Key points
- ‘Smart money’ refers to professional investors who made their fortunes on the stock market
- Ray Dalio bets big on emerging markets
- Warren Buffett advises focusing on the long term. Berkshire Hathaway’s portfolio is selling more than it’s buying
- Michael Burry continues sounding the warning on a market bubble
A stock market crash is a terrifying prospect for an investor like me. I’ve worked hard to save and invest wisely, but it could all be wiped out in a flash. But crashes also present fantastic opportunities. I just need an edge over the market, and when I feel like I need one, I look at what the ‘smart money’ is doing.
Ray Dalio
Ray Dalio is a billionaire investor and hedge fund manager who’s been Co-Chief Investment Officer of Bridgewater Associates since 1985. In an interview given in March 2021 he said that the stock market was in a bubble “halfway” the magnitude of the dotcom bubble. Nearly a year later, has he changed his tune? Well, we could gain some insight by looking at the changes made to Bridgewater Associates portfolio.
Dalio’s portfolio
From Q2 to Q3 of 2021, Dalio increased the size of his holdings in several key investments. SPDR Gold Trust got bumped up from 1.7% to 2.15% of the portfolio while iShares MSCI Emerging Markets ETF jumped all the way from 0.77% to 5.55%. In fact, his three top holdings right now are all emerging market exchange traded funds (ETFs):
- Vanguard Emerging Markets Stock Index Fund ETF
- iShares MSCI Emerging Markets ETF
- iShares Core MSCI Emerging Markets ETF
An ETF is a single share, made up of fractions of other shares. Functioning much like an index fund, ETFs allow investors to gain exposure to an entire market or sector.
In a recent interview with Reuters, Dalio claimed that inflation is now the biggest threat to investors. Gold is usually seen as a hedge against inflation, which explains his allocation to SPDR Gold Trust. Dalio has also made no secret of his admiration for China, which accounts for significant portions of emerging market indexes. All of this portfolio activity tells me he’s putting his money where his mouth is, and moving away from the US.
Warren Buffett
Buffett is easily the most well-known investor on this list and is always one people turn to when looking for which way the winds are blowing. However, he’s not overly concerned about the ups and downs of the market and has routinely advised that people focus on the long term. As a result, he has been pretty quiet on the current state of the market.
But what many call the ‘Buffett Indicator’ tells a different story.
The ‘Buffett Indicator’ is a method to estimate if the stock market is overvalued. One takes the total valuation of the US market ($50.7trn) and divides it by the country’s annualised GDP ($24.trn) to find how closely valued the market is to the nations actual income. By putting in these numbers we get a ratio of 211%.
Because the stock market is speculative, a discrepancy between valuation and GDP is to be expected. Investors pay a higher price for stocks because they expect them to be worth far more in the future. In 1950, that ratio was just below 50% and a historical trendline has been drawn from then, increasing by 1% per year to account for exponential improvements in efficiency and technology. However, this puts the ‘fair value’ ratio at 120% today, far lower than the 211% we are seeing.
Buffett once said that this ratio was “the best single measure of where valuations stand at any given moment.” but has since changed his stance and advises against using just one method of valuation.
Buffett’s activity
Looking at Berkshire Hathaway’s portfolio we can see that Buffett has been very cautious through Q3 2021. He bought 13 million shares in Royalty Pharma and 800,000 in Floor and Décor holdings. He also increased his position in Chevron by 24.13%. But these purchases only represent 0.38% of his entire portfolio.
By contrast Buffett completely closed his positions in Merck and Co, Liberty Global Inc and Organon and Co, and reduced his shares in seven other companies by a significant amount.
Does this mean Buffett is expecting a crash? It’s possible. He’s not yet changed his position in any of his key holdings like Apple, Bank of America or Coca-Cola, so perhaps he’s just freeing up some cash to put elsewhere. Stocks are at all-time highs right now and one of the fundamental investing rules he and Charlie Munger follow is to pay a fair price with a margin of safety.
Given what the ‘Buffett Indicator’ is telling us and looking at the reduced activity in his portfolio, I think there’s a good chance he thinks the market is overvalued.
Michael Burry
Burry is an investor who came to fame after he correctly predicted the 2008 financial crash. After making this prediction he went on to short the housing market and earn himself and his firm Scion Capital over $700m.
Burry is certain we are in a bubble. Referring to the state of the market, he said: “There’s more speculation than the 1920s [and] more overvaluation than the 1990s.”
In a November tweet he pointed to a Wall Street Journal article detailing the then $100bn market capitalisation of new electric vehicle company Rivian. Rivian has since lost $15bn in market cap and its shares have fallen 57% from their all-time high of $172.01 on 16 November. Burry has also taken aim at Tesla and is revealed to have taken out put options on over a million of its shares.
A ‘put option’ guarantees the owner a right to sell a share at a specified price by a certain date and generally reflects a lack of confidence in the future price of a stock.
Telsa has, for its part, soared over 20% in the past year and its CEO, Elon Musk, has hit back calling Burry a “broken clock”.
What have I taken from this?
Dalio’s belief in China intrigues me. I haven’t ever really considered Asia as an option but will look into the region more closely now. The Buffett Indicator confirmed what I already felt about US stocks. I don’t think I’ll be adding any to my portfolio soon.
Burry’s sentiment is the toughest to decipher. He’s been right in the past, but it could be years before another market correction. Not investing, while inflation runs hot, could also be considered the riskier option.
The lesson I’ve taken from this is to look at newer markets I haven’t considered, but to invest cautiously and build up a small cash reserve in case the market drops.
