The Total Stock Market Index

Assume, for the sake of this present discussion, that the term "stock market" means the "stocks in the US markets"; this will simplify matters. Other than that, you can replace the term "market" by any coherent, consistent definition and everything said here will continue to remain true, mutatis mutandis.

The (capitalization-weighted) Total Stock Market Index (or a fund designed to track such an Index) is:

• NOT over-weighted or under-weighted in any asset class or valuation style that is part of the Index. Saying otherwise is akin to claiming that Stocks are incorrectly weighted in ticker symbols beginning with the letter Z.
  Over-weighting and under-weighting are defined relative to the Index; therefore, the Index itself is neutral with respect to all weighting judgments.
  Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.
• NOT over-weighted or under-weighted in any asset class or valuation style that is NOT part of the Index since such a remark makes no sense at all. Saying otherwise is akin to claiming that Stocks are incorrectly weighted in T-bills.
  Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.

• NOT over-diversified or under-diversified with respect to any asset class or valuation style that is part of the Index. Saying otherwise is akin to claiming that Stocks are incorrectly diversified in ticker symbols beginning with the letter Z.
  Diversification is defined relative to the Index; therefore, the Index itself is neutral with respect to all diversification judgments.
  Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.
• NOT over-diversified or under-diversified with respect to any asset class or valuation style that is NOT part of the Index since such a remark makes no sense at all. Saying otherwise is akin to claiming that Stocks are incorrectly diversified in T-bills.
  Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.

• NOT contrarian or momentarian with respect to any of its assets. Contrarian and momentarian tendencies are defined relative to deviations (and the directions of these deviations) from the Index; therefore the Index itself is neutral with respect to all contrarian and momentarian judgments.
  Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.

The Total Stock Market Index represents the aggregate, averaged behavior of the entire market and all its participants. Therefore, any reasonable boolean predicate P when applied to the market should be projectible onto all of its participants. In other words, a statement of the form "The Index is FOO" makes no sense unless it is also true that "Everyone in the Market together is FOO".

Conversely, if a statement "Everyone in the Market together is FOO" does not, cannot, even in principle, make sense, then the statement "The Index is FOO" also does not, cannot, even in principle, make sense.

Corollary: Anyone who says otherwise is a fool or an unscrupulous liar.

The above statements are true regardless of your opinions on market efficiency and investor rationality.

If, however, you believe in market efficiency and investor rationality, at least in the operational sense (i.e. the market behaves as if all information is incorporated instantaneously into prices, and investors behave as if they are rational and possess full knowledge of all available market information, both to a high-degree of accuracy), then:

The Total Stock Market Index is:

• NOT over-valued or under-valued. Terms like over-valued and under-valued are meaningless in an efficient market. All assets are correctly-valued in efficient markets populated by rational investors.
  Corollary: Anyone who says otherwise and also sells funds from a company founded on the principles of market efficiency and investor rationality is a fool or an unscrupulous, lying hypocrite.
• NOT subject to bubble risk. Terms like bubble are meaningless in an efficient market. All assets are correctly-priced in efficient markets populated by rational investors.
  Corollary: Anyone who says otherwise and also sells funds from a company founded on the principles of market efficiency and investor rationality is a fool or an unscrupulous, lying hypocrite.

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First written: Thu Nov 9 14:57:10 PST 2000
Last updated: Sun Jun 27 17:00:19 PDT 2004
URL: http://geocities.datacellar.net/krishna_kunchith/markets/tsm.html