What If The Automatic Stock Buying Just…Stops?

My readers know that for the last couple of years I’ve repeatedly warned about the “passive bid” in markets. By that I mean the constant, automatic buying of stocks driven by retirement plans, ETFs, and other systematic investment programs.

This bid isn’t discretionary. It doesn’t ask whether valuations are reasonable and it doesn’t care whether earnings justify prices. It simply asks one question: did money flow in? If the answer is yes, it buys. It buys regardless of valuation, regardless of timing, and regardless of fundamentals.

This dynamic has created a market that behaves very differently from the one investors grew up with. Instead of price discovery driven by valuation and earnings expectations, we increasingly have price formation driven by flows.

And now one recent data point hints that this dynamic may be changing.

According to Vanguard data cited by the WSJ, a record 6% of workers in Vanguard administered 401(k) plans took hardship withdrawals last year, up from 4.8% in 2024 and roughly 2% before the pandemic.

Hardship withdrawals have now risen for six straight years. The median withdrawal was $1,900 and the most common reasons were avoiding foreclosure or eviction and covering medical expenses.

In isolation, that is not a market moving number. But what it represents is worth paying attention to. Because retirement accounts, which have become the backbone of passive investing, are increasingly doubling as emergency financial backstops.

For years I have argued that the market is being structurally bid higher by passive investment flows. Retirement plans, target date funds, ETFs, and automated investment programs buy stocks consistently month after month. These programs operate on autopilot. The result is a forced buyer in the market.

When contributions arrive, the funds buy the underlying securities, typically weighted by market capitalization. That means the largest companies receive the most buying pressure. This helps explain why a small group of mega cap stocks has dominated market performance. The so called Magnificent Seven, Tesla, Meta, Amazon, Apple, Microsoft, Netflix, and Google, have dramatically outperformed the broader market in recent years because of the passive bid, in my opinion.

At the same time, market breadth has often been remarkably weak. The number of advancing stocks has frequently lagged even as major indexes push to all time highs.

In other words, indexes have been rising while much of the market has moved sideways or lower. That is what happens when capital flows are allocated by size instead of value. It’s also why if I needed to start buying the S&P regularly to invest, today I’d prefer something like the equal weighted Invesco S&P 500® Equal Weight ETF (RSP) as opposed to a weighted ETF like State Street SPDR S&P 500 ETF Trust (SPY).

Regardless, for a long time the biggest question in my mind was not how passive flows drive markets higher. It was what happens if those flows slow or reverse.

Most retirement contributions come directly from paychecks. That means the passive bid is ultimately tied to employment. If fewer people are working, fewer contributions go into retirement plans. And if people start pulling money out, whether due to unemployment, financial stress, or emergencies, those funds must eventually sell assets to meet withdrawals.

That is where things get interesting.

In an interview last year, I pointed out how market analyst Mike Green laid out the mechanics of how a passive driven market could unwind. His thesis is simple but unsettling. Passive funds behave like systematic trading programs. When money flows in they buy. When money flows out they sell. Unlike traditional active managers, passive funds maintain almost no cash buffers. They are designed to remain fully invested. That means redemptions require selling into the market.

In a market where passive vehicles now represent more than half of US equity ownership, that dynamic could create structural fragility. Green’s broader point is that passive investing has fundamentally changed how markets behave.

Historically, stock markets were supposed to discount the future. Investors would anticipate recessions or slowdowns before they happened. But if flows dominate price formation, markets may no longer react to economic risks until the flows themselves change. And since those flows are tied to employment, the market may not respond to a downturn until jobs actually start disappearing.

At that point the feedback loop could become destabilizing.

Less employment means fewer contributions. Fewer contributions mean less passive buying. Withdrawals could mean forced selling. If the marginal buyer disappears at the same time sellers emerge, liquidity could vanish quickly.

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Another structural feature of passive investing is the self reinforcing momentum loop it creates. Because passive funds allocate capital based on market capitalization, rising companies receive larger inflows. This pushes their prices higher, increasing their index weight, which then forces funds to buy even more of them. It becomes a positive feedback loop.

This is one reason mega cap stocks have grown so dominant in index performance. The bigger they become, the more passive money must own them. This system works beautifully as long as the flows keep coming. But markets built primarily on momentum can be fragile when the direction changes.

It’s important to stress one key point: we are not anywhere close to a catastrophic situation today. Even the Wall Street Journal data that sparked this discussion paints a more nuanced picture. While hardship withdrawals have increased, overall retirement savings remain robust. In fact, the average 401(k) balance climbed 13% in 2025, reaching a record $167,970. Participation is rising as well—last year, a record 45% of workers increased their savings rate, largely driven by automatic escalation features built into many retirement plans.

In other words, the passive inflow machine is still very much running. Still, the WSJ data highlights something investors should keep in mind. Retirement accounts are no longer just long term investment vehicles. They are increasingly financial shock absorbers for households. If economic stress grows, those accounts could shift from being steady sources of inflows to sources of withdrawals.

And in a market where passive flows have become one of the dominant drivers of price, even small shifts in direction could matter.

For years I have described passive flows, along with options gamma, as tails that increasingly wag the market dog. As long as those tails keep pushing prices upward, the system works. But if the direction of those flows changes, investors may discover just how much of the market’s strength has been structural rather than fundamental.

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