The Mother Of All Crashes Is Coming

What's up, guys? It's Graham here!

So normally, people celebrate with champagne, but I am celebrating today with iced coffee, now for sale at bankrollcoffee.com. Because in the last week, the stock market indexes have hit yet another all-time high. We've hit brand new records after the announcement of a brand new trillion-dollar infrastructure package. Interest rates are still the lowest they've ever been in history, and the economy is beginning to reopen. So things are looking really good, right?

Wrong. During the same time the stock market is rallying higher and higher, the famed big short investor Michael Burry is warning that we're currently in one of the largest speculative market bubbles in history, and that the mother of all crashes is coming soon, with losses the size of countries caused by over-leverage with cryptocurrency in the stock market. The Rich Dad Poor Dad author Robert Kiyosaki also mirrors the same sentiment, cautioning that we'll see the greatest crash in world history. While another wildly popular thread on Reddit theorizes that 2008 never really happened; it was just extended.

So we've gotta talk about exactly what these warnings are, what's going to cause this to happen, what we could look out for as investors, when all of this can unfold, and then finally, most importantly from all of this, how we could use this information to make as much money as possible. Because I will say, I took these headlines extremely seriously, and I did a lot of research to figure out if there's any merit to what they're saying or if it's a whole bunch of...

But before we go into this topic, I want to address everybody who says that I beg for likes. Fight begging for likes? Please, I am on my knees begging you to smash the like button for the YouTube algorithm. And if you help me out, I’ll show you a quick video of my reef aquarium at the end of the video.

Alright, so first we gotta talk about Michael Burry. He was the investor who correctly predicted the 2008 housing market collapse years in advance and subsequently made 750 million dollars. He was featured by Christian Bale in the movie "The Big Short," and he has a history of making rather lofty ridiculous predictions and then being right. For example, earlier in the year, he did the unthinkable and shorted Tesla stock when it was trading at nearly 900 a share, warning Elon Musk that he should capitalize on the momentum. And he was right. Within a few months, Tesla had fallen over 35 percent, and Michael Burry made a lot of money.

He also predicted post-reopening inflation last year that, of course, he guessed is happening right now. Not to mention, after Bitcoin’s skyrocketing rise in March when it was over fifty thousand dollars, Michael Burry warned that it was unsustainable and to prepare for a correction. Well, he was right about that too, even though he says he's also in favor of Bitcoin. Plus, throughout his eight years of managing a hedge fund, Scion Capital managed to outperform the S&P 500 in every single year, including outsized returns during the dot-com crash, with, of course, the exception of 2007, which, as we all know, is the lead-up to the 2008 real estate collapse where he then made his investors a 138 return on their money. Overall, his net return during those eight years is a whopping 472 percent versus the S&P 500's measly 5.2 return.

So let's talk about exactly what he's saying now in terms of the mother of all crashes, alongside with the fact that he says we're in the greatest speculative bubble of all time. He starts by saying that people always ask me, "What is going on in the markets?" It is simple: greatest speculative bubble of all time in all things, by two orders of magnitude. Which, for anyone who doesn't follow, two orders of magnitude is equivalent to a hundred. So, depending on the context, he could mean that the market is a hundred times over-leveraged, which might start to make some sense after this tweet here: "The problem with #crypto is in most things is the leverage. If you don't know how much leverage is in crypto, you don't know anything about crypto, no matter how much you think you know."

Now, this was actually further discussed by CNBC, who legitimately mentioned that some investors were using a hundred times leverage on Bitcoin, and that has the power to completely collapse the markets if things start trending downwards and everyone starts cashing out at the exact same time. Mark Cuban even seconds this by warning that leverage will cause the markets to go up faster than expected, but when they deleverage and cash out, the forced liquidations will cause prices to fall faster than expected. All of it, as right now, is largely deregulated.

But Michael Burry goes on to say that all the hype and lost speculation is doing is drawing in retail before the mother of all crashes. #FOMO parabolas don't resolve sideways when crypto falls from trillions or meme stocks fall from tens of billions. #MainStreet losses will approach the size of countries. History ain't changed. And finally, earlier in the year, Michael Burry was warning that the stock market was dancing on a knife's edge. He says that rampant speculation and widespread betting with borrowed money has driven the stock market to the brink of collapse. And he ends all of that by saying that people say I didn't warn last time; I did, but no one listened. So I warned this time, and still no one listens. But I will have proof. I warned.

So, with all of that out of the way, let's talk about how likely this is to happen, whether or not it's something actually worth worrying about, and even if it does collapse, what you could do about it to make money. Alright, so now let's talk about that greatest speculative bubble of all time. In order to do that, it's really important to understand what defines a bubble in the first place. A bubble begins to form when there's a gathering acceleration in price for an asset that far outstrips that asset's intrinsic value.

And that's when we start running into the first problem. When we have a stock market today that's driven by monetary policy, future expectation, and demand that far outweighs supply, it's nearly impossible to know something's intrinsic value. And for anyone investing in anything, there's a certain level of calculated speculation that goes into that decision. So instead, if we just rephrase this as: Is the stock market historically overvalued and going to crash? That makes it a lot easier for us to analyze.

To do that, we should look at previous bubbles to see how we compare today. The first one, of course, would be the famous market crash of 1929. This all started in the early 1920s when low monetary policy allowed pretty much anyone to borrow money for the sole purpose of speculating in the stock market because stocks just kept going up. However, once the stock market showed the slightest glimpse of vulnerability, people started cashing out everything and withdrawing their money in cash from the banks for fear that the banks would soon be going out of business.

But the problem is that banks had lent out all of their money and didn't have enough cash on hand to give back to people who wanted to cash out. And that, of course, led to the stock market dropping 83 percent over 2.8 years, and the stock market didn't fully recover until 25 years later. But in terms of the fundamentals, though, how does that compare with today? Well, if we look at the Shiller price to earnings ratio, we could see that in 1929, it was sitting at about 30, which is high but still relatively normal. In fact, if we look at the same metric today, we're sitting at 37, which yes, is a lot higher than 1929, but tech companies, which currently lead the market, traded at a much higher multiplier.

And during a bear market, businesses typically see less earnings, which boosts that number even higher. However, if we look at the cyclically adjusted price to earnings ratio, we could also see that we're just beyond the same level that we were in 1929, suggesting that perhaps valuations are extended beyond where they should be. So when we compare all of this side by side, I mean, sure, it does look like we're a bit over-inflated, but we have monetary policies in place today that did not exist back in the 1920s.

Tech valuations have also historically been higher than earnings, while they use a lot of that revenue to grow. And even though there's plenty of borrowed money out there, interest rates are still very low to justify it. But then we have one of the most common bubbles that everyone compares us to today, and that would be Japan's real estate and stock market bubble of the 1980s, which is still trading below what it used to. For Japan, this was caused by low interest rates which fueled rampant speculation across the stock and real estate market in the 1980s, driving prices significantly beyond where they should be, and into bubble territory.

In fact, their government became so worried about a bubble that they raised interest rates to prevent asset prices from rising any further. And very soon after that, collapsed the entire market, causing everything to drop about 60 percent. The biggest problem with this was that in response to rising interest rates and falling prices, investors began hoarding their cash. With less consumer demand, prices fell even further; that caused a very vicious cycle where the more prices fell, the more investors held on to cash, which caused prices to fall even further. The result today is a Japanese stock market that is lower today than it was 30 years ago.

And the biggest concern with that is that the United States could see something similar. However, Japan's economy is also fundamentally different from the United States, which would make it very likely for that scenario to happen here. We could also see the magnitude of their bubble when we compare it with our dot-com bubble, which was only half the size of what they saw. If we applied the same metrics today with Japan’s stock market back in the 1980s, the S&P 500 would be trading at about 9,000.

Now, after that, speaking of the dot-com bubble, we gotta talk about the dot-com bubble. This was caused by a frenzy of speculation over brand-new internet-related companies because the internet was going to be the future. Well, that was unsustainable because the majority of those companies didn't actually make any money, so they eventually collapsed, wiping out most of their value. And if you were invested in tech stocks during that time, you would have lost on average 78 percent.

Now, in terms of comparing the metrics, though, today our tech prices are much more in line with profits; they're very cash-heavy, and the P/E ratio for tech is significantly less than what it was in 1999. And lastly, we got the 2008 great financial crisis. This happened when banks lent out way too much money to people who weren't qualified, who used that money to go and buy real estate, who drove those real estate prices to the moon. And then when they couldn't sustain those payments, they began defaulting. Those defaults went back on the bank, people then began losing their homes left and right, the entire market fell 50 percent, and then the Federal Reserve came in and bailed everyone out, which of course, then leads us to today.

Now, of course, we have articles warning about the everything bubble; will household net worth exceed the nominal GDP? So is there actually truth to what Michael Burry is talking about? Well, not exactly so fast. I mean, Michael Burry is an extremely talented investor who's been right quite a few times, but not everything he says pans out as expected. For example, in 2017, he said we were headed for an imminent crash, and so far since then, the S&P 500 has doubled in price. Then again, in 2019, he called index fund investing a bubble.

That's because when you're investing in index funds, you’re investing in a big basket of stocks. That means anything within that basket gets your money, and the more money it gets, the higher the price goes. So if everyone just keeps investing all of their money into these stock baskets, those stocks will continue to see money flowing into them just because they’re lucky enough to be in the basket and not so much because of their actual performance. However, this was a topic I extensively researched about two years ago because I have a lot of my money in index funds. And from all of the data I found, it was shown that adding a stock to an index has no permanent effect on the price.

In fact, it was studied that the stock's premium for being added to an index completely wore off after two months, usually returning to the same price before it was ever introduced. Overall, studies have shown that stocks added to an index do not see any superior performance in demand over stocks that were not traded within an index. Not to mention if there are any market inefficiencies where index funds are driving up the price, that would leave more room for actively managed funds to outperform by buying up smaller stocks, and so far that has not happened on a large scale.

And finally, most recently, in April of 2020, he warned that the stock market crash will get much worse, which in hindsight has turned out to be pretty much the bottom of the market. And since then, we're up another 40 percent. I say this not to try to discredit Michael Burry, but just to give you the context that stock market predictions are so dependent on so many variables that could change by the day, really making it impossible to give you any indication of where the market might be headed.

Here's the thing: for anyone who's making a prediction in today's environment, there are so many changes happening all at once that no one could see coming. We have no idea how these policies will continue to adapt and change, and that makes it impossible to take these predictions too literally. Chances are, if you listen to all of these doomsday theories, you would be sitting on the sidelines for years or even decades, missing out on some of the best times in the stock market. Sure, you would have missed some of the drops along the way, but overall historically, the stock market has continued to trend upwards.

And what some of the wealthiest investors out there have is the approach of buying consistently and holding. It makes you realize that none of this white noise matters, and you should just carry on as usual. Now, as for my own opinion, for whatever that's worth, I do have concerns that things are getting a little bit ahead of themselves. Like skyrocketing real estate prices, to me, seem unsustainable at that current pace. And while I certainly don't anticipate a crash happening, there are so many artificial factors and shortages that are leading us to the most expensive housing market ever.

But that doesn't mean it can't or won't continue going higher, so I'm not going to bet against it. And if a good deal comes along, I'm all for it. The same thing also applies to the stock market. It's very obvious that it's fueled right now by a surplus of money, low interest rates, and the enthusiasm to invest. But that doesn't mean it can't continue to go even higher.

Now the cryptocurrency market, as Michael Burry warns, is probably the biggest unknown here because we have no idea exactly how much leverage exists in that market. For example, even though CNBC reports that some people are trading with a hundred to one leverage, who’s to say that lending platforms aren’t doing the exact same thing, except on a larger scale? It's still too early to tell if and when anything might ever happen with that, but just be careful. Plus, even if the market does crash, unless you're within a few years of retirement, chances are that's just a good time to keep buying even more.

So you shouldn’t fear a crash. Instead, embrace it and use it as an opportunity to buy everything you missed out on in March of 2020 if it happens. And then, most importantly, you could use it as a way to smash the like button for the YouTube algorithm!

So with that said, you guys, thank you so much for watching! I really appreciate it. As always, make sure to subscribe and hit the notification bell. Also, feel free to add me on Instagram; I post pretty much daily. So if you want to be a part of it there, feel free to add me there. As my second channel, The Graham Stephan Show, I post there every single day I’m not posting here, so if you want to see a brand new video from me every single day, make sure to add yourself to that.

As promised, here’s the reef aquarium as a thank you for liking the video. We got everything right here, and then right down below we have all the equipment before the cabinetry gets built. Topshop Aquatics provided a lot of the coral that you see here, along with a few local reef aquarium enthusiasts who are kind enough to give me small pieces like this little frog spawn right here. Then I got a lot of the hard corals growing on top of this rock right here, and then we got this really cool green toadstool here.

So thanks so much for watching, and if you want more reef aquarium stuff, just let me know down below in the comments!