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The Passive Investing Bubble

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by Gavin in Blog
December 13, 2019 0 comments

Michael Burry is the guy portrayed by Christian Bale in the movie The Big Short. If you haven’t seen the film, you definitely should. Burry is the founder of the hedge fund Scion Capital which he ran from 2000 until 2008. He is famous as being one of the first traders to recognize and profit from the subprime mortgage crisis.

Well, Burry is back and this time he’s claiming the next big bubble is in passive investing.

He thinks that the rise in passive investing in recent years can create lots of problems when there’s another market downturn.

Here’s why. The market doesn’t really do well with crowded trades. It’s all fine when the crowd when the crowd is piling into them, but the market doesn’t really like it when the crowd comes out.

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In recent times, we’ve seen a lot of money moving to passive investment strategies, such as simply buying an S&P index fund.

We’ve been told that over time, if you just put your money in an index fund and close your eyes and watch it go, you’ll do okay, because more often than not, the markets rise over time.

When investors start building up large positions in index funds and ETF’s like SPY, you get a situation where the tail starts wagging the dog because these ETF’s end up becoming way more liquid that the underlying shares they represent.

So, what happens when those investors start to liquidate their SPY positions? Well, that selling has to also flow through to the underlying shares.

That’s going to be fine for some of the mega cap stocks like AAPL and MSFT that can absorb that liquidity, but some of the smaller companies in the S&P 500 may not be able to absorb all that selling pressure.

That creates loop where less liquidity forces the shares lower, which in turns sends the S&P 500 lower and so on.

I’m not saying that’s definitely what’s going to happen, but it’s a concern and one that Michael Burry has talked about a lot recently.

Whether this is a bubble or not remains to be seen and while this is fun to think about an analyse it’s not really something we should be basing our trading decision on.

For those that haven’t seen The Big Short, Burry’s hedge fund very nearly went bust before his call eventually turned out to be correct.

Let me know if you think there is a bubble in passive investing by leaving a comment below.

Trade safe!

Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.

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Options Trading 101 - The Ultimate Beginners Guide To Options

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