It’s a question we’re starting to get a lot from your fellow Legacy Research readers.
It’s no surprise…
I (Chris Lowe) began following markets almost two decades ago. (I got my start as a financial analyst for news company Reuters in 2001.) And some of the gains our analysts are racking up in their model portfolios are like nothing I’ve ever seen.
Dave Forest at our International Speculator advisory just recommended readers close out a position in a rare earth metals mining company he recommended just over a year ago – for a gain of 1,019%.
And colleague Nick Giambruno just handed our Crisis Investing readers the chance to make a 2,123% gain on bitcoin miner Argo Blockchain (ARB.L) – in just 78 days.
These are eye-watering returns. And they’re not the only sign the market is hitting bullish extremes.
That’s the VanEck Vectors Social Sentiment ETF (BUZZ). It’s the exchange-traded fund (ETF) Dave Portnoy, the founder of the Barstool Sports blog, is promoting.
During the pandemic, Portnoy switched from talking about sports to talking about stocks.
And by leveraging his 2 million Twitter followers, he’s become an investing internet celebrity. In particular, he’s been bullish on America’s most hyped stocks.
That’s what BUZZ does. It tracks 75 stocks with the most buzz – or hype – surrounding them online.
Basically, an algorithm reads posts and identifies the most hyped stocks on Twitter (TWTR) and other social media platforms. Then it makes an index of the most hyped stocks.
And investors couldn’t get enough of BUZZ when it debuted last Thursday. It amassed about $280 million in inflows.
That makes it the fourth-most successful debut for an ETF ever in terms of inflows. (There are more than 7,000 ETFs currently on the market.)
Investors are tripping over themselves, in other words, to pile into the most hyped stocks in the market.
Meanwhile, companies with no products and no sales, such as electric-vehicle maker Nikola (NKLA), are going to the moon. As our cofounder Bill Bonner put it last week…
The stock market – previously a place to discover the real values of America’s useful industries – is now a huge casino, like Las Vegas without the free drinks, where companies that might be worth zero are valued at billions of dollars.
Does that mean we’re in a bubble?
Today, we’ll look at what a bubble is… how to spot one… and whether we’re in one right now.
Then, later in the week, I’ll show you what you can do now to protect your nest egg without giving up on really moving the needle on your wealth with speculative bets.
The first was the tulip bulb mania in the Netherlands in the 1630s.
Prices for the recently introduced and highly fashionable tulip bulbs shot up twentyfold between November 1636 and February 1637 before plummeting 99% by May 1637.
In a bubble, valuations become unmoored from sales, profits, dividend payments, and other company fundamentals.
Investors focus solely on selling their investments to someone else for a higher price than they paid… rather than any rational assessment of value.
Economist Hyman Minsky called this the “Ponzi phase.” Even the slightest interruption of rising prices… or unexpected news… can bring the whole thing crashing down.
To really understand bubbles… I recommend you pick up a copy of Manias, Panics, and Crashes by economic historian Charles Kindleberger.
It covers bubbles throughout history… and why they happened. But if you don’t have the time, here’s the CliffsNotes version…
Every bubble leads to extreme valuations that eventually get so extreme they come crashing back to Earth.
To get to these extremes, there are two necessary conditions – easy money and an exciting narrative that will encourage people to invest.
There are hundreds of ways to value the stock market. One of the simplest is the price-to-sales (P/S) ratio.
It tells you how much investors are willing to pay for every dollar of a company’s sales. Sales are harder to fudge with accounting tricks than earnings are. So this gives you a fairly accurate picture of where valuations are.
And this picture shows current stock market valuations are back to dot-com bubble levels.
The chart above goes back to 1995. It looks at the P/S ratio for U.S. stock market bellwether the S&P 500 and for its information technology (IT) sector stocks.
By this measure, the broad S&P 500 is more expensive than it was during the dot-com bubble. The IT sector is almost as pricey as it was at the peak of that bubble in 2000.
The Senate just passed a $1.9 trillion stimulus bill… meaning it’s on its way to becoming law.
This comes on top of the $900 billion stimulus President Trump signed into law last December.
That’s just the fiscal – or government spending – side. Central banks are also doing their own version of stimulus – the monetary side.
In the six years following the Great Recession in 2008, the Fed added $3.6 trillion to its balance sheet. Since March 2020 – just one year ago – it’s added $3.3 trillion.
And Fed chief Jay Powell is saying he won’t stop the stimulus even if inflation rises above the normal target rate of 2%.
That means nobody’s going to tap the breaks on the monetary side, either…
This is creating one of the easiest-money environments of all time.
If you’re a Daily Cut regular, you’ll know I write about them a lot.
There’s the exponential growth in technology – most notably with 5G, artificial intelligence, self-driving cars, and gene editing.
There are exciting new ways for everyday investors like you to invest at the ground floor in these technologies. These ways include SPACs (special-purpose acquisition companies) and Regulation A+ private deals.
And there are new, transformative markets, such as crypto and cannabis, that didn’t exist a decade ago.
Here’s the thing… These are all genuinely great reasons to invest. But they’re also the kinds of transformative narratives that can lead to bubble behavior.
In the 1990s through the beginning of 2000, the tech-heavy Nasdaq rocketed 1,002%.
The narrative driving stock prices higher was simple. The internet was going to change the world and create trillions of dollars of wealth for investors.
The bubble peaked in March 2000. Then, it plunged as much as 77% over the next two and a half years.
But it didn’t plunge because the narrative was false. The internet did change the world and create trillions in wealth for investors.
The most valuable companies in the world today are tech companies. The five largest U.S. tech companies – Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), Google (GOOG), and Facebook (FB) – are worth a combined $7.4 trillion.
Stocks plunged because too many investors got too excited about a narrative that turned out to be true.
At least as Kindleberger defined one.
Are we in a time of easy money, with a lot of enticing narratives pulling investors into the market?
Yes.
Are valuations back to where they were… or above where they were… in the last bubble?
Yes.
Does that mean you should rush to sell all your stocks?
Absolutely not.
First, it’s never a good idea to be “all in” or “all out” of stocks in your portfolio. Instead, as I’ve been spreading the word on in these pages, you want to always play defense as well as offense in your portfolio.
That means owning assets, such as gold and cash, that do well in a crash… as well as investments such as stocks, SPACs, and cryptos, which allow you to capture gains on the upside.
Second, although we know we’re in a bubble, we have no idea how long it will last.
Some of the world’s smartest investors started sounding the warning on the dot-com bubble as early as 1995. But the Nasdaq averaged growth of about 42% a year from 1995 to 1999. And it rose 22% at the start of 2000 before it plunged.
I’ll have more for you later in the week on what that means for you as an investor right now…
Regards,
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Chris Lowe
March 8, 2021
Bray, Ireland