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

[Wildreamz]

https://markets.businessinsider.com/curr...1030542360

* Michael Burry deleted his Twitter profile again after issuing a slew of dire warnings.
* The "Big Short" investor had warned of a huge market bubble and predicted a brutal crash.
* Burry rang the alarm on crypto, meme stocks, inflation, and the Fed in tweets over the past week.

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Will there be a big crash in the near future? Maybe, maybe not. I maintain, no one, not Michael Burry, Jeremy Grantham, Ray Dalio, Warren Buffett, or even Jerome Powell himself, knows the short-term future with absolute certainty.

Make your own decisions base on objective information, and be responsible for your own results.

Peace.

[weijian]

Dr Michael Burry bought CDS (credit default swaps) from mid 2005 onwards and had to endure a torrid time from investors, including the esteemed Joel Greenblatt who supposedly "discovered" him from online forums.

It was only until around mid 2007 onwards then the odds started to stack towards him. Been early is indistinguishable with been wrong.

If you are shorting, you must have the money (like Dr Michael Burry did with those CDS) and temperament to keep losing.
If you are heavy in cash, you must have the temperament to endure fellow investors getting rich in your face.

OPMIs like us are probably better off taking a balanced approach towards a future with possibilities. Actually only in such times, will Ben Graham's The Intelligence Investor book, show itself to be as illuminating as ever!

[Wildreamz]

Dr Michael Burry bought CDS (credit default swaps) from mid 2015 onwards and had to endure a torrid time from investors, including the esteemed Joel Greenblatt who supposedly "discovered" him from online forums.

It was only until around mid 2017 onwards then the odds started to stack towards him. Been early is indistinguishable with been wrong.

If you are shorting, you must have the money (like Dr Michael Burry did with those CDS) and temperament to keep losing.
If you are heavy in cash, you must have the temperament to endure fellow investors getting rich in your face.

OPMIs like us are probably better off taking a balanced approach towards a future with possibilities. Actually only in such times, will Ben Graham's The Intelligence Investor book, show itself to be as illuminating as ever!

You were talking about mid 2005* and 2007* right?

On related note: https://www.cnbc.com/2018/09/17/big-shor...-2008.html

Most of the ‘big shorts,’ who thrived during the financial crisis, have faltered since 2008

Then there is also the question about skill vs luck.

[Kaimin]

We are definitely in a bubble now. The Shiller P/E ratio is 38, which is a earnings yield of 2.6%. The 10 year Treasury has a yield of 1.5% and that is with QE pushing the rates down substantially. If you calculate the yield as a multiple of the risk free rate, say that the earnings yield on stocks should be twice the risk free rate, the market would seem fairly price. But this train of thought does not account for how interest rates are much more unstable near zero, e.g. the yield on 10 year treasuries has tripled over the past year. 

I think the mystery of where the M2 money supply has gone over this past decade has quietly been solved. It increased by 150% (e.g. multiplied by 2.5x) over ten years but inflation has been near zero over the same period because it all went into assets instead of the basket of consumer commodities used to calculate inflation. 

Even in a "soft landing" scenario to bring the valuation to a reasonable level, if would take the S&P growing earnings by 7% for the next decade and the price remaining stagnant.

Anyone still broadly into the index instead of individual companies is dancing on a knife's edge.

[donmihaihai]

Anyone still broadly into the index instead of individual companies is dancing on a knife's edge.

Even Nasdaq is safer than red hot individual companies. Nasdaq is more than 2X higher than 2000 peak and many many red hot stocks are already long forgotten.

[smalkmus]

We are definitely in a bubble now. The Shiller P/E ratio is 38, which is a earnings yield of 2.6%. The 10 year Treasury has a yield of 1.5% and that is with QE pushing the rates down substantially. If you calculate the yield as a multiple of the risk free rate, say that the earnings yield on stocks should be twice the risk free rate, the market would seem fairly price. But this train of thought does not account for how interest rates are much more unstable near zero, e.g. the yield on 10 year treasuries has tripled over the past year. 

I think the mystery of where the M2 money supply has gone over this past decade has quietly been solved. It increased by 150% (e.g. multiplied by 2.5x) over ten years but inflation has been near zero over the same period because it all went into assets instead of the basket of consumer commodities used to calculate inflation. 

Even in a "soft landing" scenario to bring the valuation to a reasonable level, if would take the S&P growing earnings by 7% for the next decade and the price remaining stagnant.

Anyone still broadly into the index instead of individual companies is dancing on a knife's edge.

Possible to enlighten me on the part of "Anyone still broadly into the index instead of individual companies is dancing on a knife's edge.". I always thought that investing into individual companies will be even more dangerous when it comes to a crash as it's harder to pick a winner or a survivor, and alos in a crash, there are certain companies which are even more vulnerable. 

[Wildreamz]

..

Possible to enlighten me on the part of "Anyone still broadly into the index instead of individual companies is dancing on a knife's edge.". I always thought that investing into individual companies will be even more dangerous when it comes to a crash as it's harder to pick a winner or a survivor, and alos in a crash, there are certain companies which are even more vulnerable. 

Shiller PE is a rough gauge of the valuation of the broader index (specifically the S&P500). It's less relevant to the valuation of individual stocks (which needs to be evaluated separately).

The broader index can be overvalued, while individual stocks you own could be undervalued, at the same time. 

That said, I don't think it's a good strategy for indexers to time entry and exit, in general; better to dollar-cost-average over time to remove emotions as a factor.

[Kaimin]

That said, I don't think it's a good strategy for indexers to time entry and exit, in general; better to dollar-cost-average over time to remove emotions as a factor.

I broadly agree with that but as with every investment strategy: only within limits. The S&P 500 is massive and diversified but there must be a point where it trades so more much than it is worth that it can reasonably be seen to be a bad investment. And I think that point has been crossed. 

With pre-pandemic earnings and today's price the S&P trades at a 30 P/E ratio. That's as high as fast growers like Google (34) and Facebook (29). It is insanity. Costco, by all measures a stalwart, trades at 37 P/E. Walmart at 32. Johnson & Johnson at 29. The only major stocks I find trading at reasonable P/Es are banks and insurance, both interest rate sensitive businesses. 

When all is said and done ETFs are a derivative. They are structured by their creation/redemption mechanism through the primary and secondary ETF markets to keep costs low by minimizing trades of component stocks on the stock market, which they are extremely successful at. The effect of this is that shares held by ETFs are "closely held". They are bought and held with trades only necessary to feed the increase or decrease in their AUM (and ETF AUM has gone up year after year steadily). 

The magic number for the S&P 500 is presently 6.5%. This is the value of S&P AUM to the sum of its constituent market caps. Because it is a market cap weighed index, this means that 6.5% of every component stock is held under the S&P ETF. This is not a very big number in terms of reducing the float or trading volume (even low volume stocks like Wells Fargo has a daily turnover of 0.5%). But ETFs are growing at something like 23% a year. If this continues in 3 years it'll be 13% of shares held off the market, in another 3 it'll be 26% and in another 3 52%.

Burry thinks that it's a bubble not just because of the liquidity issue of trying to redeem the S&P ETF shares, but also because of the increased covariance of indexed stocks, or in his words the removal of individual price discovery. The first is not a short term issue and the second will not directly be an issue either. Indexes' 'close holding' behavior means they effectively act like a very passive investor trading a very small portion of his shares, thus they do not affect market prices much. I do not know exactly how much, but it is a very small percentage of the already small 6.5% of stocks held under the S&P ETF. 

Instead the growth of indexes affects stock prices indirectly by tying up float. This is not a very big deal in sleepy stocks like Wells Fargo, but 6.5% of Tesla is probably a different story. Reducing float increases volatility, probably compounding it with existing volatility. 

An empirical study done on the price effects of indexes show somewhat counterintuitively that indexes affect only larger cap stocks and have almost no effect on its smaller constituents. Probably an index entering to buy 6.5% of a $500 billion dollar company has more effect than 6.5% of a $5 billion dollar company. The paper suggests that it is because "noise traders" jump onto trading in big cap companies but do not for small caps. Another explanation is that it was conducted in the recent past, when the explosion in ETFs has coincided with the explosion of red hot companies whose hundred billion dollar market caps comes from high valuations and not high earnings.

If the stock market is going to crash it is best that it do in the next 5 years. Because if the Fed continues to pump in money to the system, sustain or even inflate asset prices further and really push things to a razor edged precipice, after that there is a substantial chance that the ETF bubble is going to burst at the same time as the stock bubble. That would I think be in terms of both the size and amount of Fed-fueled liquidity by far the biggest bubble to ever burst. The thing about the Jupiter sized amounts of liquidity the Fed has been pumping into the system since the GFC is that it cannot take it back without crushing the US economy like a paper bag.

[Wildreamz]

Great post. Too many points for me to address.

1. On indexing:
In general, indexers are those who concede that the market are smarter than them. They have opted for a long-term strategy (indexing), such scenarios (that the market might be overvalued, or even in a bubble from time to time) should have been anticipated, and there should be a strategy beforehand to deal with it (ride it through, or rebalance to other markets/asset class).

The worst case is abandoning your original strategy for a all-or-nothing alternative (put everything in cash etc.). If your predictions are wrong, you are either forever stopped out of the market, or need to buy back at much higher prices (highly unlikely, due to human psychology).

2. On whether the S&P 500 is in a bubble:
Without reliable forecast of future earnings and interest rates, I don't know. And I don't think there is a clear-cut, risk-free strategy to capitalize on this; even if I think it could be temporarily over-valued.

[specuvestor]

Indexing is good for those who doesn't want to spend time analysing companies. It's all about asset allocation if you want to take a view or just dollar averaging etc

But indexers are becoming the stock pickers and the feedback loop makes big becomes bigger which resulted in strange phenomenon like Volkswagen in 2008 and Nokia in 1999. We have also seen value stocks take a hit while big cap tech stocks continued to perform in past 10 years with huge ETF flows. Think many has already sounded alarm that price discovery will be an issue when markets no longer differentiates the good vs bad but just how much people are willing to speculate on eg memes stocks.

As usual people generally knows there's a bubble but no one knows when it will pop hence FOMO, but we should be mentally prepared