Michael Burry, who gained fame in the 2010 book and 2015 film “The Big Short” for shorting subprime mortgages ahead of the financial crisis of 2008–2009, is making a bet of more than $1 billion against the U.S. stock market.
Scion Asset Management, Mr. Burry’s hedge fund, purchased a nominal value of $1.6 billion in 40,000 put options against the S&P 500 Index and the Nasdaq Composite Index at the end of the second quarter, according to a Securities and Exchange Commission (SEC) filing released on Aug. 14.
The SEC document revealed that the fund acquired bearish options with a notional value of $739 million against the Invesco QQQ Trust Exchange-Traded Fund (ETF), a popular investment vehicle that tracks the tech-heavy Nasdaq 100 Index. Scion also bought put options with a notional value of $886 million against the SPDR S&P 500 ETF, another popular fund that tracks the index.
A put option is a contract that provides the buyer the right, but not the obligation, to sell an underlying asset at a pre-determined price before a specified date. Traders use put options to speculate on markets or hedge against tumbling prices. So, although Mr. Burry bought shorts on the ETFs, the value is lower than $1.6 billion.
Year to date, the S&P 500 is up by about 16 percent, and the Nasdaq has rallied by more than 30 percent. But substantial gains in several mega-cap firms, such as NVIDIA and Meta Platforms, have supported much of the market rally this year. The Dow Jones Industrial Average, by contrast, has risen by only about 5.5 percent for the year to date.
SEC filings also showed that Mr. Burry’s Scion exited stakes in six banks during the April-to-June period, including First Republic, Huntington Bank, PacWest, and Western Alliance, after spending $23 million on financial stocks in the first quarter. Scion trimmed 76 percent of its holdings in New York Community Bancorp.
Scion’s overall portfolio indicates that Mr. Burry has a long position on oil and gas companies, mining firms, banks, media organizations, and bulk shippers.
Recession and the US Stock Market
U.S. stocks were deep in red territory during the Aug. 15 trading session, despite better-than-expected retail sales data.In July, retail trade advanced by 0.7 percent in July, up from 0.3 percent in June and higher than the consensus estimate of 0.4 percent.
But the leading benchmark indexes came under pressure on higher import and export prices and disappointing homebuilder sentiment. In addition, Fitch Ratings warned that the banking industry could face more upheaval as it might be forced to downgrade dozens of financial institutions, including JPMorgan Chase.
Still, stocks have weathered the economic and political turbulence this year. But the monthly Bank of America Global Fund Manager Survey showed that investor sentiment was largely bearish last month, even as many anticipate the U.S. and global economies will achieve a soft landing and avert a recession.
Households are also skeptical of the stock market over the next year. According to the July Federal Reserve Bank of New York’s Survey of Consumer Expectations, only 37 percent of U.S. households think stock prices will be higher a year from now, a 2 percent jump from the previous month.
Although fund managers have indicated that they believe that the odds of a recession have diminished, other market observers have said that current conditions suggest a slowdown this year that could metastasize into a recession next year.
“Calling a recession timing is a lot like watching an apple fall from a tree. You can observe the external forces that are going to make it happen eventually, but the exact time is a bit more difficult,“ Ben Kirby, the co-head of investments at Thornburg, wrote in a note. ”That said, there are a lot of external forces that are acting on the economy today as we have higher interest rates and the Fed balance sheet contracting.
“So overall, liquidity is tightening, and we think that probably will cause the slowdown that we’ve seen in 2023 to turn into a recession, most likely in early 2024.”
Many of the leading recession indicators are still flashing red.
Treasury yields, for instance, have been inverted for most of the year. An inverted yield curve occurs when the long-term interest rates dip below short-term rates, highlighting that investors are pessimistic about economic prospects in the near future.
The widely monitored spread between the two- and 10-year yields is negative 77 basis points. The three-month and 10-year yield spread—the Fed’s preferred recession indicator—stood at negative 137 basis points.
Moreover, the Conference Board’s Leading Economic Index (LEI), another chief recession gauge, fell by 0.7 percent in June. The LEI has been down 4.2 percent over the six-month span between December 2022 and June 2023.
For many investors, the trajectory of the U.S. economy and stock market might depend on the Fed’s moves for the rest of 2023.
According to the CME FedWatch Tool, the futures market is pricing in a rate pause at the September policy meeting of the Federal Open Market Committee (FOMC), at which likely the benchmark federal funds rate will be left within a target range of 5.25–5.5 percent. Thirty-eight percent anticipate a rate increase in November, and close to 34 percent expect a boost to the policy rate in December.
But officials say there are still plenty of data to be published heading into the much-anticipated FOMC meeting, including another jobs report and more inflation figures.
James Knightley, the chief international economist at ING, said he believes the central bank will refrain from pulling the trigger on additional rate increases.
“Add in the squeeze on household finances from the restart of student loan repayments for millions of households and it means further weakness in retail sales and broader consumer spending ... has to remain our base case,” Mr. Knightley wrote in a research note. “The concern is that it will also heighten the chances of recession, which we believe will discourage the Fed from any further interest rate increases. Instead, we expect interest rate cuts from March 2024 onward as monetary policy is relaxed to a more neutral footing.”
Following upticks in the latest Consumer Price Index and Producer Price Index reports, how the Fed navigates monetary policy at the next meeting may ultimately depend on the second round of data surrounding consumer and producer prices.
In the end, being cautious might be the best way to trade this market, according to Ashish Shah, the chief investment officer of Public Investing within Goldman Sachs Asset Management.
“Our view is that we are late-cycle when it comes to the economic cycle,” Mr. Shah said. “It doesn’t mean that you want to sell everything down. But you have to be cautious around what could transpire next given the fact that the Fed is very tight.”
