As one of the few investors who bet against the housing market prior to the Great Recession, hedge fund manager Michael Burry became one of the more famous investors on Wall Street after being featured as one of the main characters in Michael Lewis' highly acclaimed book, The Big Short. Later on, Christian Bale would portray Burry in the movie adaptation.
Despite his widespread notoriety, Burry has largely maintained a low profile, with minimal public appearances and sporadic tweets. Recently, though, Burry has made a big change, shutting down his fund, Scion Asset Management, and launching a Substack newsletter. Burry even recently did a podcast interview with Michael Lewis, which may have been his first public interview since he went on CBS' 60 Minutes back in 2010.
No longer a fund manager, Burry isn't pulling any punches -- and his warning to Wall Street couldn't be any clearer.
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Market structure is a problem
During his interview with Lewis, Burry said he shut down Scion because he is worried about the stock market, which he believes could experience a prolonged downturn, a scenario he doesn't want to have to relive while running a fund with investors.
During his bets against the housing market in the mid-to-late 2000s, Burry received significant pushback from his investors because he had to make monthly premium payments on the credit default swaps he purchased on mortgage bonds, which wouldn't pay out until the bonds collapsed, a process that took several years to play out.
Even when Burry turned out to be right and made tremendous profits for his investors, during the recent interview, he said that nobody called to apologize, but also that he didn't expect anyone to, either. Now, Burry seems mainly concerned not just about market froth and excessive exuberance over artificial intelligence, but also the structure of the stock market, which has shifted from more actively managed a few decades ago to being very passive.
Active investing refers to the process of conducting thorough research and frequently buying and selling stocks to outperform the market and generate alpha, as there are inefficiencies to capitalize on. Passive investing involves investing in a diversified basket of stocks that can replicate a broader index, and holding those stocks over a long-term period to reduce the costs associated with more frequent buying and selling of stocks.
Today, according to Burry, over half of the money invested in the stock market is passive. Meanwhile, less than 10% of money is being actively managed by managers who think long term, so things could be different this time around:
And so the problem is, in the United States, I think when the market goes down, it's not like in 2000, where there was this other bunch of stocks that were being ignored, and they'll come up even if the Nasdaq crashes. Now, I think the whole thing is just going to come down, and it will be very hard to be long stocks in the United States and protect yourself. And so that's why I decided to get out.
Burry is not the only fund manager to raise this concern, and many of even the best managers say that value investing might be dead, due to this very reason. Historical data show that the market has consistently generated solid long-term returns and that investing in stocks is less risky when held for the long term. As a result, investors are more likely to passively invest and buy the dip, especially when the government and the Federal Reserve appear to always intervene to stabilize market conditions as they seem to be rapidly deteriorating.
The issue is that if people truly start to get scared and sell, it could have a cascading effect that would be difficult to escape. Just like the market has gone up and reached extremely high valuations, sometimes without any explanation, that effect could be just as penalizing when the market is going down.
Burry has also expressed skepticism regarding artificial intelligence, comparing it to the dot-com bubble of 2000, for several reasons, including the incredible capital expenditure by AI giants that may not yield good returns. Burry has also expressed concerns over accounting practices, in which he claims AI companies are inflating the useful life of chips and servers, thereby artificially lowering their annual depreciation expenses.
Steps retail investors can take to protect themselves
Burry is clearly one of the best investors in the game. However, there are other astute investors who disagree with Burry, and ultimately, retail investors are very unlikely to correctly time the market.
Investors with a 10-, 20-, or 30-year investing horizon ahead of them don't necessarily need to take any action, as history suggests that the longer one holds stocks, the more likely they are to generate solid returns. However, if you are concerned, as Burry suggests, that passive investing has become a newer issue that the market may not be ready for, there are certain strategies one can take.
One option is to shift funds to a more conservative investment strategy, such as investing in an equal-weighted ETF following the S&P 500 index, which removes the weighting of stocks in the S&P 500 and therefore has less exposure to the high-flying AI companies. An equal-weighted ETF likely won't dominate the way the normal S&P 500 has, but it should protect your downside more. Investors who own individual stocks may also want to look carefully at valuations, as Burry actually suggested.
If a stock you own has been a multi-bagger in a short period of time and now trades at a ridiculous multiple like 100 or 200 times forward earnings, it may be time to start trimming and taking some gains, at the very least. Just as investors can dollar-cost average into a stock or index, you can employ a similar strategy and sell a portion of your gains each month.
