> Thus the cap-weighted investment strategy becomes a self-fulfilling prophecy.

Either you’re doing the math wrong or you’ve skipped some steps.

Let’s say you have companies X and Y, each with 50% of the market. X is a winner, and the stock price goes from $10 to $45. Y is a loser, and the stock price drops from $10 to $5. The new weight is X=90% and Y=10%.

But this cannot be a self-fulfilling prophecy for index funds, because the index funds do not have to buy or sell any shares of X or Y to keep up (I mean rebalance, specifically). In this scenario, the index funds are just holding. (By “holding” I mean “not rebalancing”.)

This is… an oversimplified scenario. But it illustrates the problem here with the “index funds cause a small number of stocks to be winners” theory. There are alternative theories that make sense, but not this one.

(What makes the scenario more complicated is when you think of buybacks, dividends, delisting, etc.)

If new money is then invested into the index fund, it's effectively routed 90% to X and 10% to Y though, no?