This is the most exciting time in the market that I’ve ever lived through. I realize these words may sound deeply insensitive and at odds with what’s happening in our country. The fact that financial markets don’t respond the way you think they should is a different topic for a different day. Today I want to talk about the exuberance that we’re witnessing on a daily basis.
I don’t think the stock market is in a bubble, but speculation is running rampant.
I don’t think the stock market is in a bubble, but it’s surrounded by them.
How do these seemingly contradictory statements make any sense? I’ll come back to this in a minute.
When speculation is running rampant, as I believe it currently is, people stop thinking about the future and only think about today. Theoretically, stock buyers are purchasing the discounted cash flows of the underlying business. In reality, when speculation is running rampant, it doesn’t matter what the business might be worth in ten years. What matters is what somebody is willing to pay for the shares today and tomorrow.
The higher prices go, the more eager people are to buy. The more eager people are to buy, the higher prices go. And the higher prices go, the more eager people are to buy.
Last week, SoFi announced it is going public through one of Chamath Palihapitiya’s SPACs, IPOE. Shares immediately rocketed higher and gained 58% by the end of the day. Which, okay, if Doordash can gain 80% on its first day, then I guess the SoFi pop makes sense.
But what do we make of IPOD, another one of Chamath’s SPACs that is still looking for a target? That gained 13% on the same day that the SoFi deal was announced. Or what about IPOF, another one of his empty SPACs that gained 21% in the two days following the SoFi deal? This doesn’t make any sense in a textbook, but it makes perfect sense in the real world. Chamath has had the golden touch, and people are responding rationally to that.
On that same day, Elon Musk tweeted, “Use Signal.” Signal Advance, a tiny stock with a market cap of $6.3 million on the day before, gained 525% that day. The next day it gained another 90%. Here’s the kicker. The stock, Signal Advance, was not the company Musk was referring to. Complete silly town.
This one makes no sense, but weird things happen with tiny companies, and we’ve seen shit like this before. And that would be cool if the madness were isolated to a few tiny companies, but um, Tesla added $165 billion in market cap in the first 5 trading days of 2021. That needs no context, but I’ll give you some anyway. How many stocks in the S&P 500 have a larger market cap than what Tesla added in 5 days? 44. That’s it.
This morning I was thinking about the environment we’re in. As a relatively young person, I’ve never experienced anything like it. So how can I say with a straight face that the stock market isn’t in a bubble? First of all, Tesla isn’t the market. Neither are SPACs. The market is the S&P 500.
The S&P 500 is rising, but not at the level that would normally be associated with “bubble,” a word that gets used way too frequently. A bubble is when investor behavior and fundamentals become completely detached from reality, all but ensuring the bubble’s popping.
Let’s look at behavior, or price. The stock market is not going parabolic. The S&P 500 is up 3.6% over the last 30 days, which is in the 76th percentile going back to 1950. Warm? Sure. Hot? Not really.
A quick look at fundamentals also doesn’t support the bubble argument. At 33x earnings, you could make the case that there is froth in the top 10 stocks. I wouldn’t argue.
But what about the other 490 companies whose stocks trade at 19.7x earnings? Cheap? No. Bubble? Come on.
There is exuberance in certain areas of the market. There can be no denying it. So the question is, how long can this go on before it infects the overall market? Actually, this might be backwards. I think some of the froth in the top 10 names, given their size, are causing all of the exuberance that we’re seeing. There is reflexivity at work, circular relationships that are causing a feedback loop.
In my opinion, there is not a bubble in the index, but there are bubbles inside of it and around it, which are being caused by froth at the top of the index itself.
Apple, Microsoft, Amazon, and Google are worth $6 trillion. It wouldn’t take much money coming out of these names to inflate other areas of the market that are tiny in comparison, even if they are 10 figures.
I can’t help but think that the retail crowd is playing a bigger role than I initially thought. I was with Nick Maggiulli, who showed that they’re not moving the biggest names. Maybe they’re not moving Apple, but given that they’re now 20% of the daily volume, and their tendency to herd, it would be naive to think they’re not having an impact.
So what do we do with this? I wish I had an answer. I don’t know where this goes. Nobody does. It’s already lasted longer than I thought it would.
Two pieces of advice that work now and work always are this. If you’re going to join the party, and full disclosure I am, then keep your positions small.* If the party continues, you might kick yourself for not owning more. But that’s a small price to pay should the party end tomorrow.
The other thing you should do, today and always, is put yourself in a position to hang on to the bull and hold on for the bear. Survival is the name of the game.
*I own 12 shares of AirBnB, 14 shares of CrowdStrike, 41 shares of DraftKings, 156 shares of OpenDoor, 13 shares of Peloton, and 8 shares of Snow. I realize that I’m fortunate when I say these stocks have no material impact on my life or my financial well-being.