Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

Big Short Investor predicts Index Fund Meltdown that could destroy Retirement Accounts

“Big Short” investor Michael Burry is predicting an index fund meltdown that could wipe out millions of Americans’ retirement accounts.

“Big Short” investor Michael Burry is predicting an index fund meltdown that could wipeout millions of Americans’ retirement accounts.

Now Burry calls the passive investing craze a bubble, Markets Insider reports. “The bubble in passive investing through ETFs and index funds as well as the trend to very large size among asset managers has orphaned smaller value-type securities globally,” Burry tells Bloomberg.

Half of US Investment Assets could be a Bubble by 2021

The bursting of a passive investing bubble could be catastrophic because Moody’s Investors Service estimates passive funds controlled 29% of the US stock market in 2016.

Frighteningly, Moody’s predicts “passive investments will overtake active market share between 2021 and 2024,” Reuters reveals. In addition, Moody’s now forecasts that passive funds will overtake active funds in 2021, a press release announces.

In detail, Reuters estimates Americans invested $506 billion in passive funds in 2016. Passive funds are popular because they are cheap. For instance, some funds charge $3 to manage up to $10,000 in funds.

Furthermore, Moody’s claims passive-index investments will make up over half the managed investments in the US by 2024, Reuters writes. Thus, over half of America’s managed assets could be in a bubble if Burry’s crystal ball works.

Why you should Listen to Michael Burry

Author Michael Lewis made Burry famous with his book The Big Short. A 2015 movie they loosely based on the book added to the fame. In particular, Christian “Batman” Bale burnished Burry’s heroic image by playing a heavily fictionalized version of the speculator in the movie.  

Currently, Burry’s investment firm Scion Asset Management is touting orphaned small-cap stocks Mr. Market is neglecting, Markets Insider reports. Therefore, Burry is promoting Ben Graham’s classic value investing strategy of buying unappreciated companies.

Those stocks include GameStop Corp (NYSE: GME), Markets Insider claims. However, I consider GameStop’s stock junk because of its outdated business model of selling video games through brick and mortar stores.

Is the Big Short Speculator Predicting a Retirement Catastrophe?

An index-fund bubble could be catastrophic because a large percentage of the $7.85 trillion Americans held in individual retirement accounts (IRAs) in 2017 is being invested passively. In detail, Statista estimates there was $7.85 trillion in American IRAs in 2017.

Thus, Burry is predicting a bubble that could annihilate tens of millions of Americans’ retirement savings. Consequently, millions of older Americans could find themselves with nothing but Social Security to live on.

Furthermore, the average Social Security recipient receives $1,471 a month or $17,652 a year in June 2019, Market Madhouse estimates. Thus, millions of Americans could live just above the poverty level in retirement.

Big Short Speculator’s Index Bubble Could Make Income Inequality worse

Therefore, America could experience a collapse of economic activity rivaling the Stock Market Crash of 1929, if Burry’s passive investment bubble bursts.

Moreover, Big Short II could make income inequality worse because the rich are more likely to actively manage their money. The wealthy are more likely to own stock and have large cash holdings.

Thus, Big Short II could make the rich richer and average Americans poorer. Politically, the beneficiaries will be populists like Joe Walsh (R-Illinois) and leftists like U.S. Senator Bernie Sanders (I-Vermont), Andrew Yang (D-New York) and U.S. Senator Liz Warren (D-Massachusetts).

Leftists will benefit because they want to tax the rich to pay for more government benefits. Interestingly, Warren is making predictions of an economic crash similar to those Burry is making.

In detail, Warren believes a bubble of debt, that could burst any time traps average Americans. Predictably, the investment media is mocking Warren’s warnings while fawning over Burry.

Why is Warren Buffett Stockpiling Cash?

Tellingly, one of America’s shrewdest economic observers; Warren Buffett, is stockpiling cash.

Specifically, Berkshire Hathaway (NYSE: BRK.B) had $122.38 billion in cash and short-term investments on 30 June 2019, Ycharts estimates. Berkshire’s cash was up from $114.17 billion in March 2019 and $111.10 billion in June 2018.

Buffett hoards cash so he can buy companies during economic downturns when they are cheap. For example, Berkshire Hathaway (NYSE: BRK.A) bought the Burlington Northern Santa Fe Railway for $26 billion in 2009, The New York Times DealBook reports.

The cash shows Buffett could agree with Warren and Burry’s belief that an economic crash is imminent. However, I do not think the crash will be a recession; as the media expects.

Why are Corporations Hoarding Cash?

Frighteningly, Uncle Warren is not the only big corporation or billionaire hoarding cash. Disturbingly, Mark Zuckerberg and the gang at Alphabet (NASDAQ: GOOG) are also holding large amounts of cash.

Alphabet (NASDAQ: GOOGL); for instance had $121.06 billion in cash and short-term investments on 30 June 2019. Disturbingly, the former Google’s cash holdings grew from $113.49 billion in March 2019 and $102.25 billion in June 2018.

Meanwhile, Facebook’s (NASDAQ: FB) cash and short-term investments grew from $42.13 billion in June 2018 to $45.24 billion in March 2019 to $48.6 billion in June 2019, Ycharts estimates. I have to wonder, why are the billionaires hoarding cash?

How Facebook and Alphabet could profit from the cash

Notably, Alphabet and Facebook have a long history of buying potentially lucrative distressed companies for cash. Alphabet; for example, bought YouTube for $1.65 billion in 2016.

Meanwhile, Facebook spent $19.6 billion to buy WhatsApp back in 2014. WhatsApp makes no money but Statista estimates the encrypted messenger app had 1.6 billion users in July 2019. Moreover, I think, WhatsApp could be the basis of Zuckerberg’s Project Libra cryptocurrency scheme. To explain, Zuckerberg could theoretically distribute his Libra Tokens to 1.6 billion WhatsApp users worldwide.

Thus, I have to wonder what Alphabet, Buffett, and Zuckerberg plan to buy with all that cash. Additionally, I have to wonder what heights a crash could push Alphabet, Berkshire Hathaway, and Facebook stock too.

Interestingly, Berkshire Hathaway, Alphabet, and Facebook stock could be a good hedge against a coming crash. To explain, these cash-rich actively managed stocks could provide more protection than the index funds Burry is criticizing.

What about a Trade War?

Strangely, one disaster I do not fear is a trade war between the United States and the People’s Republic of China.

To explain, President Donald J. Trump’s (R-New York) trade policy has been all Tweets and no action. For instance, Trump delayed a promised 10% tariff on many Chinese imports on 14 August 2019 until December 2019, The New York Times reports. I think Trump delayed the tariffs to avoid offending voters during the all-important 2019 holiday shopping season.

“We’re doing this for Christmas season, just in case some of the tariffs would have an impact on U.S. customers,” Mr. Trump said, before veering back toward his usual line by adding, “which, so far, they’ve had virtually none.” Thus, Trump himself admits the tariffs have little effect.

Notably, the official Chinese policy is now to ignore Trump’s trade tirades, The Guardian reports. Additionally, I suspect Beijing will ignore Trump until after the U.S. Presidential election on November 3, 2020.

How Trump could Hurt the Stock Market

However, Trump’s behavior can affect the stock market by increasing US Chinese tensions, Vox observes. Under these circumstances, I think the biggest danger is Mr. Market overreacting to Trump.

Oddly, Buffett, Zuckerberg, and Alphabet are betting on such an overreaction. To explain, Buffett and others could hope Mr. Market overreacts to Trump sending stocks down. Hence, they could swoop in and buy shares or companies cheap.

Such a Trump correction could occur if the President ratchets up the trade war rhetoric to fend off former U.S. Representative Joe Walsh’s (R-Illionis) presidential primary challenge. To explain, Walsh is a national conservative who is challenging Trump on a platform of economic populism.

In particular, Walsh hopes to appeal to Trump voters disappointed by the president’s failure to fulfill his trade and immigration promises, New York Times writer Peter Wehner speculates. Thus, Walsh could affect the stock market if he does well in the polls.

Fear the Market and Big Short II

In the final analysis, I think the stock market is in an interesting and dangerous place.

Burry is right in his observation that large amounts of money is in passive investments few people understand, while Mr. Market underprices many companies. However, that situation is so unprecedented nobody knows what will when the passive fund bubble bursts. Yet, Buffett, Zuckerberg, and the Alphabet managers are hedging against something.

Only time will tell if contrarians like Buffett, Burry, and Zuckerberg are right about a Big Short II. However, it will be fun to watch and write about.