SPY - Michael Burry Just Bet Big On A Stock Market Crash Or Did He?

2023-08-16 09:00:00 ET

Summary

• Michael Burry's "Big Short" isn't what is being trumpeted in the headlines.
• The market will eventually crash, and it looks overvalued, so there are simple steps to take to protect your portfolio.
• Let's take a look.

Did Michael Burry Just Short The Market?

It is imperative to read beyond headlines.

Investing headlines scream that Michael Burry (of "The Big Short") just put a $1.6 billion bet on a market crash after his latest investment disclosure. This has led to a slew of commentary on the state of the market and whether a crash is imminent. But before we discuss this, let's look at what Burry did and, more importantly, what he did not do.

#1: This is already old news.

13F filings are delayed by 45 days, so by the time it is revealed, Burry may have closed these positions already. Or, he could have added to them. We will know after the next filing, which will also be old news when it comes out.

#2: He did not spend $1.6 billion.

The $1.6 billion headline is incredibly misleading. Burry bought Put Options on the S&P 500 ETF Trust ( SPY ) and the Nasdaq Invesco QQQ Trust ( QQQ ). The notional value, which you can read about here , refers to the total value of the underlying assets - not what is paid for the options. In actuality, Burry paid a fraction of $1.6 billion, and the options could be a hedge or speculative.

#3: He did not go "all in" on a market crash.

Despite what you may have read, Burry did not put all his chips on double-zero at the roulette wheel. Scion Management is still long stocks. The fund increased its holding in MGM Resorts ( MGM ), Expedia ( EXPE ), and CVS ( CVS ). Increasing bets on consumer discretionary and staples stocks isn't exactly a bet on calamity. Instead, it lends credence to the put options being used as hedges against the fund's long positions.

The stock market will crash - eventually.

The stock market will crash again, as it did in 1987, 2000, 2008, 2018, 2020, and 2021, depicted below.

Even better, the same graph shows how far the market fell from its highs during each downturn.

Is another crash imminent? I could speculate, but in reality, I have no idea. But it will happen again, and there are things we can do to protect our portfolios along the way.

What are the best ways to hedge against a market crash?

It does look like the market is overheated again, but remember; it is a market of stocks, not a stock market. Investing in high-quality companies in secular growth industries will always be the winning long-term strategy. It is also wise to have cash on the sideline (especially when you can get a risk-free 5% return these days) to whether a downturn and invest when stocks go on sale.

There are other things to do when the market gets ahead of the fundamentals.

Covered calls example: The Trade Desk.

The Trade Desk ( TTD ) was one of my top picks for 2023 because of its incredible growth and secular opportunity in programmatic advertising, especially connected television ((CTV)). Programmatic advertising is on a secular uptrend as advertisers shift their budgets from traditional television to streaming, web and mobile display, and online video. The Trade Desk stock is up 64% year-to-date.

The Trade Desk's revenue has risen 240% since 2019, from $661 million to $1.6 billion in 2022. The growth continues in 2023, with a 22% gain in sales through Q2 despite a challenging advertising market. The company is creating tons of free cash flow, using share buybacks to offset stock-based compensation dilution, and has over $1.4 billion in cash and investments with no long-term debt.

The company's price-to-sales (P/S) ratio has shot up from 14 at the start of 2023 to over 21. The stock is pricey given the advertising slowdown and the threat of a recession carrying the slowdown into 2024.

Selling a covered call is an excellent way to make income and hedge against a stock when (1) we still love the company, (2) we don't want to sell the stock, but (3) we think it has gotten ahead of its skis.

A covered call gives the buyer the right to buy the shares at the strike price on or before the expiration date. When The Trade Desk took off this year, I used this strategy to sell a June 2024 $100 Call for $14.85, pocketing $1,485. This is a winning hedge unless the stock rises above $115, or 56%, by June.

Collect dividends from recession-resistant companies: AbbVie.

AbbVie ( ABBV ) is the subject of handwringing for many commentators this year. Losing patent protection for the best-selling drug of all time will do that. But AbbVie's management has prepared for the arrival of Humira biosimilars since 2019, when it acquired Allegan. It now has a well-rounded portfolio and two blockbusters to take its place.

Humira provided $21 billion in sales in 2022, and AbbVie has guided for at least $17.5 billion in combined sales of Skyrizi and Rinvoq by 2025. Neuroscience (Botox therapeutic and Vraylar) and Aesthetics (Botox Cosmetic and Juvederm) are also performing well.

Everything isn't perfect. Oncology has lost ground to the competition, and the Humira loss is difficult. However, the industry is recession-resistant, and AbbVie has more than enough free cash flow ($25 billion trailing twelve months (TTMs)) to service the dividend ($10 billion over TTMs), which has risen every year since AbbVie's inception.

Investors flock to safe havens like AbbVie when the market stumbles, making it a compelling play.

Cash flow juggernauts and share buybacks: Alphabet.

Most stocks lose ground when the market pulls back; Alphabet ( GOOG )( GOOGL ) is better positioned to take advantage than most. The company produces ridiculous free cash flow, $71 billion over the last year alone, allowing it to buy back $60 billion in stock, as depicted below.

The buybacks account for 3.5% of the current market cap. Google can buy back more shares for the same investment if the stock falls, which will leverage shareholder gains when it comes back. And Google stock would rebound handily.

Despite the rumors of its demise, revenue, net income, and free cash flow are up this year . Google Search holds 85% of the market, artificial intelligence ((AI)) innovations are plentiful, Google Cloud is growing like a weed, and management is focused on efficiency .

The bottom line

The fact is that Michael Burry is often bearish on the market, but coverage of his purchase of Put Options is overblown. With that said, the QQQ's 37% YTD gains make it look pricy. This is especially true if you think (like I do) that we are whistling by the graveyard of a recession. Keeping cash, selling calls, and buying stock industry leaders generating cash are concrete steps to protect long-term investments and emerge in an even stronger position without timing the next market retreat.

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