Michael Burry’s New Warning for the 2023 Recession

Michael Berry made his name betting against the housing market. It took two years for the drama to play out, but the subprime mortgage market finally collapsed in 2007, just as he had predicted. So, he made a ton of money, much more than I ever imagined I’d ever have. Michael Berry is one of the select few investors that accurately predicted the great U.S. housing bubble that played out in the mid to late 2000s, as depicted in The Big Short. He bet big, buying credit default swaps on subprime mortgage bonds, personally profiting approximately 100 million dollars from the collapse of the financial system.

While most call him a one-trick pony, there's no denying that in more recent times, he's also accurately predicted the massive inflation spike we've seen over the past year, the white-collar employment bubble, the demise of meme stocks such as AMC and GameStop, and of course, we can't forget the utter obliteration of our next global currency, being Bitcoin. The guy has a weird knack of getting things right, perhaps not immediately, but eventually. One topic he's been particularly vocal on over the past few months has been the idea that this sudden bull run we've seen in the stock market is nothing to get excited about. Since the market bottomed last October, we've now seen the S&P 500 rise more than 14%. But in Barry's eyes, this is merely a short-term bounce.

He's noted before that in previous financial crises, there were plenty of short-term market rallies along a much longer downward trend. Just recently, he tweeted some very interesting evidence to show that there are actually some pretty obvious reasons as to why we're seeing this short-term market rally, and also why rosy conditions might not last. So with that said, let's examine Michael Berry's cryptic tweets once again to see what he's thinking about the stock market over the next few months.

Thank you. So yes, Michael Berry has been at it again on Twitter, this time discussing an important reason as to why we haven't yet seen the full drop-off in the stock market that he's been anticipating. On Thursday, the 30th of March, Berry said via Twitter, "Going back to the 20s, there's been no by the effing dip generation like you. Congratulations." And yes, this is very much sarcasm, as Barry is noting that despite current economic conditions weakening and corporate earnings reports suffering, there's still a hell of a lot of inflows into the stock market when it dips. This point is shown in the chart that he posted, so let's take a look.

As we can see, along the x-axis we have years, and along the y-axis what it's showing is the S&P 500's average return on the day after the market falls. This is a very interesting chart because it shows whether a down day in the market is generally followed by optimism or pessimism. As you can see, in the 30s, the S&P 500 returns after down days were pretty solid, showing that people saw them more as buying opportunities rather than moments to run away. Then, during the 40s, 50s, 60s, and 70s, there was a lot more pessimism following down days in the market. But in more recent years, really since the dot-com bubble, again there's been relative optimism in the market.

We can see the one-day returns following those down days averaging between 0.1 and 0.3 percent. But what's interesting is that, and this is Michael Berry's point, if you look at the last few years in particular, the average return after down days has really skyrocketed. Last year, we saw the average one-day return up around 0.3 percent. What that means is that, on balance, there's a lot of money flowing into the market after it happens to fall. What does this mean? Well, it really means that investor sentiment hasn't truly changed, and people still see the market as a great place to put their money rather than a place that's going to be painful to hang around.

As long as that general sentiment is good, well, the markets will probably stay propped up. Have a look at this chart provided by State Street Global Advisors. Now, this isn't the full story, but it does give you a bit of an insight into what's going on in terms of cash flows into the market. So in 2020 and 2021, ETF cash inflows skyrocketed over 900 billion worth of inflows in 2021. But interestingly, despite interest rates rising and inflation biting throughout 2022, inflows were still really strong at 589 billion. What does this tell us? Well, it tells us that there was still plenty of money going into the market last year, supporting Michael Berry's rationale.

However, the interesting point that this article raises is that maybe those juicy inflows are coming to an end because if we take that same chart but now show cash inflows from just January and February, well, you can see a bit of a different story emerging. This year, 2023 has seen the weakest inflows to the start of the year since 2019, suggesting that the "by the effing dip" mentality that Michael Barry refers to might be diminishing. The article notes, "Stock and bond funds had inflows 85 and 90 percent below their long-term monthly averages, respectively. Meanwhile, commodity, specialty, and alternative funds had combined net outflows."

The subdued February flows, combined with below-average flows in January, have led to one of the weakest starts to a year ever. The two-month total of 49 billion is the worst two-month start to the year since 2019. Back then, the market was mired in a drawdown and the Fed was raising rates, not unlike today. So it seems as though while Barry talks about investors propping up the market by buying the dip, we probably don't have to wait too long before this effect diminishes. This thesis is further backed up by what we've seen in consumer spending and savings patterns.

With interest rates steadily rising right now, this limits the amount of spare cash people have lying around. Debts like mortgages and car loans become more expensive to service, and with inflation also running hot and raising the cost of living, this leaves very little money left over for anything else. As you can see right now, the personal savings rate is very low, so on average, Americans simply don't have any spare cash to put towards investments. Plus, with the tightening of credit we're likely to see over the next month or two in response to the banking shocks we've seen, there'll likely be even less borrowing going on, which can only choke cash inflows to investments even further.

So there is a fair amount of evidence that while the last few years have seen people in a "buy the dip" mentality, this could very soon be ending, and thus, so could the support of the market. If the market starts falling again but there's nobody really there to back it up, this could lead to the scenario that Michael Barry has been predicting all along, where we get another big downslope. As I said before, from tweets last year, he's called this rebound a dead cat bounce multiple times, predicting that we're only halfway down the slope. Why? Likening our current situation to the midpoint rally we saw along the S&P 500's demise in 2001. He also noted halfway through last year that this time around the theater took over 10 years to stuff, and it's unlikely everybody gets out in under a year, suggesting that honestly, if the market does begin falling across the next year, we could be in for a prolonged downturn if those cash inflows actually start turning into outflows.

But with that said, what do we take from this as investors? Well, if I'm being honest, not a whole lot. You know, while I like to follow Michael Barry's thoughts and opinions on the market, and while you guys seemingly enjoy following his thoughts and opinions too here on the channel, it is worth remembering that this sort of information really shouldn't have an impact on our own investing. Yes, it's interesting to stay updated on what he's thinking, but in terms of our own actions in the market, really it shouldn't change anything. For passive investors, their whole shtick is to dollar-cost average into an index with absolutely no thought to the current state of the market. They bury their head in the sand and they just keep sending it for 40 years straight.

Then, in terms of active investors, well, chances are Michael Barry's commentary on the short-term market trends won't have much of an impact on us either because remember in the active investor camp, and I know I've said this a million times, we're all about sticking to individual businesses that fall within our circle of competence and then buying them at reasonable prices. That strategy just does not need any sort of market analysis. It's always helpful to understand as much as you can about economic conditions, but at the end of the day, macroeconomic analysis and stock market predictions actually add very little value to what we're doing. In fact, you could make the argument that they do more harm than good.

I recently interviewed Guy Spier on this topic, and he had a really good analogy. The economy is going to go up and down, interest rates are going to go up and down, we're going to go through recessions, we're going to go through periods of bubbles. But it doesn't matter. You know, that ship is sailing. It has its North Star. And so it's not so much about "Is now a good time to invest?" It's "How do I become a better version, or how do I become a person who is on a daily basis more capable of investing?" And to take the running analogy, "Is now a good time to go running?" versus "I am a runner. I'm a guy who goes running come rain or shine." That's just it. It's not about pondering whether it's a good time to go running; it's about being a runner. That's what's important.

It's also worth remembering that for someone like Michael Berry, he's playing a bit of a different game to what most of us are. While he is definitely a value-minded investor, his 13F filings show that time and time again, he acts more like a trader than a long-term investor. Just have a look at his 13F history. As you can see, there's absolutely no pattern whatsoever. He rarely holds a position for more than three months, and on top of that, he occasionally places short-term options bets on market performance. Contrast that to what we see in Warren Buffett's 13F filing. How much change do you see in his quarterly filings? Yeah, not a lot.

So while Barry and Buffett are very value-oriented, Buffett is very much focused on buying a business and watching it compound for 10 years, whereas Michael Barry is much more focused on taking advantage of short-term mispricings over the space of weeks or months. And while that type of investing might appeal to you, I think for most of us it's just not a good idea. As Monish said in our last video, as an individual investor, our main advantage is our time advantage; our ability to hold stocks for the ultra long term and watch them compound.

I know for me personally that has proven to be a much better strategy than trying to dance in and out of the market to make a quick buck here and there. But with that said, guys, thanks very much for watching. Also, before I sign off, I want to hear from you guys down in the comments: what sort of content are you guys interested in seeing from me and from the channel over the next little while? If there are any topics you'd like me to cover, anything you'd like explained, anything like that, definitely let me know your ideas down in the comment section below. I'd really appreciate it. But apart from that, guys, definitely leave a like on the video if you did enjoy it or if you found it useful. Subscribe to the channel to see more, and with that said, we'll see you all in the next video.