So what? Index funds still ultimately own shares in a diverse portfolio of companies. That's why they were a good idea in the first place, and it's why they are still a good idea.
If your argument is that this feedback loop is distorting the value of the companies index funds invest in, such distortion would impact anyone who buys stock in those companies whether or not they do it through index funds. Therefore, picking and choosing individual stocks doesn't become more attractive even if we know index funds distort the market, unless you only invest in stocks that are not owned by index funds -- good luck with that.
If your argument is that this feedback loop is distorting the value of the companies index funds invest in, such distortion would impact anyone who buys stock in those companies whether or not they do it through index funds. Therefore, picking and choosing individual stocks doesn't become more attractive even if we know index funds distort the market, unless you only invest in stocks that are not owned by index funds -- good luck with that.