Big Short’s Michael Burry warns of the biggest market bubble in history

The famed investor who predicted the US housing market collapse and the GFC says we're living in the "greatest speculative bubble of all time". Could he be right again?

When Michael Burry – the US hedge fund manager immortalised in The Big Short – talks, people listen. So it naturally rattled investors when he recently emerged from a 10-week Twitter hiatus to tweet:

"People always ask me what is going on in the markets. It is simple. Greatest Speculative Bubble of All Time in All Things. By two orders of magnitude. #FlyingPigs360"

That's a pretty damning appraisal of the market, with a clear warning. Burry has repeatedly chastised institutional investors for excessive greed, wild speculation, taking on too much risk and chasing unrealistic returns.

So what does this mean?

The hashtag likely refers to those old words of wisdom about the risk of greed when investing:

Burry’s tweet also echoed his other previously called out cautions.

For example, he’s compared the hype around Bitcoin, electric vehicles and meme stocks to the dot-com and housing bubbles, and said earlier this year that the stock market was "dancing on a knife’s edge".

How will this affect Australian investors?

According to a recent global survey conducted by eToro, there is an agreement among 43% of Australian retail investors that markets are in a bubble. But are they correct in thinking this, and is Burry on the money this time?

In my opinion, after watching the stock market closely, probably not.

It’s worth remembering that, while valuations are high, equities are currently cheap compared to bonds.

As stock indexes edge towards all-time highs, we have seen an array of new retail investors joining the market over the last 18 months. Many of these investors are operating a 60/40 strategy of equities and bonds, and are concerned about the same issues as their institutional counterparts, such as inflation.

With the increase in retail participation in the market and with lots of bullish investor sentiment, it begs the question, who is left to buy? It’s argued that it’s not as bad as it looks, but a stark reminder that the market is pointing towards a more modest return rather than a market fall.

Returns are likely lower in the second half of 2021, compared to the very strong first half which saw 38 new all-time highs year-to-date.

What to keep an eye on

It seems that Burry fears stock prices have been driven way above their actual value, with investors paying a significant amount more for stocks than earnings can justify. He warns that the "greedy" will get "slaughtered" if this boom ends in a collapse and the bubble bursts.

It's true that valuations are high in some specific sectors, but this is supported by solid growth and climbing revenues. As of the 13 August 2021, 91% of the companies in the S&P 500 have reported earnings for Q2 2021. Of these, 87% have reported earnings per share above estimates. We are currently seeing the highest year-over-year earnings growth since Q4 2009.

It's also true that tech assets boomed at the start of 2021, admittedly veering into bubble territory. Stocks like Tesla and Nio soared at a rate that earnings couldn’t match.

Pressure has eased during the year, with growth in the tech sector slowing as investors rotated towards cyclical equities. These include companies in discretionary industries that are more in demand when the economy is doing well, such as:

• Restaurants
• Hotel chains
• High-end retail
• Car manufacturing

Meanwhile, other assets in the market are still undervalued, such as in the financial sector. The S&P 500 looks set for a third year of straight gains, a rare achievement which has only occurred twice since the 1970s, showing there is still plenty of upside to be found.

Are there any benefits to a “market bubble”?

One of the other bigger arguments for a stock market bubble is the recent investment into "meme stocks". These are stocks that see an increase in value because of online hype, rather than how well the company performs.

From GameStop (GME) to AMC, meme stocks have become an overnight sensation in global stock markets. These "meme businesses" are often struggling or trying to implement a turnaround plan with professional investors "shorting" them, provoking communities of retail investors to unite and support a brand they love.

This has since led to an astronomical rise in these meme stocks' share prices, with GME and AMC both witnessing their share prices climb by as much as 1,000%, heavily inflating their valuations.

Although we are likely to see this new influx of capital help these businesses reverse their (mis)fortunes, it still won’t match up with their lofty valuations. So when Burry refers to "market bubbles" it’s also likely that he’s referring to the meme saga rather than the broader market itself.

As always, investors should think long-term by diversifying their portfolios to guard against potential losses, particularly if they are concerned about a market bubble.

Josh Gilbert is a market analyst at global multi-asset investment platform, eToro.

Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder has taken into account your personal circumstances. You should seek professional advice before making any further decisions based on this information.

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