September 25, 2021
This week, I must be clear from the start…
This is a bubble.
If you know me well… you know “this” is referring to stocks, of course.
When investors still pour record amounts of money into any asset trading at the highest valuation it has ever reached, it’s a bubble. And that’s happening with stocks today…
So far this year, investors have poured more than $400 billion into exchange-traded funds (ETFs)… And it’s on track to exceed $500 billion by the end of the year. If that happens, it’ll be about 67% higher than the previous record of roughly $300 billion in 2017.
That data comes from the Financial Times, which recently published the following chart from macro advisory firm Strategas. You can clearly see the big uptick in ETF inflows this year…
It isn’t just one corner of the market, either. As Strategas analyst Todd Sohn told the Financial Times…
It’s the persistency of the equity rally, up 100% since last March with barely a pullback. It’s everybody into the pool, it’s everything, every region, every sector.
Today, with ‘everybody’ in the ‘pool,’ stock prices naturally have been bid up to record-high valuations…
You can see this in any measure of the stock market’s value throughout history that has negatively correlated well (90% or more) with subsequent 10- and 12-year returns.
The easiest of those measures to understand is the S&P 500 Index’s price-to-sales (P/S) ratio…
The S&P 500’s P/S ratio rarely eclipsed 2 times sales before January 2017… But it has mostly been above that level in the nearly five years since then.
It never hit 3 times sales until this past April… And it’s around 3.2 today. So it’s not the least bit controversial to say that…
U.S. stocks have never been more expensive than they are today.
At this point, warning everybody about a bubble in stocks – or even worse, bonds – makes me feel like that boorish guy at the party who won’t stop bloviating about how much he hates some politician… You just can’t shut him up.
But I can’t stress this enough… U.S. stocks are more expensive by any meaningful measure than at any other time in history. And instead of being scared of stocks…
Everybody wants to buy them.
Sorry about the boorish thing, but what the heck do you expect me to tell you?
Maybe you’d rather hear something like, “Gosh, I don’t know how to tell you this, but you’re about to earn the worst 10- and 12-year returns any U.S. equity investor has ever earned… But hey, everybody is doing it… so tequila shots are on me!“
And no, I don’t care what the popular sentiment indicators say…
I know some of them are flashing “fear” right now, implying that it’s a great time for contrarians like us to buy.
I couldn’t care less, though… In my mind, some of those sentiment indicators are so volatile that they’re practically worthless (something it took me years to figure out).
For example, the American Association of Individual Investors (“AAII”) Investor Sentiment Survey is indicating fear about stocks at the moment… Just 22.4% of respondents are bullish – with the S&P 500 only about 2% lower than its all-time closing high of 4,536.
Meanwhile, back on April 21, 52.7% of AAII survey respondents were bullish – with the S&P 500 roughly 6% lower than today. That’s the most bullish reading of the past six months.
The market is trading at almost the identical valuation today as it was on April 21… Its P/S ratio was 3.13 back then, and it’s at 3.18 now – a meaningless, minuscule difference.
To be fair, the survey asks investors if they’re feeling bullish, neutral, or bearish about stocks over the next six months… So it’s a short-term indicator, which is kind of the point.
In other words, it’s useless for long-term investors… And after all, it tends to take years of holding on to shares of great companies to make real money in stocks.
If a sentiment indicator goes into extreme fear mode on a tiny little pullback of roughly 2% below a new all-time high… how valuable is it to long-term investors? It seems like the AAII survey’s main value is to create the illusion of an ever-changing narrative.
Let’s face it…
Economic conditions and company fundamentals tend not to change nearly as much or as fast as stock prices. Simply put, investors systematically overreact in the short term.
For an extreme example, if you bought shares of online juggernaut Amazon (AMZN) 20 years ago… do you really care about sentiment? And if you’ve adopted something like my truly diversified portfolio of stocks, cash, gold and silver, and bitcoin… again, do you really care about little weekly fluctuations in the market that somehow translate to big swings in sentiment indicators?
If you’re a short-term trader, maybe.
But if you’re a truly diversified long-term investor, I hope not…
The only indicator you need is the market itself.
The S&P 500 has roughly doubled off the COVID-19 panic bottom of March 23, 2020.
Doubled! In roughly 18 months!
And instead of exercising caution… investors have reacted to this incredible, record-setting rally by pouring record amounts of cash into stocks through ETFs.
One of the main reasons folks think they need an indicator besides the market itself is because they’re under the delusion that they can predict the market’s short-term direction.
Don’t predict, prepare… It’s the only reliable way to manage your own money and grow your wealth over the long term.
Right about now, I figure the keyboard cowboys are hard at work on their e-mail missives…
It’s Not the Fed
They’re probably writing in to tell me that identifying a bubble is silly because the one I’m pointing out is all the Federal Reserve’s fault.
It’s inevitable… Talk about bubbles, and somebody always brings up the Fed. This is another thing it took me years to figure out. And I want to get straight to the point again…
The Fed doesn’t make the stock market go up. Period. I don’t care what anyone else says.
The Fed prints money and buys debt securities from member banks (“quantitative easing”)… It’s essentially swapping U.S. dollars for bonds. You’ve probably heard that discussed here in the American Consequences and elsewhere around Stansberry Research before.
But the thing nobody ever tells you is that… the money never leaves the Fed. It just sits there in the member banks’ accounts with the Fed. It doesn’t go into the stock market.
That turns quantitative easing from “magic stock market levitation voodoo” into something as interesting and consequential as trying a different kind of mustard on your hot dog. (I’ll spell it out clearly for the keyboard cowboys… It’s not that interesting or consequential.)
I used to say the Fed’s market stimulus was like putting a penny behind a fuse (back when our homes had fuses instead of circuit breakers)… You’ll keep the lights on by doing that, but eventually, you’ll burn the whole house down. Scary, right?
I don’t say that anymore, though… That’s because it’s not that mechanical, and it’s not that scary.
It’s more like Kabuki theater… The performers gesture in a grand, highly stylized way. Their costumes are lavish and colorful.
But nobody is really waging war, falling in love, or committing suicide… It’s just make-believe actions. It’s all for show.
And like the richly costumed Kabuki dancers, the Fed’s activity – and announcements of its activity – does what it’s designed to do… It distracts and entertains us.
Real Kabuki is an entertaining distraction you sign up for when you buy a ticket to the show. But you don’t sign up for quantitative easing and the accompanying noisy narrative of a Fed-manipulated market. It’s more like a tax… It’s the part of the price you pay that is forced upon you when you choose to get involved in the financial markets.
Now, I’m not saying there’s zero connection of any kind between the Fed’s activity and the stock market… only that there’s no mechanical, tangible connection. (Hat tip to John Hussman of Hussman Funds and Jeff Snider of Alhambra Investments for helping me figure all this out.)
The point is, the Fed isn’t using any kind of magic stock market levitation voodoo…
The Fed’s behavior is not nearly as inexplicable and consequential as that of investors who continue to believe in the central bank’s power to keep the stock market propped up… even though it has presided over two of the biggest wipeouts in stock market history since 2000.
Alan Greenspan served as Fed chair from 1987 to 2006… That period, of course, included the dot-com bubble and ensuing bust. And Ben Bernanke presided over the Fed during the housing bubble and financial crisis that followed in the mid- to late 2000s.
After months of extraordinary gains, the U.S. stock market is now looking off. Investors worldwide now ask, “Is this the beginning of the end of the most epic stock rally in history?” All eyes are on September 28 for the answers. Here’s the entire story.
Bubble, Meet Burst
Why are we all so forgiving of their total lack of ability to see bubbles? Or is it just me? Am I like the kid in The Sixth Sense? He saw dead people… I see bubbles.
If the Fed has so much control over the market, why doesn’t it act ahead of time to prevent the bubbles and their inevitable bursting?
The Fed doesn’t control anything but its own narrative…
It may influence stocks for extended periods of time, but the truth always comes out during the inevitable crash. I just don’t get why more people don’t see it that way. As asset manager Jeremy Grantham said recently on the We Study Billionaires podcast…
The most impressive thing here is… the faith the financial community has in [the Fed], despite the fact that they’ve been let down badly twice.
These were not insignificant setbacks. The tech crash was brutal… The housing bust was merciless…
And yet, it’s as if it never happened… Hey, Greenspan was our friend. Bernanke was our friend, and we got croaked, guys! What is the matter with you?
Greenspan was conveniently blind to the dot-com bubble… as was Bernanke to the housing bubble. Both men claimed not to see the massive imbalances that many accuse them of helping to create… It’s the same way that current Fed Chair Jerome Powell claims not to see the one we’re clearly living through at this exact moment.
The world sits in awe of the Fed’s massive money-printing capability… causing many folks to conclude that it can print enough money to keep the markets afloat.
A speculative, “can’t lose” psychology takes hold… Asset prices soar into the exosphere (the highest layer of Earth’s atmosphere)… And finally, one day, you wake up and you’re in a bubble.
But as Grantham has noted, all bubbles burst at some point… And when that happens, it frequently creates a massive crisis that wipes out countless investors, banks, and others.
I’m not the only one talking about bubbles right now…
David Hay of wealth-management firm Evergreen Gavekal is the latest analyst to point out in a recent blog post that the current bond market is “arguably the biggest bubble of all time.” (And he noted that if it weren’t for Dogecoin, he wouldn’t need to say “arguably.”)
Bond prices are scraping 5,000-year lows… Japanese and European sovereign bonds are priced to pay negative yields… And all U.S. Treasurys are sporting negative real yields.
That’s all you need to know to understand Hay’s argument.
What’s the matter with anyone buying stocks and bonds today on the (even partial) belief that the Fed is propping up those markets?
There’s a slight difference with bonds…
Unlike in the stock market – where the effect is purely psychological – the Fed really does prop up the bond market by buying Treasurys, corporate bonds, and even high-yield (or “junk”) bonds… And it props up the housing market by buying mortgage-backed securities.
(We can quibble some other time about the Fed’s relatively small level of activity compared to the overall bond market, which is much larger than the stock market.)
I can’t imagine anyone believing any kind of propping up could ever turn out well…
Wall Street analysts, executives, and asset managers should march on the Eccles Building in downtown Washington, D.C., holding torches and pitchforks and demanding that the Fed stop encouraging speculative bubbles to form.
But they won’t, of course… They have no incentive to do so.
Wall Streeters get paid based on trading activity, which would plummet if folks suddenly believed the Fed rug had been pulled out from under them. Wall Streeters also get paid a percentage of the assets they collect… So the more valuable stocks, bonds, and other assets are, the more money they make to pay for houses in the Hamptons and elsewhere.
This isn’t just about bubbles, either…
Free Money Kills
The Fed’s policy of either directly influencing interest rates and housing or indirectly running a Kabuki show for the stock market may be seen as part of a more insidious trend that includes everything from corporate welfare to stimulus checks for those put out of work by the government’s Draconian COVID-19 response.
Park Aerospace CEO Brian Shore improvised a stream of consciousness rant about the social impact of “cheap and easy money” on a recent investor conference call:
Strange days have found us…
People are getting paid not to work. Free money [is] being force-fed into the system.
In the old days, people believed work was something honored and valued. It gave a person self-respect, self-reliance, [and] dignity.
But now, maybe not. Free money.
It used to be that you worked hard, you sacrificed, you were frugal with your money. And one day… you’d be able to use that hard-earned money because it had some real value.
But now, it’s just use the cheap and easy money. If it doesn’t work out, it doesn’t really matter because it never was really your money anyway.
So it’s kind of sad actually. Why bother to work hard and sacrifice because – why do that? Why not just tap into the cheap and easy money? It’s kind of tragic, in our opinion. But the world… seems upside down and backwards to us.
What was supposed to matter, doesn’t. What was not supposed to matter, does.
That’s what you get when central banks and governments around the world try to “fix” the markets they broke. They’re constantly running a narrative of fixing things – like markets – that work best when they simply back off and do a lot less fixing.
If anybody actually cared about investors, they’d use their power and money to educate them and warn them that they won’t be bailed out… instead of bailing them out.
That “solution” just discourages them from becoming prudent and educated. It never permits them to learn that partaking in bubbles is a fool’s errand and only ends one way…
I have no idea exactly when the current bubble will collapse…
No one does.
But that doesn’t mean it doesn’t exist…
It’s not hard to see. I’ve shown it to you many times. Yet, with market participants glued to the Fed’s Kabuki play, there’s no telling how long it’ll go on like this.
In the end, investors would be wise to heed the words of thoughtful market practitioners like Eric Cinnamond of asset manager Palm Valley Capital. A couple of weeks ago, he said…
Current operating results, and the response by investors, reminds us of 1999 and 2006. Similar to those peaks in the economy and market, we believe investors are currently extrapolating exceptionally strong operating results far into the future.
In fact, based on current equity valuations, we believe extrapolation risk has never been higher.
With that, we turn back to Strategas analyst Todd Sohn’s quote at the beginning of today’s essay…
These days, it’s “everybody into the pool” because they all believe the Fed has their back.
From there, as Cinnamond noted, it’s not much of a stretch for folks to expect “strong operating results far into the future.” And if you believe that… it makes perfect sense to pour record amounts of money into stocks at the most expensive prices ever recorded.
The Kabuki play might seem like it can go on forever… But the curtain always drops at some point. And with that in mind today, you know what my advice is…
Prepare, don’t predict. Maintain a long-term perspective. Hold a truly diversified portfolio of stocks, cash, gold and silver, and bitcoin.
When the bubble inevitably bursts, you’ll be glad you’ve done that.
Love us? Hate us? Let us know how we’re doing at [email protected].
Contributing Editor, American Consequences
With Editorial Staff
September 25, 2021