Michael Burry likes to style himself as a modern-day equivalent of the legendary Cassandra, an ancient priestess and daughter of the Trojan King Priam.
Notorious in Greek mythology as the prophet of truth fated never to be believed, the comparison seems to be fairly apt. Burry famously predicted the sub-prime mortgage crisis of 2007, which turned into a financial catastrophe that triggered a global recession and led to a correction that wiped trillions off the value of the world’s major stock exchanges.
While few heeded Burry’s warnings at the time, it appears that history is about to repeat itself. In fact, the hedge fund manager’s been busy on Twitter lately, desperately trying to bring to attention the collapse of what he calls the “greatest speculative bubble of all time in all things.”
Nearly a year ago, Michael Burry said below.
Do you think the “Greatest Speculative Bubble of All Time in All Things” has burst? pic.twitter.com/NnLqfEpEz4
— unusual_whales (@unusual_whales) July 31, 2022
In one of his recent tweets, the harbinger of doom states that “passive investing” has inflated the market over the last decade, with little opportunity for investors to exit their positions without “trampling each other.”
— Michael Burry Archive (@BurryArchive) October 2, 2022
If Burry is correct – and the bubble is popping – it could mean a long, hard road to recovery for traders everywhere. But has he got his analysis right?
Because, even with the market in such a parlous state as it is right now, there are still some excellent ways for investors to make money – and some to studiously avoid.
Source: Unsplash
Why Is Passive Investing Such A Problem?
Passive investing is a long-term investment strategy that relies on buying and holding a well-diversified portfolio of assets for a gradual but steady return.
Index investing and benchmark funds are popular methods of passive investing, as they aim to track the performance of a specific market index or sector.
Passive managers typically avoid frequent trading and instead focus on creating a portfolio that is less complex and more tax efficient.
While passive investing does come with some risks, it also has several advantages that make it attractive to many investors.
First, by adopting a buy-and-hold approach and minimizing trading, investors can avoid high fees that can eat into returns.
Second, a long time horizon gives passive strategies the potential to compound returns over time, which can be especially beneficial for young investors starting out with limited capital.
Finally, because they are generally less complex than active investing strategies, passive strategies tend to be more straightforward and easier to implement.
According to Michael Burry’s assessment, the stock market is being propped up by a bubble originating from the proliferation of passive investing. This bubble has inflated valuations to unsustainable levels and has made the market extremely vulnerable to a correction.
Today, passive funds have poured billions of dollars into the stock market, spiking valuations to unsustainable levels, in his view.
This has made the market much more vulnerable to a correction, and, when the next recession really starts to bite – as some believe it already has – these funds will be forced to sell their holdings, further exacerbating the decline.
Momentum Stocks Show No Sign Of Reversing Course
However, the problem for investors looking to get out of the market today is that nobody is willing to buy companies at overinflated prices.
This is especially true for momentum stocks, which have seen their valuations soar in recent years when the market was on the way up – yet now look like they’ll continue falling now that the market is on the way down.
Moreover, with a potential recession on the horizon – and inflation and interest rates rising – it’s no wonder that many investors are starting to get cold feet about these high-flying stocks. If the market does start to decline, then these poor valuations will be exposed and companies will come crashing back down to earth.
Cash Flow Is King
That said, not all companies are as overvalued as momentum stocks just now. In fact, with share prices as depressed as they are today, it’s natural that valuation metrics should become a lot more attractive. And one thing that some companies are still able to do is generate massive cash flows from their businesses.
Indeed, free cash flow is important to investors for a variety of reasons. For instance, it allows companies to pay down debt and reinvest in their business, helping them to grow and become more profitable. Moreover, it also gives firms the flexibility to make strategic decisions, such as undertaking acquisitions or investing in new products.
On top of that, free cash flow provides a cushion against difficult financial times. As a result, companies that focus on free cash flow can often weather economic downturns better than those that don’t.
They are also able to finance dividend payments and share repurchases, which can attract new investors and help to keep existing shareholders happy. By reinvesting free cash flow back into the company, management can help to ensure long-term growth and stability.
One recent example of a company that’s generating massive amounts of cash in the present economic climate is energy giant Exxon Mobil. With $24.4 billion of cash flow from operating activities, the multinational oil and gas corporation reported one of the largest quarterly cash flow hauls of any company in history.
And XOM isn’t even trading at a high earnings multiple, either. Its trailing twelve-month non-GAAP P/E ratio is lower than its sector median at 8.71x, while its EBITDA growth is a staggering 154% year-on-year.
This just goes to prove that despite an otherwise harsh operating environment for most other industries, there are always viable investment options somewhere.
Conclusion: Cash Flows are King
Most people are probably hoping that Michael Burry doesn’t turn out to be right regarding his latest prediction. However, if he is, avoiding momentum stocks and seeking out valuable businesses with high cash flows is one way to beat a market that is getting decidedly more bearish by the day.
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