Michael Burry believes passive investing makes the entire stock market more vulnerable.
However, trying to time the market can be costly.
Investors can target stocks with moderate valuations and low betas as a way to reduce some of their overall risk.
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The dot-com bubble burst is known to have been one of the worst stock market crashes in recent years. The internet was still in its infancy and the value of many stocks soared simply due to hype.
Investors sometimes compare today’s optimism about artificial intelligence (AI) stocks to what the market was doing at the time. this S&P 500 Index (SNPINDEX:^GSPC) The third consecutive year of double-digit percentage gains may have investors worried that a crash or serious correction is inevitable.
However, unlike the dot-com boom, when many risky internet stocks surged with no revenue or earnings, the companies that have taken off in recent years are becoming truly profitable and have strong financial results that justify their valuations. NVIDIAFor example, has become a growth machine. While its valuation looks high, with a market capitalization of about $4.6 trillion, its forward price-to-earnings (P/E) ratio (based on analyst estimates) is below 25, which may not look all that expensive given its growth potential.
But Michael Burry, the founder of Scion Asset Management and best known for predicting the housing crash nearly two decades ago, believes valuations are so high and inflated across the board that a severe crash is possible. That’s why he thinks it could even be worse than the dot-com crash.
Burry believes that this time the crash may be more severe, and a big reason is the increasing popularity of passive investing. Instead of people investing in specific stocks and only certain stocks being overvalued, a broader range of stocks may decline, rather than a specific group of stocks like when the dot-com bubble collapsed.
“In the U.S., I don’t think when the market goes down, like in 2000, there are a lot of stocks that are ignored, and even if the Nasdaq collapses, they will go up,” he said. “Now, I think the whole thing is going to blow over.”
Since many exchange-traded funds and index funds hold hundreds of stocks, and all move up and down together, a market crash is likely to have devastating consequences. Nvidia and other top tech stocks account for a large portion of investment dollars, and if they fall, it could cause many other stocks to fall.
Burry said protecting yourself in any accident is extremely difficult. The reality is that when the market crashes, it’s often difficult to protect yourself from any losses. This is an unavoidable risk that investors must always consider.
In a crash, investors may be tempted to pull money out all Their investments are not just money invested in ETFs and other passive investments. It’s this general panic that can send entire markets into chaos.
But trying to time the market is never a better strategy. Even though you may be concerned about overvaluation and the potential for bubbles in today’s market, simply selling all your investments and converting the funds into cash may not be the best solution. It can take months or even years for an accident to occur. Trying to time the market is a risky move because it may leave you on the sidelines, possibly watching the stock market continue to move higher.
There is no doubt that there are many very expensive stocks to avoid in today’s market, but that does not mean there is no hope for investors and the only solution is to sell the stocks. These are examples of a few ways investors can reduce overall risk by focusing on stocks that are moderately valued, as well as stocks with low betas that are out of step with the overall market.
While almost all stocks can fall in a market correction or crash, that doesn’t mean they all fall to the same extent. Investors can and should always protect their portfolios by considering a company’s fundamentals and growth prospects, as well as its valuation.
Burry’s warning may be true given how hot the stock market has been in recent years, but that doesn’t mean there aren’t a lot of safe investments today, especially for the long term.
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David Jagielski, CPA has no position in any of the stocks mentioned. The Motley Fool has a position and recommends Nvidia. The Motley Fool has a disclosure policy.
Worse than the dot-com bubble burst? Why Michael Burry thinks the market is in deep trouble originally posted by The Motley Fool
