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‘The Big Short’ says a stock market crash is coming

Businessman looking at a red arrow crashing through the floor
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Usually, an investor’s biggest fear is a stock market crash as savings can be cut in half or more. So, when an investor like Michael Burry compares stock markets of today to the dotcom crash, it pays to take notice. Michael Burry was made famous in ‘The Big Short’. The film documented his call to short the housing market heading into the financial crisis.

He was able to predict that crash. Is he right again?

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The pandemic

The chances for a stock market crash have to be viewed in the context of the pandemic. When Covid first started to spread, ensuing lockdowns caused a lot of economic damage. Stock markets then fell as share prices had to reflect the prospect for lower profits.

We’ve seen a huge rebound in economic growth since then, and stock markets have rallied accordingly. Particularly in the US where Michael Burry is based. But stock markets rebounded at speed. The S&P 500 is now up over 100% since the low in March 2020.

There was good reason for the stock market to rally. Central banks such as the Federal Reserve slashed interest rates to all-time lows. The Fed also started quantitative easing – buying bonds to keep interest rates low and encourage lending. This floods the financial markets with liquidity, and reduces borrowing costs. Stimulus like this normally reverses a stock market crash, just like in 2020.

Governments also helped with fiscal stimulus, or spending to support their economies. In the UK we had the furlough scheme to support jobs. In the US, there were cheques sent directly to consumers’ bank accounts. Because of lockdowns, there were limited places to spend this money, so savings rates increased.

Some commentators have said excess savings and financial liquidity have created greater demand for cryptocurrencies and NFTs (non-fungible tokens). But Michael Burry has a rather stark warning for today’s markets: “More speculation than the 1920s. More overvaluation than the 1990s. More economic strife than the 1970s.” Wow. If this is the case, then we’re about to see an all-mighty stock market crash!

Stock market crash: is there one coming?

I want to separate out the UK and US stock markets. I agree with Burry to an extent on overvaluation in the US. The price-to-earnings (P/E) ratio for the S&P 500 is high at almost 26. But the FTSE 100 index is far cheaper at a P/E of 17. The FTSE 100 also hasn’t recovered fully from the stock market crash of 2020. This doesn’t say to me that the UK market is full of speculation.

My biggest concern, which aligns with Burry’s comments on economic strife, is rising inflation. The current consumer prices index (CPI) reading in the US was a huge 6.2% in October. The Bank of England is forecasting CPI at 5% early next year. Inflation really impacts lower-income households the most. Then, central banks may be forced to reverse economic stimulus quicker than expected. This may lead to a stock market crash.

Final thoughts

I don’t know if Burry is right. But I always refer back to a famous Warren Buffett quote in times like these: “Be fearful when others are greedy, and greedy when others are fearful.” I will still aim to buy shares of good businesses, and look for bargains if a stock market crash does happen.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services, such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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