Weight Problem

William Ehart

MICHAEL BURRY WAITED years to be rewarded for his bet against subprime mortgages. Actor Christian Bale, in the movie version of Michael Lewis’s book, The Big Short, portrays Burry curled up in the fetal position on the floor of his office. When the financial crisis finally hit in 2008, he made $100 million.

I’m no Michael Burry and the chance I’ll ever see $100 million is about 100 million to one. But I know what it’s like to bet against the market and wait vainly to be rewarded for it.

Now, Burry sees a bubble in market cap. He says the obliteration of active management by indexing has caused large-cap companies to become overvalued and small-cap value stocks to become, well, smaller and more undervalued.

In this case, I can truthfully say I’m years ahead of Michael Burry, because I’ve long worried that large-company stocks are overvalued, especially the popular growth stocks. It’s not like I’m a genius—just a worrier who fancies himself a contrarian. Friends call me more of a contrarian indicator, which—sadly—the record confirms. Still, to use a phrase popular with our president, “many people are saying”—especially those with a stake in selling smart beta ETFs—that the biggest-cap stocks are headed for trouble.

Traditional index funds weight stocks according to their total stock market value, so the bigger a company, the more the funds have to invest. By contrast, smart beta, or factor investing, involves weighting stocks by fundamental characteristics such as corporate profits and dividends, or equal weighting stocks in an index, or simply overweighting small-cap stocks. The argument is seductive. Results have been mixed.

Nothing boosts the ego like knowing something the crowd doesn’t. Truth be told, it boosts our ego just to think we know more than everyone else. It’s gratifying until the market doesn’t cooperate. Let me recount two unsuccessful ways I have bet against market cap:

  • Icahn Enterprises (symbol: IEP), which I bought on Dec. 31, 2014. I was half sold on indexing. Few people could beat the market. But Carl Icahn had been an exception, hadn’t he? The market clearly was overvalued (in my beautiful mind) and here was a chance to put my money with a value-investing legend. Result: Vanguard 500 Index Fund +59%, IEP +16%.
  • Third Point Offshore (TPNTF), which I purchased on April 1, 2016. I read in Barron’s about a way to invest with billionaire Dan Loeb. As with Icahn, I felt that activist investors would have an edge. They’re the true opposite of passive investors—not just picking stocks, but actively shaking up management to create shareholder value. Result: Vanguard 500 Index Fund +54%, TPNTF +7%.

Reversion to the mean—the tendency of observed data, such as the investment returns of market-beating money managers, to gravitate toward average—can be just plain mean. I could also go on about my smart beta incursions into emerging markets in 2014, but suffice it to say that small-cap, high-dividend stocks aren’t going to save you when the whole asset class sucks. Currently, I distrust China’s market weight in the emerging market indexes—a clear signal, according to my friends, that you should load up on Direxion Daily CSI 300 China A Share Bull 2X Shares.

Someday, Icahn and Loeb may have the last laugh. IEP, at least, has gained ground in recent years against the S&P 500. I’m still holding both stocks, despite firing myself as a portfolio manager and moving the vast majority of my investments to target-date retirement funds.

I’m not hanging on to avoid admitting a mistake. Rather, I am trying to think long-term and wait for the tables to turn. At least that’s what I tell myself. It’s the old Wall Street saw: I wasn’t wrong, just early.

But the dates on my target-date funds keep getting closer. And yet my belief in my own perspicacity—and in the ability of investment legends like Icahn and Loeb to beat the market—keeps delaying my own retirement.

Related: Adam Grossman on Michael Burry

William Ehart is a journalist in the Washington, D.C., area. Bill’s previous articles include Not My GuruChina Syndrome and Before the Fall. In his spare time, he enjoys writing for beginning and intermediate investors on why they should invest and how simple it can be, despite all the financial noise. Follow Bill on Twitter @BillEhart.

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