Passive-aggressive Investment Behaviour

Over the past thirty years passive investing has surged.

Over the past thirty years interest in passive investment has surged.

From under 5%, it is now thought that at the start of 2025, passive investment vehicles, through US mutual funds and Exchange-Traded Funds (ETFs), are managing a staggering $15 trillion of assets. This is 50% of the total invested in US equity and fixed-interest markets.

Passive investing aims to match the returns of a specific market, index and even commodities. This involves mirroring the holdings and underlying investment weightings, thus, in theory, replicating returns after fees. Funds tend to focus on the larger, most liquid areas of the market aligning with the major global indices.

As the passive investing juggernaut has gained momentum, so more investors have jumped aboard. The catch, however, is that this shift has led to greater market concentration and reduced-price sensitivity. This has become especially apparent in US large-cap stocks, particularly the Mag7, that the index-tracking funds must buy regardless of valuation.

As passive funds replicate share indices with fewer securities, their influence on price action has grown, making some equity markets increasingly sensitive to the wall of money or being ‘flow-driven’, rather than by investment fundamentals. It could be argued that these passive flows have also dampened market responsiveness to negative news and suppressed short-selling activity, which has reinforced upward momentum. This is all well and good as long as passive fund flows remain supportive.

Could anything change this?

A key source of these fund flows is retirement-linked passive investing, underpinned by a resilient US labour market. It will be interesting to see if any material weakness in employment could curtail these passive flows. Trump tariff and policy changes have created uncertainty for many US businesses while his immigration plans are likely to reduce labour force growth. Tariff driven and wage inflation risks are mounting, constraining the Federal Reserve’s ability to cut interest rates.

The interplay between the US labour market, inflation and passive fund flows are likely to dictate the shape of the path ahead. In addition, Big Tech stock concentration will also come into play as concerns remain about the pace of adoption of AI by US businesses. These AI behemoths such as Nvidia have become the mainstay of passive index exposure.

Finally, whilst US equities have recently hit fresh highs, political and economic uncertainty in America has seen US equities underperform other markets year-to-date, as global investors have sought to diversify their US exposure. Should US Dollar weakness continue, then this may serve as a further challenge to the US stock market.

 

What have we been watching?

 

‘Peace in our time?’ – unlikely but markets breathed a collective sigh of relief with the end of the ‘12-Day war’ as Trump called it and we must now hope that the ceasefire holds. Oil prices dropped as the potential threat to the Strait of Hormuz was lifted. The other geo-political news last week was NATO’s agreement to increase defence spending to 5% of GDP by 2035 (3.5% core spending and 1.5% on infrastructure). How some countries will pay for this is tomorrow’s problem, as for now Europe, seems to once again have Trump’s support which remains crucial as the war of attrition continues in Ukraine.

Markets can now re-focus on the economic challenges although are likely to remain wary of the various ongoing geo-political risks. The first is the US Tax Bill, which is currently working its way through the Senate, and which Trump is hoping to get passed by Independence Day on 4th July. Alongside tax cuts, the bill also contains an increase in the US debt ceiling. As well as the Tax Bill, markets will be focusing upon tariffs as the 90-Day extension to the reciprocal tariffs ends on 9th July. The Whitehouse said that an agreement with China has now been reached and that imminent plans have been made to agree deals with ten of America’s major trading partners although it is not clear if this includes the EU.

Markets will also be watching the US inflation data for June due on 15th July. This is likely to be particularly important for markets which will be watching for the trade tariff pass-though being felt in consumer prices. Price increases are already being seen in sectors reliant on Chinese goods such as toys and domestic appliances. Even with the 90-day reciprocal tariff delay, there is still the impact from the 10% baseline tariff, sector tariffs such as steel and the tariffs on China, Canada and Mexico!

 

The June US inflation numbers will be crucial for the Fed’s interest policy. Fed Chair Jerome Powell has already mentioned the uncertainty around this, saying that in terms of who will pay for this that ‘it’s very hard to predict that in advance.’ Into this mix can be added Trump’s rants on Truth Social calling for the Fed to be more aggressive on interest rate cuts! Sterling hit a three-and-a half- year high against the US Dollar, moving to $1.37 on media reports that Trump is considering announcing Jerome Powell’s replacement early. However, Trump is not expected to announce the new appointee until September, and they would not replace Jerome Powell until the end of his 4-year term in May 2026.

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Brent oil dropped over 12% to under $68 with the end of the ’12- Day war’ between Israel and Iran.

Finally, remember the UK CO2 shortage that threatened food packaging and fizzy drinks? Well, the UK could be facing another CO2 crisis as the Ensus biofuels plant on Teesside is facing risk of closure. Furthermore, the other major CO2 producing plant, Viivergo Fuels in Hull might also close. The reason is the US-UK trade deal which gives tariff-free access to the UK market to US bioethanol producers. UK producers are urgently seeking a government support package. Given how critical this industry is to the grocery and pub sector it sounds as if the government will have to find yet more cash.

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