Carson Block discusses the potential ticking time bomb of passive investing, as leveraged ETFs and index funds continue to surge in inflows.
When SpaceX went public last month, it took just 15 days to reach the Nasdaq-100. The moment it joins, every index fund tracking the benchmark will be required to buy it – regardless of price, valuation or fundamentals. More than $800bn in retirement assets tracks that index alone.
For Carson Block, the activist short-seller who built Muddy Waters Research on exposing what other investors miss, that automatic, price-blind buying is the story of the modern market and a structural distortion few are pricing correctly. “Passive investing must buy when it receives inflows,’ he says. ‘Passive demand is completely price-inelastic”.
Block’s argument is that this creates a self-reinforcing cycle: Passive funds buy because they receive inflows, which constricts supply, which generates further demand and drives prices higher. The effect is most parabolic in the largest index constituents, amplified further by share buybacks that shrink the available float. It is, in his view, a slow-building distortion in how markets set prices. And one that works in reverse just as powerfully when the flows turn.
Space X will join $8.9tn worth of assets in passive funds, such as ETFs or index mutual funds. A Bloomberg report noted that leveraged SpaceX ETFs generated more than $1bnin trading volume on their first day of trading. A pattern mirrored in adjacent stocks: the CSOP SK Hynix leveraged ETF has become a $13bn fund nine months since it launched, powering the KOSPI to record gains.
A research paper from Lucian A. Bebchuk and Scott Hirst in 2021 estimated that BlackRock, Vanguard and State Street together owned a median of approximately 22% of shares of S&P 500 companies.
Through market-cap weighting, the larger companies receive larger allocations, creating a feedback loop as companies continue to grow. Moreover, index inclusion generates structural demand, as capital is continuously allocated through index-tracking funds. This has reinforced current levels of high market concentration, now evident in today’s market.
A UBS chart from June illustrated this more clearly. Out of the largest 1,000 US companies by market cap, 108 stocks in 2026 have a negative beta to the S&P 500, compared to 18 in 2025, a 500% increase. This suggests that an increasing proportion of listed companies are moving independently of, or against, the broader market, while a relatively small number of mega-cap stocks are increasingly driving index performance.
This structural backdrop becomes even more pronounced in leveraged ETF strategies. Michael Green, Portfolio Manager and Chief Strategist at Simplify, explains how these products intensify flow dynamics. “These daily requirements mean that stocks experience extreme buying pressure from flows in ETFs. This drives prices higher, which requires more buying on the rebalance. If enough shares are not available, the fund must buy call options, driving both implied volatility and prices higher.”
Hedge funds are often viewed as the opposite of passive investing, favouring short-term trades. Yet Bloomberg Intelligence data from April showed a tripling in exposure to ETFs from funds over the past three years. Funds don’t use ETFs as long-term compounders in the same way as a retail investor, but as a trading tool or hedge against macro views or to provide factor risk. This exerts further pressure on ETFs and thus the market, as they serve a dual role of passive investment and active speculation, creating diverging flow dynamics.
While Block emphasises the structural impact of passive flows, hedge fund behaviour reflects a more opportunistic response. A recent Bloomberg article articulated how funds are exploiting pressure on passive funds by trading against the mechanics of their flows and harvesting volatility, positioning for ETF demand, increasing prices through option hedges, or hedging the index exposure through spread positioning. Furthermore, Nomura estimated that leveraged ETFs now generate about $9bn in rebalancing demand for every 1% market move; how funds position amid competing market dynamics will be central to interpreting whether these flows amplify volatility or reinforce momentum.
Block had always assumed the mechanics of passive investing would continue until the US economy experienced a real increase in unemployment, causing inflows to drastically decrease and leading to an inflexion point. However, the distorting effect that AI is having on the labour market has accelerated the expected downturn. “The best users of the current generation of AI have been able to replace seven colleagues; teams consisting of eight employees can now operate with one high-level AI user, plus the model itself. If we think about this exponential improvement and extrapolate three years out, that’s a 15% reduction in the workforce of knowledge workers.”
If that scenario materialises, Block lays out the repercussions for passive funds: “These are some of the best-paid people in the economy; they’re major contributors to 401(k)s and taxable investment accounts. This dynamic would turn flows into target-date funds negative.”
According to Block, this is a contrarian view. Many investors and market speculators focus on headline valuations, seeing the continued growth of the biggest companies and ignoring the microstructure. “People ask whether they’re overvalued, but that is entirely the wrong question. All the hyperscalers can service their debt. Fundamentals and flows are the biggest determinants of prices.” For Block, that means considering “future passive inflows, effective float, share buybacks, and further float reduction. That is the framework for evaluating stocks; you must analyse them through that lens, and passive flows are intrinsically attached to that framework.”
Watch the full Alternative Views interview below.
