Michael Lewis' "The Big Short" has become a modern classic of financial journalism, chronicling the final days of the subprime housing bubble of more than a decade ago, as well as the adventures of the small group of investors who predicted it would burst in spectacular fashion. Dr. Michael Burry was among the contrarian fund managers profiled in the book and made still more famous by his depiction in the film of the same name.
Burry made his name through his contrarian insight before the last great market collapse, a fact that has made him a sought-after commentator in recent years. According to his latest outlook, there may be another catastrophic blowup on the horizon.
Burry's diagnosis
Burry has been thrust into the public spotlight in recent months thanks to his widely reported long position in GameStop Corp. (GME, Financial). When shares in the video game retailer became gripped by a speculative frenzy last month, many traders continued to cite Burry's bullish call, which was first made in August 2019.
However, as I discussed previouslly, GameStop's sudden ascent had little to do with Burry's original thesis coming to fruition. Rather, it seemed to be the result of intense retail speculation, which led me to wonder at the time whether Burry could possibly still be bullish on the name. As it turned out, we did not have long to wait as the investor made his current opinion quite clear the very next day:
"If I put GME on your radar, and you did well, I'm genuinely happy for you. However, what is going on now – there should be legal and regulatory repercussions. This is unnatural, insane, and dangerous."
Burry essentially echoed my own advice of Jan. 23, in which I suggested that GameStop investors might be best served taking their profits and getting out while the getting was good. The subsequent rapid collapse of GameStop that has played out over the past two weeks appears to have vindicated that position.
A bitter pill to swallow
GameStop's collapse was inevitable. No security can defy gravity forever, despite the best efforts of some market participants to keep the music playing indefinitely. That is especially true when the price dislocation is the result of the deliberate, coordinated efforts of a multitude of individual market participants, as was the case with GameStop. On Feb. 2, investment analyst Jaberwock Research highlighted the key weakness of any such trading strategy:
"There is a major flaw in the 'buy and hold, squeeze the shorts' strategy, the participants end up holding shares they have bought at grossly inflated prices. The benefit accrues only to those who moved in at the start of the squeeze and got out quickly, the rest are left holding the bag when the stock inevitably returns to its true value."
The "infinite gamma squeeze" dreamt of by GameStop's promoters on Reddit's WallStreetBets page simply could not last forever since its own success created an even greater pressure on individual participants to take profits while they could. Those who held out too long found themselves trapped in a self-reinforcing downward spiral as the trade unwound even faster than it began.
Prognosis negative
The whole GameStop situation reminds me of one of my favorite passages from "The Money Game" by George Goodman:
"We are at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air. We know at some moment the black horsemen will come shattering through the terrace doors wreaking vengeance and scattering the survivors. Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time. So everybody keeps asking — what time is it? But none of the clocks have hands."
Clearly the wheels have come off the GameStop trade. However, this strange episode may not be an isolated incident. Rather, it may prove to be yet another signal of an inflating market bubble. Burry took to social media this week to offer investors his own prognosis:
"Markets have now bubbled over in a dangerous way...We are in a blow-off top in all things."
Burry is hardly alone. For example, as I discussed earlier this week, GMO Capital's Jeremy Grantham (Trades, Portfolio) also sees an "epic bubble" afflicting the stock market. Even Wall Street titans have started sounding the alarm. On Jan. 22, Bank of America (BAC, Financial) published a report indicating an imminent reckoning in the market:
"When those who want to stay rich start acting like those who want to get rich, it suggests a late-stage speculative blow-off."
My prescription
Overall, I see plenty of reasons for concern given the current state of capital markets. GameStop may stand out for the sheer scale of its rise and collapse, but it is arguably indicative of a much wider and more deep-seated pathology afflicting the market.
Under such conditions, my prescription for a healthy portfolio is to proceed with extreme caution.
Disclosure: No positions.
Read more here:
- Why Active Investing Is More Important Than Ever
- Jeremy Grantham: We Are Facing an Epic Market Bubble
- Volkswagen Is Making a Play for Tesla's Electric Crown
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