Wednesday, May 25, 2022

Is the Stock Market Still Dangerous?

This feels like it's a bit late, but I want to share some stock market advice today, from market gurus Ray Dalio and Michael Burry. 

Dalio is one of the most successful hedge fund operators out there. Burry’s claim to fame lies in a chapter of Michael Lewis’s The Big Short. You will recall that Burry counts among the few who shorted mortgage back securities before they crashed in 2008.

Anyway, as you know, the stock market, not to mention the cryptocurrency market, has been having a bad time of it. Now, some people are confident that the market will bounce back. Others, like Dalio and Burry, are advising caution.

For those who believe that it is better to be in cash, Dalio repeats his famous statement-- “cash is trash.” This means, I take it, that he sees inflation heating up and making your money worth less.

Here is a report of a recent Dalio conversation:

Reiterating his initial "cash is trash" call from January 2020, Ray Dalio, Bridgewater Associates Founder, Co-Chief Investment Officer and Member of the Board told Andrew Ross Sorkin on CNBC this morning that:

“Of course cash is still trash... Do you know how fast you’re losing buying power in cash?”

"So when I say cash is trash, what I mean is all currencies in relationship to the euro, in relationship to the yen, all of those currencies like in the 1930’s will be currencies that will go down in relationship to goods and services."

Is Dalio advising people to buy stocks and bonds? Not exactly:

Unfortunately, he added, this doesn't mean that investors will be much better off keeping their money in stocks or bonds, because "equities are trashier".

Dalio warned that after more than a decade of unprecedented equity market gains, the problem has become the fact that too many investors are crowded into stocks, and while the last few weeks have been a relative bloodbath for some, Dalio says there is room for more pain to come…

In other words, if you think that the worst has already happened, and think that the market is filling up with bargains, think again. Dalio even throws in a bit of psychology, suggesting that the people who are still long stocks believe that the stocks will go up-- because they are hopeful and optimistic-- and that the current decline is healthy.

"Here's the dynamic that I think is a problem: everybody is long equities, and everybody wants everything to go up.”

“The more they hype it the more it becomes somebody else’s financial asset they’re holding.

"You can’t have that, so you’re going to have an environment of negative real returns. Everything can’t go up all the time, that system won’t work that way,” Dalio explained.

Now, Dalio suggests that people should invest in real assets, like real estate. Another adviser also recommends art. Here I would demur slightly. If the real estate market does not feel like a bubble, I do not know what a bubble is. As commercial real estate in midtown Manhattan sits idle, and as homebuying is on a tear, I would expect that real estate is topping out. Further increases in interest rates are not going to be good news for the real estate market.

As for art, it depends largely on which art by which artists. Much of what is being sold at ridiculous prices these days is being bought by people who do not seem to know anything about art. So, while I would agree that art has intrinsic value-- as opposed to cryptocurrencies-- one does need to choose wisely:

With inflation crushing real returns, Dalio suggested investors would be better off with "real" assets like real estate (echoing Guggenheim’s Scott Minerd, who said he expects real estate and art to outperform stocks over the next five years).

"...the question is... what's going to get you a real return?"

As for predictions of  pending recession, being engineered by the Federal Reserve, Dalio joins those in the pessimistic camp. It's always nice to see someone who does not hedge his opinion:

"Can the Fed reduce demand without breaking the back of the economy?" Sorkin asked.

“The answer is no,” Dalio replied.

And then we have Michael Burry, who was predicting a bear market for a little over a year now. So, since he has apparently been right, he comes forth to take a bow. 

Just as he thought that mortgage back securities were ready to crash in 2007 and 2008, so too does Burry think that we are living through a gigantic speculative bubble:

Michael Burry, the hedge fund manager of "The Big Short" fame, rang the alarm on the "greatest speculative bubble of all time in all things" last summer. He warned the retail investors piling into meme stocks and cryptocurrencies that they were careening towards the "mother of all crashes."

He advises against buying the relief rallies, the gigantic rallies that are designed to convince people that the worst is over, but that are really sucker rallies:

Burry has taken credit for calling the sell-off, explained why he expects further declines, and cautioned against buying into relief rallies.

How low can the market go? Today the S&P stands are something like 3941. Burry expects it to drop to 1862 within a few years. This means, you do not want to be in stocks during this time period:

The S&P 500 index has rebounded strongly from the pandemic crash in the spring of 2020, rising from a low of 2,192 points to 4,089 points as of Tuesday's close. However, it could plummet by 54% to 1,862 points in the next few years, Burry tweeted on May 3.

When the S&P 500 has crashed in the past, it has traded lower several years later, Burry noted. He pointed to the index bottoming 13% lower in 2009 than it did in 2002, 17% lower in 2002 than it did during the Long-Term Capital Management fiasco in 1998, and 10% lower in 1975 than in 1970.

If the benchmark index follows that historical pattern, it could trade 15% lower than its level in the spring of 2020, Burry said.

As for the relief rallies, which are very powerful and very seductive, he says this:

A "dead cat bounce" refers to a temporary rebound in stock prices after a significant fall, often because speculators buy shares to cover their positions.

They often occur during major declines in the stock market, Burry said in a May 4 tweet. The implication is that investors shouldn't get their hopes up about any rallies in the coming months, as they're likely to be brief respites that won't result in a market recovery.

Burry noted that 12 of the 20 largest one-day rallies in the Nasdaq index took place as the dot-com bubble burst, while nine of the S&P 500's 20 biggest one-day rallies occurred in the aftermath of the Great Crash in 1929.

The pattern has played itself out over previous crashes:

Burry also emphasized that after the Great Crash of 1929, the Dow Jones index rallied 10 times by more than 10%, rising by an average of 23% each time, before bottoming at a 89% decline.

The US stock market appears to be following the pattern of previous bubbles, leaving it poised for a monumental crash, Burry noted in a May 8 tweet.

The Scion chief pointed to the S&P 500's trajectory over the past 10 years, noting it was strikingly similar to the index's chart for the decade leading up to the dot-com crash, and the Dow's chart for the 10 years before the Great Crash of 1929.

Burry suggested that human nature was behind the consistently decade-long buildups, and implied that history is repeating itself.

So, a few words of caution. Don’t get suckered into thinking that the stock market can only go up. And don’t get suckered into thinking that the massive rallies that we see from time to time mean anything. 

In a previous post, from this past October, I cautioned against taking Bitcoin seriously. Obviously, it was not my call, but it was still a good call. It was the best opinion from the crankiest seers I could find.


Anonymous said...

"Cash is trash" I do understand his point but... he is an investor millionaire who only makes money if you the middle class investor take you cash and give it to him to invest. Maybe he isn't being 100% honest.

Anonymous said...

Peculiar. Two days in a row ---giant text on Stu's post.

markedup2 said...

There is a bit of a problem with 401(k)s, though: One doesn't have many options. Stock funds of various sorts and bond funds of various sorts are the usual fare. Even Fidelity's "Gold Fund" is a bunch of gold-related stocks.

Anonymous said...

Anon, I don't have that problem. I can resize my screen.