders have expanded their use of ETFs as trading tools and hedges. Industry data show hedge fund exposure to ETFs has risen substantially over recent years as managers use ETFs to express short‑term macro views or to position ahead of predictable index rebalances. One investment bank estimated leveraged ETFs generate roughly $9 billion in rebalancing demand for every 1% move in the market.

Block had expected an economic downturn that raised unemployment to reduce passive inflows. He now points to artificial intelligence as a potential accelerator of that inflection. He estimates that current AI tools can reduce headcount among knowledge workers by about 15% over three years, which would cut contributions to 401(k)s and taxable accounts and could turn flows into target‑date funds negative.

On valuation, Block recommends focusing on market microstructure: future passive inflows, effective float and share buybacks rather than headline valuation multiples. He argues, “People ask whether they’re overvalued, but that is entirely the wrong question. All the hyperscalers can service their debt. Fundamentals and flows are the biggest determinants of prices.”