'Big Short' investor Michael Burry warns of a massive bubble and epic market crash

[Wildreamz]

..

But indexers are becoming the stock pickers

..

What do you mean by that specifically? I think there are several ways that one could interpret that statement. 

I think there are good reasons why people are choosing to index over active management, far too many active managers simply underperformed. 

Overall I think the exit of expensive, and lousy performance active-funds as a good thing. Survivor of the fittest, only the best (lowest fees, best performance etc.) actively managed funds deserve to survive; this should be net positive for the average investors.

That said, the active vs passive trend has seen a mini-reversal as of late: https://economictimes.indiatimes.com/mar...667407.cms

[specuvestor]

But indexers are becoming the 'stock pickers' - I should have added the inverted commas to be clearer that when you buy an index the indexer are helping you pick the stocks based on a simple dominant quant variable, market cap, if you exclude externalities like US blacklist:

https://wolfstreet.com/2019/11/21/chines...ock-scams/

[Wildreamz]

But indexers are becoming the 'stock pickers' - I should have added the inverted commas to be clearer that when you buy an index the indexer are helping you pick the stocks based on a simple dominant quant variable, market cap, if you exclude externalities like US blacklist:

https://wolfstreet.com/2019/11/21/chines...ock-scams/

I see, I have not done thorough studies on such "front-running" of indexes, my instincts is that, there is probably no risk-free way to profit from index inclusion (with regards to the link you posted). 

As for whether market-weighted index fund skews the market, again, requires sound quantitative research to prove. Fortunately, this 2019 Youtube video summarizes the arguments/data quite nicely; in short, passive index fund, only accounts for 5% of daily trading volume (of the underlying securities) compared to active funds (2019 report).



I also found the cited Blackrock report (2019): https://www.blackrock.com/corporate/lite...l-2019.pdf
This is an updated related report (2020), data on index fund daily trading volumes are similar: https://www.blackrock.com/corporate/lite...y-2020.pdf

I think one is free to draw their own conclusions based on available data, but hope these helped.

[specuvestor]

The link I provided is to demonstrate that indexing affects price of the security, regardless the fundamentals of the underlying. "Passive" is a misnomer when it gets big enough. There is a supply and demand factor just like Meme stocks... A ponzi will continue as long people don't draw out more than it was put in.

As indexing becomes a larger part of the market, the supply shrinks in a sense and gives rise to the similar phenomenon of Malaysian market where the PE of big cap has been high since AFC as the government owns more and more of the market which in Australia it's the superannuation.

The timebomb is that when people starts to rush out of the door at the same time and it will be the cash market that will have to hold the weight of the run. Arguably portfolio insurance was not a major volume generator in 1987 but it crashed the market, just as flash crashes that we see ever now and then in individual markets or stocks. Similarly CDOs traded in notional much more than the underlying. In fact one red flag is when the derivatives trades significantly more than the underlying cash market.

A rising tide lifts all boats but when people start going for the exit, that's when we know who have been swimming naked. It's simplistic to just focus on trading volume determines the safety of index funds, just as saying PE fund volatility determines that it is safer than treasuries.

[Wildreamz]

1. One example alone, may not prove a wide-scale systematic positive or negative pricing skew (temporary or permanent) of Index inclusion (a one time event). This is an interesting evidence-based analysis by Prof Aswath Damodaran on the inclusion effect: http://aswathdamodaran.blogspot.com/2020...stock.html

The Evidence: Not surprisingly, the evidence on index inclusion has been focused on the S&P 500, with studies examining how stock prices are impacted by a company's inclusion in or exclusion from the index. While there are dozens of papers, the findings can be broadly summarized as follows:

Positive or negative: The consensus view across studies is that a company that is added to the S&P 500 sees its stock price increase modestly, and that the increase is permanent, and that companies that are removed from the index see small drops in stock prices that persist.

There are two caveats. The first is that this increase may be more a consequence of the circumstances that led to the the company being added on to the index than the index addition. This paper, for instance, looked at a matched sample, where companies added to the index were paired with companies with similar characteristics (high momentum, rising earnings etc.) that were not added to the index and concluded that there was no index addition effect. The second is that there seems to be some evidence that the index effect has become smaller over time, rather than larger, even as passive investing has become a larger part of the index.

2. Index ownership is 17.2% of US stock market (as of 2019) and 5% of trading volume. Market price (ie price discovery) is set by daily trading. Passive strategies follows market price. This is just to say, it's unlikely that the daily trading volume of passive funds, would cause a systematic problem (positive or negative) with stock price discovery (mispricing). 

3.

The timebomb is that when people starts to rush out of the door at the same time

Interesting. What are some of the possible the catalyst you feel, might cause a mass draw-down of passive assets to other asset classes (cash or otherwise) by index funds investors?

[specuvestor]

Spark can come from anywhere including a failure along the chain, but the conditions has to be there in the first place. Breaking the buck for money market instrument during GFC was another unforseen. Don't fight the Fed with the hike coming could be one this time as catalyst but probably won't be THE one.

Looking back it's hard to know how at the time, but the why is easily explained. And of course ex-post people can write books about it like it's all predictable.

I think it's "more" and major shareholder index funds don't attend AGMs or briefings to question management
https://www.theatlantic.com/ideas/archiv...my/618497/
Indexing has gone big, very big. For nine in 10 companies on the S&P 500, their largest single shareholder is one of the Big Three. For many, the big indexers control 20 percent or more of their shares. Index funds now control 20 to 30 percent of the American equities market, if not more.

[karlmarx]

Apart from his GFC bet, I don't think MB has made any other big bet which turned out to be right.

There are many other investors like MB; one hit wonders who scored a big one but subsequently never got quite right in their predictions.

No doubt that MB and many of the other one hit wonders are incredibly smart/intelligent/savvy individuals, but their track record should also tell you how hard it is to be consistently correct.

The only exception is probably WB (and maybe some others who are more reserved about their track record).

[opmi]

well, you can track his 13F over the years Scion

https://minesafetydisclosures.com/stock-screener

[Wildreamz]

On Financial Twitter (FinTwit) and Financial Youtube, debates about Inflation (on the US side) being transitory or not has been on-going: https://www.businesstimes.com.sg/governm...-inflation

What I noticed though, is that USD/SGD is creeping up. This is actually a sign of deflation (at least, relative to SGD).

Wonder what buddies' opinions are?

[Kaimin]

What I noticed though, is that USD/SGD is creeping up. This is actually a sign of deflation (at least, relative to SGD).

Wonder what buddies' opinions are?

My opinion is not original, it is a mishmash of many different thoughts, but I think we have entered an "inverted liquidity trap". I think to understand what happened post GFC we have to go back to fundamental monetary theory. Since the GFC M2 money supply has increased by 150% while inflation has went up on average less than 2% annually. That's a huge disconnect. Everyone from Bernanke to Buffett have been scratching their heads about how you can have low inflation, huge government deficits and huge monetary expansion all at the same time.

The start of the answer might lie in money velocity. Money velocity is so important that even Hayek said it was advisable for the government to step in to keep it up during times of crisis. Before the GFC it was 2, so every US dollar on averaged was spent twice a year. Now its barely above 1. Money velocity is M2 money supply divided by GDP, so when your GDP is mostly stagnant like it has been for the US, money velocity is almost perfectly inversely proportional to the expansion of M2. In other words, it seems most of the new M2 money supply has been sitting idle. There's a lot of anecdotal and empirical evidence for this. Everyone knows of Berkshire's record cash pile, now sitting at 145.4 billion (a fifth of market cap), an incredible amount for a man who is so insistent on investing cash that he doesn't issue dividends. Jamie Dimon is hoarding cash at JP Morgan because he expects interest rates to rise. Excess bank reserves have grown thousands of fold pre GFC to now. There's so much money but no one is spending it.

Rates have been pushed down by quantitative easing. At the time of the GFC it was an unconventional but brilliant move. It simultaneously flatlined interest rates while expanding the money supply, theoretically boosting the economy by increasing the spread between an investment's return and the interest on loan to finance it while keeping banks stuffed full of cash to stave off any bank run. Bernanke, a student of the Great Depression, was adamant that credit had to be cheap and ample to prevent another. He was in that regard extremely successful. To a large extent it worked - for awhile. Banks build up cash. Companies refinanced and invested into lower projected return projects that could not before. But there is a limit to this. These all increase the production of goods and services, but not its demand (inflation). As disciplined capital managers, companies anticipate the demand for new factories and stores to see if their investment will make returns. If the demand is not there they won't do it. So there's also no demand for new capital in the form of loans. 

Now in theory the economy should rebalance between the two. There is a time value to money, a minimum rate which depositors/investors expect to make in return for investing their money. If the market offers a rate below this then people would rather spend their money instead, thus balancing the production and consumption of goods. And this would have happened - had the money not largely gone to two very kinds of entities. 

The first is billionaires and the growing wealth gap. As we learn form microeconomics, the utility of goods decreases the more of it you have. Billionaires have so much most goods have almost no utility to them. This is empirically supported, as people's net worth increase, so does their expenditure as a percentage of income and returns decrease. Likewise in America if you're in the bottom 50%, you spend as much as you earn and do not accumulate net worth. There has been tremendous asset price inflation and its indicators such as the CAPE Shiller P/E have went up tremendously. This pushes real returns down. But billionaires have almost no use for spending it so they put it into assets to accumulate more wealth. More accurately we can imagine that the money has gone disproportionately to wealthier people who disproportionately do not spend it. So something like every dollar to the top 5% sees 5 cents spent on consumption, while every dollar to the bottom 50% sees 95 cents on consumption. In between the middle classes spend less and less of every dollar on consumption. This problem is compounded by the stagnation of real wages in the USA's blue collar workers, which is a natural source of inflation. 

This theory is supported by how inflation has spiked temporarily after stimulus - but only if they had substantial money flows to lower to middle classes such as Trump's tax cuts and the Coronavirus stimulus package which included a flat few thousand per citizen. But things like Obama's stimulus worked to some extent, but only the payroll credits and other lower income focused stimulus which was a small part of it had an effect. But virtually all of QE went to banks, financial institutions and to a lesser extent fund government deficits (which probably has been the biggest consistent driver of inflation but still not enough). 

Second is the explosion of what can be called third party capital allocators, everything from funds to banks to publicly traded companies. These are people who get their capital from someone else but invest it professionally. These people's compensation are virtually all based on their AUM or profits, so they have zero incentive to return cash to investors to let them spend it even if returns are extremely low. They've been around for as long as capitalism has existed but as investors get more numerous, it becomes harder for them to work in concert to force management to change, and management gets less accountable while their AUM explodes.

A third possible factor is that the long and persistent rise in asset prices like the S&P 500 has caused more people to buy into them regardless of the increasingly low real return. Or as Lawrence Summers put it, it's getting increasingly dangerous as investors have had their pessimism beaten out of them by the decade long bull run.

This is a bit paradoxical because if stocks are returning so well why is there a build up of cash and decrease in investments? It's because the its an increase in prices of assets, not returns. Entities like Berkshire and banks who get real returns are hoarding cash. Speculators who look for price increases are throwing money into the market. Real returns are down, pushing up money demand and driving down money velocity for capital (because if investments have high returns, money ought to be circulating fast as people invest). But because of the growing wealth gap and third party capital allocators, all the M2 is circulated among assets and very little money is flowing for consumption. And there is so much money created there is enough to fill up banks an push up the whole stock market to ridiculous P/E ratios.

I call it an inverted liquidity trap because it has many similarities to a liquidity trap but some of its effects are inverted. There's extremely low interest rates, high money demand, high money supply and low inflation. But unlike a liquidity trap there is no shortage of demand for debt, or any other asset for that matter, because of the reasons above.

The reasons are systemic reasons and show no signs of changing. Because of that I think Powell is right when he says inflation pressures are transitory. If we get down to brass tacks, people need to spend to have inflation. As cynical as it is to say the poor still have nothing to spend while the rich are still refusing to spend.