My readers and followers know that I am a big advocate for financial, economic and market education. I truly believe we are in the golden age of ACTIVE investing and trading and we will see the demise of PASSIVE investing.
Michael Burry, from the Big Short fame and who shorted the US housing market, has made headlines with his new big short idea. What is it? Passive investment funds or Index funds.
Michael Burry claims that this is the overcrowded trade and the ETF bubble keeps growing meaning the fall will be devastating. Passive investing is what has inflated stock and bond prices.
Index investing and passive investing has been the big trend in the fast few years. The market keeps going up so the whole ‘buy the dip’ mentality has been cemented. ETFs has been touted as the best way to grow your money by wealth guru’s. I read Tony Robbins book on wealth and he also recommends going into an ETF that tracks the market (also a 0% allocation in Gold might I add).
Just to get a little technical here, ETF’s have been popular due to their Alpha and Beta statistics. Alpha is essentially by how much your investments have outperformed a market benchmark, so for example if we are using the S&P and it is up 12 percent for the year, but your investments are up 16 percent, you have an alpha of 4. If your investments returned 8 percent for the year, your alpha would be -4 measured against the S&P index.
Beta is the volatility of a stock measured against the market. So a Beta of 1 means the stock moves the same percentage as the market. A beta of 2 would mean the stock moves twice as much as the market.
ETF’s look for 0 Alpha and 1 Beta. They want to mimic and the returns of a particular index or asset.
Again, they have been very popular due to the ‘do it yourself’ and manage your own money mentality now. There are of course fees, but they are less compared to what you would pay for active management.
The economic backdrop and environment has made this short trade very appealing.
First of all, these markets have been propped due to cheap money. Since interest rates have been suppressed low, there has been nowhere to go for yield except stocks. This has made stocks essentially go up these past few years, and many average joe traders think they are genius’ due to the returns they got in this environment.
This is why central banks will now want to cut rates and issue some sort of stimulus. There would be a huge crisis if stocks fell say 10% or more due to the people who are chasing yield. We would have retirement issues and pension issues.
Enter the confidence crisis, or what Ray Dalio calls, the paradigm shift. People will realize (if they have not already) that central banks are out of ammunition. In Europe and Japan they are already at negative rates meaning when the next recession comes they will have to cut further into the negative. Stimulus and 0 percent rates will be the new norm with central banks being the BUYERS of last resort.
As Jim Rickards has said in his latest book “Aftermath”, the Fed can expand their balance sheet to 5 Trillion…maybe 6 Trillion… or maybe even more. Nobody knows what the number will be when market participants realize what the game is: QE and 0 rates forever. Essentially no more free markets.
I believe this is coming, and we are already seeing the beginnings of it. The answer from the central bankers seem to be Modern Monetary Theory and Digital Money. Which also means bigger government.
When this confidence crisis occurs, that’s is when markets will fall. What I am looking for is a large sell off in bonds which spikes interest rates. That is when we know we are approaching this confidence crisis. Ray Dalio has even said in his paradigm shift that if the Fed cuts to zero, there will be a time when it makes no sense to hold US treasuries for yield. Now can the Fed copy what Japan and Europe has done by killing their bond markets? Yes. But it would mean the end of the US Dollar as the reserve currency in my opinion.
This big short relies on a big market sell off. Since so much money is in ETF’s than individual stocks, ETF’s have a long way to fall. So how do you play this trade?
Well as mentioned, a lot of the components of the ETF’s are linked to the bigger equity indices, particularly the Nasdaq and especially the FAANG stocks. Shorting those stocks or indices using futures or CFD’s are an option.
Another more controversial way is to play the small cap stocks. Small caps are not large components of ETF’s. This also supports the active investing resurgence going forward. It will become a stock picker’s market rather than an ETF market.
You need to remember that big funds and hedge funds cannot be in a large cash position. They need to be invested for returns. If stocks begin to sell off, and the run into bonds make it so holding bonds for yields make no sense, we will probably see money run into Gold and the US Dollar and the Japanese Yen. However, some managers may delve into smaller cap stocks.
We are living in very interesting and entertaining times to say the least. I will repeat this again, but we are in the GOLDEN AGE for ACTIVE investing and trading. When this market sell off occurs, it will be the MIDDLE CLASS left holding the bag. Wall Street always wins. In order to be able to profit from this scenario, you NEED to be a retail trader.