Yes, It’s a Bubble
There are signs of recession everywhere and these are good indicators. It’s not just sentiment or guesswork.
I’m not going to get into the weeds here, but things like inverted yield curves and negative swap spreads, among other indicators, are all pointing to recession. In addition to those technical indicators, manufacturing is down, global trade is down, etc.
Europe’s in a recession right now, Japan is hanging on by a thread, and I haven’t even talked about China. China’s reopening after COVID has been a bust and it’s probably getting close to recession as well.
So significant portions of the world are either in recession or flirting with recession.
In the midst of all these problems, in addition to the most aggressive rate hikes ever and an economy that’s saturated with record amounts of debt, the market’s up 15% or so over the past year.
Why are stocks going up? The simple answer is that the market’s in a bubble. There are a couple of things to consider…
The S&P Four
First off, the S&P 500 is really the S&P Four, meaning it’s a cap-weighted index. What that means is that the impact of a stock’s price on the index is a function of its market capitalization. The bigger its market cap, the greater its impact on the index.
Right now, the top 10 stocks in the S&P account for about 30% of the index.
And it’s just a small handful of stocks like Apple, Microsoft, Nvidia, Google (Alphabet) and a couple of others that account for most of the market’s gains this year.
If you actually take the 500 stocks in the S&P 500 (503 to be precise), more of them are down this year than are up. So when you say the S&P is up 15% on the year, or what have you, it presents a very distorted picture.
The reality is that it’s almost all being driven by a small number of stocks. Why are stocks like Nvidia up so much on the year?
Part of the answer is the latest market fad concerning artificial intelligence (AI), GPT (generative pre-trained transformers).
Do people buying these stocks, do analysts putting out all these reports actually know what GPT is? No, they don’t. They can recite its name, but they don’t really know how it works. But they do know that it runs off of high-end processors from Nvidia.
I happen to be doing a lot of research on AI and GPT right now. Pretty well immersed in it. Yes, it has lots of potential. It’s powerful technology, and I’m not discounting its potential impact. But it has a lot of problems.
In many ways, there’s a lot less there than meets the eye. You can make a good case that it’s really just a very fast speed reader, little more.
Does it justify these stock valuations? No.
How Bubbles Form
But people buy into the hype because they don’t want to miss out on the next big thing. And so they buy the stock. That drives the stock higher, which attracts more buyers, which drives the price even higher, which attracts even more buyers.
It’s a positive feedback loop. We’re now in that feedback loop. It’s amplified by institutional investors.
Most people don’t buy individual stocks. They put their money into 401(k)s, into index funds, and the index funds buy the stocks. Well, who are the index funds? It’s Vanguard, State Street, Fidelity and some others.
They follow the index. If Apple’s a large part of the index, for example, they’re going to buy Apple. What happens when they buy Apple? The stock price goes up. Then what happens? They buy more Apple stock because it has an even larger place in the index.
So it’s a process that feeds on itself. And it can go on for a long time. That’s how bubbles form.
How does it end? Well, it ends with a crash eventually. The music can’t keep playing forever. The question then becomes when exactly is the music going to stop playing?
The answer is I don’t know. No one does, and anyone who says they do know is either a fool or a liar.
I just know it’s coming, even if I can’t say when. I can see the bubble.
Bubbles are actually easy to identify. People say, “You can never tell if it’s a bubble.” But you can. Just look at the Nasdaq in early 2000. Look at the Nikkei in late 1989. These were classic bubbles.
But again, you just don’t know when they’re going to pop. You can say that for sure that they will, but you don’t know when or the specific catalyst that will set the crash in motion. Often, the catalyst is only obvious in retrospect. No one sees it coming.
Which Snowflake Will Trigger the Avalanche?
I’ve often compared the causes of financial crises and market crashes to snowflakes that can trigger an avalanche. A massive amount of snow can accumulate before that one final snowflake comes along to start the chain reaction.
A snowflake can cause an avalanche. But of course not every snowflake does. Most snowflakes fall harmlessly, except that they make the ultimate avalanche worse because they’re building up the snowpack. And when one of them hits the wrong way, it could spin out of control.
The way to think about it is that the triggering snowflake might not look much different from the harmless snowflake that preceded it. It’s just that it hit the system at the wrong time, at the wrong place.
In other words, the climbers and skiers at risk can never know when an avalanche will start or which snowflake will cause it. It only becomes obvious afterward.
But it helps to know what to look for. And right now, the stock market is overvalued according to several key indicators.
The bottom line is trying to time the market is very risky. You can lose a lot of money being right but early. It’s like Keynes said: “Markets can remain irrational longer than you can remain solvent.”
But you can see the dangers forming and prepare accordingly. Be nimble.
I’m not saying you should get out of stocks entirely. But you might want to reduce your exposure. I also advise that you keep some cash set aside and to get your hands on some gold.
Don’t get caught in the avalanche, whenever it comes.
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