Michael Burry Predicts Another Market Crash. The Index Fund Bubble Explained.

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Michael Burry predicts another market crash. We’ll explain Burry’s views on the index fund bubble and how it impacts investors like you and me. Subscribe here for more content: http://bit.ly/SubscribeMichaelJay

► Access my stock portfolio & financial spreadsheets here: https://michaeljay.teachable.com/p/michael-jay-s-investor-membership-group

In short, Michael Burry believes that we are now in a period of time where index funds and other passive investments are becoming a ‘bubble’. He holds these beliefs for three main reasons:

1. Passive investing has removed price discovery from the equity markets. Index funds continue to invest (in potentially overvalued stocks) regardless of business fundamentals.

2. The rise of passive indexing has created hidden liquidity risk, especially for small cap stocks. The theater keeps getting more crowded, but the exit door is the same as it always was. If there is a market sell-off and large redemptions (sales) of index funds, there will not be enough buyers for the thinly-traded small cap stocks in the index. This can cause very dramatic price swings.

3. Potentially making it worse will be the impossibility of unwinding the derivatives strategies used to help some of these funds pseudo-match flows and prices each and every day. This is a more nuanced argument that applies to leveraged and inverse ETFs and not as much to standard index funds like SPY, VTI, QQQ, etc.

As we discuss in the video, here are some of my abbreviated thoughts on each:

1. It is true, passive investing doesn’t require fundamental analysis and can lead investors to buy stocks when they are expensive (overvalued to fundamentals). However, there is not strong evidence alone that index funds are causing the overvaluation. It appears to be a combination of factors which likely also include historically low interest rates.

2. Liquidity risk appears a valid concern especially for some small cap funds. This doesn’t mean that investors should avoid them, but understand that we are likely to see greater volatility during market crashes/panics than we have seen in the past. Index funds are part of this, but momentum-based algorithmic trading (not directly discussed by Burry) also helps exacerbate short term market volatility.

3. The derivative strategies used in leveraged and inverse ETFs are complex and can be susceptible to tail-end risk events like what we saw in February 2018. Most investors would be better served avoiding these products. Regular index funds do not share these risks to the same extent as leveraged and inverse products.

So what is the conclusion? Are we in a passive investment/index fund bubble?

Overall, there is evidence that U.S. stocks (and the index funds that buy them) are relatively expensive compared to historical valuation levels. This means future returns from index funds likely won’t be the 10%+ we have seen since 2009. More likely we’ll be seeing 4-6% returns from U.S. stock index funds over the next 8-10 years. However, individual investors can still continue to find success in the markets by continuing to save and invest, especially during periods of short term market volatility and stock price declines. This is true both for index fund investors and individual stock selectors.

DISCLAIMER: This video is a resource for educational and general informational purposes and does not constitute actual financial advice. No one should make any investment decision without first consulting his or her own financial advisor and/or conducting his or her own research and due diligence. There is no guarantee or other promise as to any results that may be obtained from using this content. Investing of any kind involves risk and your investments may lose value.

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Comments

Michael Jay - Value Investing says:

New video on Burry's updated portfolio is now out (Sept. 2019 13F filing). He is now invested in just 7 stocks! https://youtu.be/Bh07pg85FJU

Captain Charisma says:

The concept of money has been stretched to its limits and will be replaced with A.I that governs all resources universally kinda like a futuristic communist wet dream. Most will not be able to navigate this change only those being born now have a chance. Thank you Goodnight .
.lol

TestY says:

There will be bubles and bubbles. Endlessly. Although in this case he has a very good logic, you don't need to have any to predict the bubbles. Now what needs to be documented is their increasing frequency. It is due to a very very simple phenomena, the same behind the CDO bubble: the retirement money. Billions of people over the world put their money in funds they have not chosen and even when they have chosen them they don't make any decisions on what they buy. The result is the increase of any assets those funds buy and being mainly momentum oriented it is a receipt for desaster. In 2016 my bank wanted me to buy bonds and sell stocks. When I told them rates were so low it made no sense they laughed at me and told me it meant the bonds were at the high so they were a good buy. I never met them again after that.

Lucas Davenport says:

This will be the next big short.

…. but not yet.

Toryboy1807 says:

buy as much South Sea Company stock and tulips as you can 👌

bisquitnspanky says:

WTF does "eck-specially" mean?

bisquitnspanky says:

Get a real job.

Tom Watson says:

I really liked this guy until I realized he is using very distorted information. Go to 14.08 time. He is showing a -5,-15.-30 for stock losses. those losses where exceeding 45 and 50% from peak to peak. It really makes the good times look much better. Wish he was actually showing the market. Very distorted accounting.

Timanator says:

His theory would really indicate the index kept on growing. If all the large companies are the ones on the receiving end of the investment(Indexed funds) Then they will continue to grow and crush or buy out these smaller capital companies.

Paul Meyer says:

I very much appreciate your thoughtful analysis and data rich presentation. We don't seem to be having a blow-off market top like we did in 1999, but by some measures valuations seem similar to then. My main concern is that a global recession and declining earnings could knock the market down 30 or 40% followed by a sideways motion that lasts five or six years. If I were a young investor, I would agree that such a decline would likely be a buying opportunity, but as a retiree, with only a couple of decades yet to enjoy, I feel the need to be cautious right now. I hope that your overall assessment is accurate, but I worry that you are a bit sanguine at this point.

Andrea Spooky says:

"distorting" more like "blatantly lie"?

Bob Smith says:

I wouldn't be surprised if the stock market goes up in the next recession. We have no price discovery because of central banks

Abhinav Gautam says:

Thank you, so much Michael. Really well explained!!

Daniel Bonner says:

It has to crash it’s a contorted bullshit system to favour debt ridden fools…in other words white people 🤮🤮

Na Na says:

Everyone is predicting a market crash in 2020 but the market is breaking records every week. Yield curve inverted, Fed cut rates, trade war, tariffs all over the world, etc. Yet there market is still going up.

Craig Howarth says:

An index fund is nothing like a CDO, to compare them is absurd. An index fund is an ownership interest in a business. A CDO is effectively an insurance instrument with no assets to back it up other than the general assets of the firm issuing it. The problem with CDOs was companies issued them way above their ability to back them up. A good way to think of them is insurance without the assets an actual insurance company would have to have to issue a policy. It's garbage!

Index funds are attractive to people who are investing for the long term, so exactly why would you have everyone exiting at the same time?

watchotrade says:

We are in a everything bubble. Housing bubble heating up again. This scam will keep going until fed cuts rates to zero. Then the job market will take a hit. People have no saving nothing gets paid everything bubble crashes. I mean everything it's going to be a shit show. I have cop friends in New York who think there pensions will be there forever lol

HumbleTrader001 says:

I predict that holding 100% cash instead of equities will still result in a loss of purchasing power while waiting for the crash to occur.

Chris says:

@Michael Jay – You're assuming the future is one way because the past has been a certain way. The past doesn't always repeat.. What if this is the high, and it will not recover for 30 years, or 40? Look at Japan NI225 They went from 40k to 8k, and now at 20k.. 1989 to now, never recovered!.. How about HSI ? .. Still below 08 level! They had always recovered since 08, but not after 08. They could've said the same thing you're saying and they'd have been waiting 10 years now with no profit. We're at a point where debt is ruining everything,.. governments not paying anything back, lots of people maxed out, prices rising, wages stagnant compared to price increases,.. how will growth happen when consumers are getting maxed out and governments maxed out?.. and FED won't have enough to cut to get out of a recession. I'd like to think everything is peachy and will recover as it has always done, but I'm seeing things aren't the same as before. Debt has risen, interest rates have fallen, and despite all the massive efforts with QE and cuts, GDP is falling,.. It seems like interest cuts are like logs on a fire.. they eventually burn out and more are needed, but we're running out of logs!!..

fredocorleone says:

You can make decent profits by shorting new, leveraged ETFs which have low volumes. Most all of these seem to be Ponzi schemes – they keep dropping in price even on days when they should be going up.

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