The huge SpaceX IPO has spawned the following speculation: Index funds are forced to buy shares of new large companies, in proportion to their market capitalization.
"SpaceX is reportedly targeting an IPO date of June 12, 2026, with shares expected to begin trading on the Nasdaq under the ticker SPCX. The expected offer size is projected to be around $75 billion", notthe $1 trillion that you postulate in the blog post.
Right. There is some confusion in the post, which says index funds weight by market cap. That's certainly not true if the float is small, in that case they will weight by the float.
This makes a lot of sense from an academic finance way of looking at the stock market. But that ignores the important role that the stock market plays in capitalism. Yes, it is needed because without an easy way to sell an investment, most people wouldn't make the investment and companies could not easily get the equity capital they need. That is important, but obvious.
What is either unknown to academics or never mentioned is the market's role as a crowd-sourced system that tells business people what others expect to be industries or niches that will be very profitable in the future. Being profitable means that the buyer of a stock thinks that there will be an excess of demand for its output over the supply, so by taking on more capital and expanding supply a company can reap more of those profits, although, by doing so, their increased supply will result in lower profits than if they had not.
When many people all think that, say, AI will be very profitable, and push the AI stocks up to high valuations, that message gets absorbed throughout the business world. We've seen that in the last few years where the excitement about AI has caused the VC industry to direct something like 75% of all its investments in the last few years towards AI companies. If we had no stock market, would they have thought to do so? I doubt it.
Keep in mind that we don't have a high savings rate. Most income gets consumed (or taken by the government where it is consumed and wasted.) Given our limited savings, it is a good thing that the stock market can alert those with savings of where some good opportunities are expected to exist. Countries without a broad and active stock market never get that information, and you could say that the downfall of the USSR was that despite its extremely high savings rate, which Samuelson insisted would ensure high growth, without a stock market they misdirected all their investment, causing their economy to fall further behind the US.
That doesn't mean that stock investors all have any special insights into the future. Some do, and some don't. But one of the great things about the market is its Darwinian method of directing more money toward those who are good at predicting where capital will be rewarded by giving them profits on their investments; those who buy stocks in companies that do poorly are punished by losses. That way, over time, more money migrates into the hands of those good at predicting where capital will be most needed, and bad predictors are left with less money to misallocate in the future.
What index investing does is discourage investors from having any insight into the future. There are still fundamental investors who want to own stocks that are cheap compared to what their expectations are, and if they have pushed up certain stocks, index investors will piggyback on their insight by buying more of them as their index weighting rises.
But index investing creates upward and downward spirals that distort any insight. The more a stock in an index outperforms, the higher its weighting will be in the next rebalancing, at which point the index fund buys more shares, financed by the sale of stocks that underperformed. IOW, an index fund is a system of buying more of companies that are increasingly overpriced, while dumping the shares that are increasingly underpriced.
If you like to buy high and sell low, an index fund is just the thing for you. Although, like any Ponzi scheme, that can work out well for a long time.
I'm not saying that index investing isn't the right thing for many people whose guesses about the future on their own are likely to be random, but the force of the "passive bid" from all the retirement money pouring into index funds are increasingly overwhelming the impact on the economy of the useful messages coming from fundamental investors who are good at it, and we will have increasing amounts of our capital misdirected as a result. (My guess is that AI has a good chance of being the first big example of that.) Check out my most recent Substack post for more on the subject.
I am not suspicious of index investing, I actually like it and have put my money where my mouth is: but how the “gatekeepers”, the index providers, changed their rules to accommodate SpaceX left a bad taste.
Spacex is loss making to the tune of several billion dollars per year. Bear this in mind when you tell me how much the shares are worth. How much would you pay for a loss making rocket?
I get that the theme here is “Don’t ditch your index strategy because of one meme megacap” and that is good and appreciated, but I think your stylized example would have benefited from grounding the float closer to reality (<5% rather than 50%) given the index is modifying its float-size rule (among others) to allow for spacex’s inclusion
Trades are what officially print the last price, but bids and asks can still move the quoted market before any trade happens. If buyers raise their bids and sellers raise their asks, the visible price range moves up even without a transaction. Same in reverse if bids disappear or sellers lower their asks. So yes, quotes can move first, but the “stock price” most people see as the last traded price only changes when an actual trade prints. Hope it helps!
This weekend's BARRONS has this to say - long article - here are highlights
"Indisputably, there are signs—some of which hark back to the dot-com era—that it is (a bubble). For instance, take a gander at this not-so-little equation: $1.75 trillion divided by $18.674 billion equals 93.71 times.
That’s the expected midrange market capitalization of SpaceX’s initial public offering ($1.75 trillion), divided by the company’s 2025 revenue ($18.674 billion), with the quotient of 93.71 being SpaceX’s price-to-sales ratio. Which is ridiculous. (The S&P 500 index’s ratio is just 3.38—and that’s with stocks at record highs.)
Perhaps, though, you think SpaceX is deserving of a stratospheric valuation. After all, this is a company that holds itself out as the North Star of our incipient “space-faring civilization,” as Elon Musk puts it in SpaceX’s prospectus.
In fact, the word “civilization” is mentioned 24 times in the S-1, along with 38 pages of risk factors, a 6½-page glossary of terms, and myriad beauty shots of rockets and space. Overall, the 389-page document is a monument to unbridled ambition—a sorcerer’s space dream of norm-stretching finance, massive capital spending on chips and data centers (more than on rocket launches), and billions of dollars of losses.
In 2002, Scott McNealy, former CEO of Sun Microsystems, a star of the dot-com age before it was swallowed by Oracle in 2010, was asked if he thought stock prices in 2000 were too good to be true. McNealy responded with a rant addressed to those who bought his stock when it sold for 10 times revenue:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I have zero cost of goods sold, which is very hard. That assumes zero expenses, which is really hard. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Do you realize how ridiculous those basic assumptions are? What were you thinking?”
My totally amateurish take:
IPO's like this one + Anthropic, Open AI and who knows what else etc are events that happen at the tail end of a long bull markets. If we hit 8,000 to 8,500 (to pick a figure on the S&P 500) some Black Swan (like COVID) or a Gray Swan (Russia or North Korea use nukes not out of the Blue because both countries threaten with nukes all the time, but the assumption is they won't use them.)
The trigger really doesn't matter as much as historical over-valuation. I lived through 1973-1974, 1979 -1982, 2008/2009 and 2020 COVID and the crashes are the same amount of pain. When I was born in 1947 the Dow was at 200 - now 50,000 so as they say "in the long run.............. "
You will see a 40 to 60% haircut extremely fast like March 2008 to March 2009 or 1550 on the S&P 500 to 666 by March 2009 12 months or a 57% decline.
"SpaceX is reportedly targeting an IPO date of June 12, 2026, with shares expected to begin trading on the Nasdaq under the ticker SPCX. The expected offer size is projected to be around $75 billion", notthe $1 trillion that you postulate in the blog post.
Right. There is some confusion in the post, which says index funds weight by market cap. That's certainly not true if the float is small, in that case they will weight by the float.
This makes a lot of sense from an academic finance way of looking at the stock market. But that ignores the important role that the stock market plays in capitalism. Yes, it is needed because without an easy way to sell an investment, most people wouldn't make the investment and companies could not easily get the equity capital they need. That is important, but obvious.
What is either unknown to academics or never mentioned is the market's role as a crowd-sourced system that tells business people what others expect to be industries or niches that will be very profitable in the future. Being profitable means that the buyer of a stock thinks that there will be an excess of demand for its output over the supply, so by taking on more capital and expanding supply a company can reap more of those profits, although, by doing so, their increased supply will result in lower profits than if they had not.
When many people all think that, say, AI will be very profitable, and push the AI stocks up to high valuations, that message gets absorbed throughout the business world. We've seen that in the last few years where the excitement about AI has caused the VC industry to direct something like 75% of all its investments in the last few years towards AI companies. If we had no stock market, would they have thought to do so? I doubt it.
Keep in mind that we don't have a high savings rate. Most income gets consumed (or taken by the government where it is consumed and wasted.) Given our limited savings, it is a good thing that the stock market can alert those with savings of where some good opportunities are expected to exist. Countries without a broad and active stock market never get that information, and you could say that the downfall of the USSR was that despite its extremely high savings rate, which Samuelson insisted would ensure high growth, without a stock market they misdirected all their investment, causing their economy to fall further behind the US.
That doesn't mean that stock investors all have any special insights into the future. Some do, and some don't. But one of the great things about the market is its Darwinian method of directing more money toward those who are good at predicting where capital will be rewarded by giving them profits on their investments; those who buy stocks in companies that do poorly are punished by losses. That way, over time, more money migrates into the hands of those good at predicting where capital will be most needed, and bad predictors are left with less money to misallocate in the future.
What index investing does is discourage investors from having any insight into the future. There are still fundamental investors who want to own stocks that are cheap compared to what their expectations are, and if they have pushed up certain stocks, index investors will piggyback on their insight by buying more of them as their index weighting rises.
But index investing creates upward and downward spirals that distort any insight. The more a stock in an index outperforms, the higher its weighting will be in the next rebalancing, at which point the index fund buys more shares, financed by the sale of stocks that underperformed. IOW, an index fund is a system of buying more of companies that are increasingly overpriced, while dumping the shares that are increasingly underpriced.
If you like to buy high and sell low, an index fund is just the thing for you. Although, like any Ponzi scheme, that can work out well for a long time.
I'm not saying that index investing isn't the right thing for many people whose guesses about the future on their own are likely to be random, but the force of the "passive bid" from all the retirement money pouring into index funds are increasingly overwhelming the impact on the economy of the useful messages coming from fundamental investors who are good at it, and we will have increasing amounts of our capital misdirected as a result. (My guess is that AI has a good chance of being the first big example of that.) Check out my most recent Substack post for more on the subject.
Well, managed to get through it for the first time. Tomorrow, I will give it another go! Should go well with my morning coffee.
I am not suspicious of index investing, I actually like it and have put my money where my mouth is: but how the “gatekeepers”, the index providers, changed their rules to accommodate SpaceX left a bad taste.
Spacex is loss making to the tune of several billion dollars per year. Bear this in mind when you tell me how much the shares are worth. How much would you pay for a loss making rocket?
I get that the theme here is “Don’t ditch your index strategy because of one meme megacap” and that is good and appreciated, but I think your stylized example would have benefited from grounding the float closer to reality (<5% rather than 50%) given the index is modifying its float-size rule (among others) to allow for spacex’s inclusion
Does anyone have to make a trade to cause stock prices to move? Can't bids and asks get the job done with no trades occurring?
Trades are what officially print the last price, but bids and asks can still move the quoted market before any trade happens. If buyers raise their bids and sellers raise their asks, the visible price range moves up even without a transaction. Same in reverse if bids disappear or sellers lower their asks. So yes, quotes can move first, but the “stock price” most people see as the last traded price only changes when an actual trade prints. Hope it helps!
That accords with my understanding. Thanks for the confirmation. ☺️
You are very welcome :)
This weekend's BARRONS has this to say - long article - here are highlights
"Indisputably, there are signs—some of which hark back to the dot-com era—that it is (a bubble). For instance, take a gander at this not-so-little equation: $1.75 trillion divided by $18.674 billion equals 93.71 times.
That’s the expected midrange market capitalization of SpaceX’s initial public offering ($1.75 trillion), divided by the company’s 2025 revenue ($18.674 billion), with the quotient of 93.71 being SpaceX’s price-to-sales ratio. Which is ridiculous. (The S&P 500 index’s ratio is just 3.38—and that’s with stocks at record highs.)
Perhaps, though, you think SpaceX is deserving of a stratospheric valuation. After all, this is a company that holds itself out as the North Star of our incipient “space-faring civilization,” as Elon Musk puts it in SpaceX’s prospectus.
In fact, the word “civilization” is mentioned 24 times in the S-1, along with 38 pages of risk factors, a 6½-page glossary of terms, and myriad beauty shots of rockets and space. Overall, the 389-page document is a monument to unbridled ambition—a sorcerer’s space dream of norm-stretching finance, massive capital spending on chips and data centers (more than on rocket launches), and billions of dollars of losses.
In 2002, Scott McNealy, former CEO of Sun Microsystems, a star of the dot-com age before it was swallowed by Oracle in 2010, was asked if he thought stock prices in 2000 were too good to be true. McNealy responded with a rant addressed to those who bought his stock when it sold for 10 times revenue:
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I have zero cost of goods sold, which is very hard. That assumes zero expenses, which is really hard. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Do you realize how ridiculous those basic assumptions are? What were you thinking?”
My totally amateurish take:
IPO's like this one + Anthropic, Open AI and who knows what else etc are events that happen at the tail end of a long bull markets. If we hit 8,000 to 8,500 (to pick a figure on the S&P 500) some Black Swan (like COVID) or a Gray Swan (Russia or North Korea use nukes not out of the Blue because both countries threaten with nukes all the time, but the assumption is they won't use them.)
The trigger really doesn't matter as much as historical over-valuation. I lived through 1973-1974, 1979 -1982, 2008/2009 and 2020 COVID and the crashes are the same amount of pain. When I was born in 1947 the Dow was at 200 - now 50,000 so as they say "in the long run.............. "
You will see a 40 to 60% haircut extremely fast like March 2008 to March 2009 or 1550 on the S&P 500 to 666 by March 2009 12 months or a 57% decline.
What % of the index is owned by index funds versus other investors?