Michael Burry, the renowned investor known for his accurate prediction of the 2008 financial crisis featured in the film " The Big Short," has expressed concern about a potential significant market crisis , turning his attention to index funds and ETFs .
Burry's Main Arguments
- Stock Price Inflation: According to Burry, the increasing volume managed by index funds is driving an irrational rise in stock prices. This dynamic occurs because index funds purchase stocks that comprise an index without considering the individual performance of the companies, creating a seemingly endless cycle of stock value growth.
- Profitability Circle: The appreciation in the value of the indexes generates profitability. This profitability attracts more investment, causing prices to continue to rise and perpetuating the cycle.
- Risk of Massive Crash: Burry warns that if index fund investors decide to sell simultaneously in a panic scenario, a market crash could occur due to an excess of selling volume and a lack of buying volume, resulting in unprecedented price declines.
Critical analysis
- Is it really feasible that indices will only rise due to high capital inflows?
- Could a market crash occur if all investors decided to sell, with no one willing to buy?
To address these questions, it is essential to understand how index funds work and to examine the hard data, which defines reality.
Relevant data
- Volume Growth in Index Funds: Although index fund volume has grown over the past few decades, comparative studies indicate that 90-95% of actively managed funds do not outperform index funds over a 15-year period.
- Index Funds' Share of Total Volume: According to the last book published by Jon Bogle, founder of index funds, before his death, only 15% of the total volume managed corresponded to index funds in 2018.
Comparatively, the volume managed by active investment funds remains predominant, with 64% compared to 36% by passive investment funds.
These points suggest that the concerns expressed by Burry may not fully reflect the current reality of the financial market, especially considering the proportion of volume traded by index funds relative to the overall market.
In addition to what we have just seen, Burry is not right .
Another strong argument is that companies gain value just by being part of an index, and do not lose value due to all the money that flows into them.
To do this, I found an article that studies this fact: Is it really true that just by entering or being part of an index, a company will already maintain its value on the stock market even if it is not really performing well?
In an article on Seeking Alpha, a comprehensive analysis is provided on the real impact of a company's inclusion in a stock index.
According to the study:
1- Immediate effects of inclusion in the index
- When the inclusion is announced, it is common to see an increase in the share price.
- However, this increase is usually temporary; the stock normally corrects its price, returning to previous values.
- The share price then no longer follows the path of the index and moves based on its own performance and general market sentiment.
2- Michael Burry's statements about smaller companies:
- Burry suggests that in times of panic, massive selling by index fund investors could lead to share prices of smaller companies falling dramatically, possibly to zero, due to a high supply and no demand scenario.
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S&P 500 Reality
- The SP500, the most recognized American index, has had an average return of between 7 and 10% over the last 120 years.
- It is made up of 500 American companies, ranked from highest to lowest according to their stock market value.
The funds or ETFs replicate this index based on the market capitalization of the companies that comprise it.
Example of the current composition:
- Apple: 7% of the index
- Microsoft: 6%
- Meta (Facebook): 1.47%
Key observation: The top 10 companies account for 30% of the capital allocated to index purchases. In contrast, the remaining 70% is distributed among the next 490 companies.
This pattern shows that, although there is a concentration of capital in the leading companies, the smaller companies in the index also receive a portion of the capital, albeit smaller. This structure seeks to replicate the real composition of the market as closely as possible.
For example: Ralph Lauren , ranked among the bottom positions in the index, receives only 0.01% of an investor's capital in the SP500.
Bottom line: Capital is not distributed evenly among the companies in the index. Those not in the top 10 or 20 receive a tiny fraction of the volume allocated to index funds, putting little buying or selling pressure on the shares of these smaller companies.
Fun fact
Of every 1,000 invested in an index fund, the companies in the lowest positions receive barely 1 cent!
Recent events and their impact on large companies
This week, we have seen significant fluctuations in major companies following the release of results:
- Meta (Facebook) fell by 30%
- Amazon and Google rose 20%
- Spotify and Netflix fell by 20%
These movements are due to the reactions of active investors, not to the activity of the indices.
Reflections on Michael Burry's theory
If money were concentrated only in indices, there would be lucrative opportunities outside them, allowing investors and funds to earn high returns and eventually balance the market.
Analysis: The logic behind the index bubble theory lacks solid foundations, as the market operates under the dynamics of supply and demand.
Looking Beyond: Hidden Interests and Catastrophic Predictions
It is important to be wary of alarming predictions that may have ulterior motives. For example, fund managers may be pushing for lower fees to compete with passive management, or are failing to retain clients despite reducing fees.
Recommendation: Stay firm on your strategy
Stick to your ETF or index fund investment plan, subscribe to this channel for more advice, and don't let fear guide your financial decisions.
Invest a percentage of your income each month and maintain a robust emergency fund.
Remember: An emergency fund allows you to weather tough times without touching your investments. Plan for the future and stay calm during market downturns.
