'Big Short' investor Michael Burry warns stocks are long overdue for a crash — and 'fragile' markets could worsen it

• Pricey US stocks are long overdue for a painful correction, Michael Burry wrote on his Substack.
• He warned that a return to historical valuations would require the S&P 500 to be cut in half.
• The "Big Short" investor said the index-fund and buyback booms have supported stocks but may falter.

US stocks could suffer a devastating crash as the forces propping them up falter, Michael Burry has warned.

The investor of "The Big Short" fame, who reinvented himself as a newsletter writer late last year, sounded the alarm on a historically expensive market in a Substack post on Tuesday.

Burry, one of the few people to predict and profit from the collapse of the mid-2000s housing bubble, laid out why stocks are overdue for a painful correction.

He noted that as bull runs lose steam and bear markets set in, valuation multiples have always returned to historical averages. Yet that hasn't happened for a record 34 years now, he continued.

Using the S&P 500's level at the start of this year, he calculated it would have to crash 32% to around 4,700 points for its Shiller cyclically adjusted price-to-earnings (CAPE) ratio to fall from 40 to its average level of 27 since 1990.

The benchmark would have to collapse by 52% to about 3,300 points to return to its long-term average of 19, he estimated.

Burry said declines of that scale "might be expected from an extreme disappointment of exuberant speculation on a capital asset buildout," referring to Big Tech companies spending eye-watering sums on data centers to power an AI revolution.

The market stool could lose its legs

Burry explained why he believes stocks have resisted a reversion to the mean for so long.

He pointed to the boom in passive investing via index funds, partly fueled by baby boomers swapping bonds for stocks in recent decades.

He underscored that market-cap-weighted indexes like the S&P drive capital to the most valuable companies, helping them to become even more valuable.

He also nodded to companies' stock buybacks shoring up their market capitalizations, and authorities intervening to curb any major sell-offs.

Burry said those forces have interacted with other trends, such as the rise in high-frequency trading and pod shops, to make markets less liquid and more vulnerable, which exacerbated the COVID-19 and Liberation Day downturns.

"I believe stock market crashes will continue this trend: becoming more severe, more correlated, and, ultimately, more consequential and of greater length," he added.

Burry cautioned that stocks could lose some of their support. He pointed out that Big Tech companies have shifted from ramping up stock buybacks to borrowing cash for their data-center buildouts.

Moreover, baby boomers are poised to pull money out of stocks en masse over the next few years as required minimum distributions from their retirement accounts kick in at age 73.

The reversal of those drivers is one thing, but that occurring in a historically expensive market that is "structurally becoming more fragile, more prone to correlation and cross-asset contagion is another," Burry wrote.

Throw in rising geopolitical risks, and tech giants shifting from throwing off cash to pouring it into data centers, and that's a recipe for trouble, Burry said.

The trigger for a crash might not be "much of anything," Burry wrote, suggesting it could be disillusionment with "VC unicorns," tech titans' free cash flow "disappearing," or simply "because it is time."

"My point is that the next one is likely to be even more violent than Liberation Day," he wrote, adding that the "gloom might stick" at some point and prevent a swift recovery.