The majority of stock market participants, by dollar value of assets, have to be long. Dollar value of assets here means how much money these participants control, because that’s what ultimately matters in markets. Think of it this way: ten thousand individual investors with $10,000 each control $100 million in total. While that is a large amount of money, from the perspective of the asset management industry, $100 million isn’t large at all. 

In fact, equity mutual funds in the US had approximately $12 trillion in assets at the end of 2020. That’s only mutual funds. It excludes other pools of capital that invest in equity markets such as hedge funds, exchange traded funds, mutual funds that are not incorporated in the US but invest in US equities, etc. 

Of course, one of the reasons that equity mutual funds in the US are so large is that they are the primary vehicle through which American retail investors invest in the stock market. While this gives them, as a group, a lot of power to move the markets, they don’t actually wield this power. Instead, they pass on their power to make buying and selling decisions to the asset management industry when they purchase mutual funds.

And this industry is largely long only. That’s trillions in dollars which have to be long. They do not have a choice – their investment mandates ensure it. Investment mandates are what funds can or cannot invest in, and what strategies they can or cannot use when investing. Investors who buy into a fund will presumably be familiar with what its mandate is.

As such, the largest pools of capital in US equity markets (it’s the same situation around the world) are in a position where they can only make money when the stock market goes up. This means that after every sell off, large or otherwise, there will always be capital needing to be deployed on the long side.

Put another way, trillions of dollars of mutual fund money always has to buy stocks at some point – it is the very reason for their existence.

Of course, this structural long bias does not exist in isolation. On top of it comes other important factors such as what other investors are doing in the market, and which narratives created by the financial media/analyst community are in vogue. This is in turn related to what paradigm the majority of investors hold, which leads us to current market psychology and herd behavior.

Let’s put all of this in today’s context. We have trillions of dollars with a structural long bias, and a majority which holds the paradigm that QE actually increases liquidity in the financial system (it doesn’t). We also have financial media/mainstream commentators reinforcing this mistaken paradigm by constantly reiterating the “boom times” narrative. Finally, as markets keep going higher in response to all of these factors, we have even more money coming into the market to chase returns, because it seems that all the market can do is keep going higher!