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

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: bit.ly/SubscribeMichaelJay

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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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