Your theory directly contradicts the Efficient Market Hypothesis. If "dumb money" is flowing in to large cap funds, institutional investors should be able to take advantage.
The question is: how much are you willing to bet on it?
P.S. In case you are wondering, I have bet a significant amount of money on the EMH being correct.
A better strategy would be to underweight S&P500, and overweight the companies that are the closest to being included.
My first response was intended more as a rhetorical question asking whether the poster is actually willing to bet money on their idea. I never really meant to enter into a discussion on the pros and cons of various trading strategies.
My point is just that seeing if someone is putting money behind their opinions about the long term isn't really telling, because "markets can remain irrational longer than you can remain solvent" and you may not know just how long term it'll be.
I'll assume that you meant the opposite of this quote (, that the stocks being short-sold beat expectations, and their fair value went up,) as what you said would benefit the short seller.
You are right that the stock could take longer than expected to reach its eventual (lower) value, but this is why you would bet on a large number of stocks (i.e. S&P500), to reduce the risk of a single or few adverse events cancelling out the strategy. In addition, by purchasing the S&P501-750, with the money from short-selling, you would be fairly well protected against market upside risk (as it is unlikely that the S&P500 will be the only stocks to do well in a bull market). You could also purchase options to reduce the risk of the short, but a (simpler) alternative would be to take out a put option on the S&P500, which the better believes will go down; this is obviously somewhere between the portfolio bias approach, and the short approach in terms of risk (and reward if you believe in EMH).
Also I'm not saying that the phenomenon in my above comment is something would be an efficient use of money to trade. Personally I'd much rather look at out-of-favor sectors like commodities than try to pick up pennies in front of a steamroller by attempting to arbitrage the S&P 500 and S&P 501+ (as you put it)
In any case, thanks for your comment it does give some important food for thought
Read what he wrote: he stated that if you believe what you wrote, you can collect the spread by shorting side you claim underperforms, and going long on the side you claim outperforms.
If what you said is true, it's extraordinarily low-risk arbitrage.
If what you said is false, you're best served to say a bunch of bullshit that 's unrelated and then not make the trade.
Oh... I see... so you know you're full of shit.
But if it makes you feel good to swear at strangers on the internet, you can sign up for anonymous accounts and say I'm full of shit, and I'll be glad that I could help boost your self esteem.
You can buy far out of the money options to limit those.
I have bet a significant amount
of money on the EMH being correct.
Or, rely on EMH and just buy the index.
How is your bet structured and can you explain your opinion?
The Quantum Fund (started by Jim Rogers and George Soros) had a 3365% return in the 70's, while the S&P 500 returned 47% (http://www.streetstories.com/James_Rogers.htm). Rogers also bet against Black Monday in 1987, wrote about the housing bubble and 2008 financial crisis as early as 2004 in his book "Hot Commodities", and called the collapse of the gold price in 2012 as well as the recent epic dollar rally.
"Why do you think the same five guys make it to the final table of the World Series of Poker EVERY YEAR? What, are they the luckiest guys in Las Vegas?" (http://www.imdb.com/title/tt0128442/quotes?item=qt0379517)
You could be right and my understanding of EMH might be off base... but if all information was "priced in" I can't understand how such individuals could consistently be "right" when the broader market is "wrong".
Go is a popular strategy game. Strategies that work should be encoded into computer algorithms and "priced out". Yet computers can't beat the best human Go players. Are the best human Go players simply lucky: they have no true strategy, and it's chance when they win?
(Hint: not every strategy is easily encoded into a deterministic algorithm. Expert human insight and judgment, that finicky beast, is not yet replicable by machines.)
He takes a large enough position to have considerable influence over how his companies are run. That kind of clout isn't available to most of us.
Berkshire Hathaway has not beaten the market since before 2008[1], marking 8 solid years of alpha=0.
In light of that, I find it very hard to believe that a huge valuation discontinuity right between company # 500 and company # 501 is likely to stand for long.
Which isn't to say that I necessarily think the EMH is correct, but I do think even if EMH is incorrect there's still plenty of reason to believe that any major market distortion created by something as obvious as the popularity of index funds is unlikely to stand for long.