The Index Trap
Why the AI revolution and structure of modern markets are about to make stock market picking matter again
There is a robot that buys US stocks every day.
It does not look at price. It does not read earnings. It cannot tell the difference between Nvidia and a soon-to-be-disrupted software vendor. It just buys, in proportion to whatever yesterday told it to buy.
That robot now sets the price of the US equity market.
Indexed funds reached 52% of long-term US fund assets at the end of 2025, up from 3% in 1995. The Magnificent 7 are 33.7% of the S&P 500. Seven names generated 42% of the index’s total return last year. Only 30.5% of S&P 500 stocks beat the benchmark.
When you buy an S&P 500 ETF today, you are not buying a diversified portfolio. You are buying a concentrated bet on seven mega caps, dressed up as one.
And then AI walks in.
There is a comforting story that AI is a rising tide that lifts every boat in the index. I disagree. AI is the opposite of a tide. It is a K-shaped force.
Hyperscaler capex will hit $602 billion in 2026, more than double what it was two years ago. On the other side, Klarna replaced 700 customer service agents with an AI assistant in a single month.
Both companies sit in the same index. In weights set by yesterday’s market cap. The robot owns the AI winners and the AI losers in the same vehicle, and it cannot rotate.
This is the trap.
I have put the full case in a 25-page paper. It walks through how we got here, why 79% of active managers actually lost last year, why that statistic is now the loudest signal for stock pickers in 15 years, and what an AI-era equity portfolio looks like in practice.
If you allocate capital, you should read it.
You can download the full paper below. I hope you find it useful, and as always, I would love to hear what you think.
Michael
Michael: Thank you for another well researched and thought-provoking essay. I've followed and agreed with Michael Green's comments on passive investing for years. I'm surprised that passive is still "alive and well" let alone now receiving 52% of new money, but then I've been surprised by the longevity of many market trends during my five decades as a trader. I've learned the hard way that trying to time the end of a trend is expensive, but when "conditions" are in place for a possible "turn" it pays to wait for a "catalytic moment" (PTJ's term) that potentially defines a "turn" before fading the trend. The catalytic moment could be "hard evidence" like fingerprints on a murder weapon or more esoteric like "I don't hear a thing" from the Margin Call movie. I sense that "conditions" are in place for a turn in the passive trend, can you imagine a catalytic moment?
wasn't able to download the document