Equilibrium Happens

There is a great deal of discussion these days regarding the impact of passive investing (or of systematic active investing in risk factors), and what it means for active management, and perhaps for security pricing generally.  In many cases – even with an in interesting or intuitive conclusion – the premise is all wrong.

Stock prices are not “made” by investors, whether they are active or passive.    Demand curves for shares are generally horizontal, and while things can get out of equilibrium temporarily due to price pressure (e.g. index inclusion), eventually the value of something is the value of something, and not dependent on price pressure.

Granted, the market may become depressed or exuberant, but we don’t need market participants to actually trade the underlying shares for individual prices (or markets in aggregate) to fade or rally.

For example, imagine company XYZ closes at €40 per share, and overnight agrees to a takeout by company ABC at €55 per share, and issues a press release before the market opens the next day.   We don’t need an actual buyer to “lift” XYZ toward €55, it just would have happened without a single share trading.  In other words, even in the absence of flow, equilibrium eventually happens.