Storm in the Midst of Calm
In a prior report, we suggested that a crowded boat may serve as a metaphor for the stock market. If the crowd becomes too enthralled by the starboard view and moves all together to that side, the boat is likely to capsize.
During this past quarter, the crowd began to move all to one side, but each time pulled back. The boat was then able to stabilize. This happened repeatedly during the quarter. Each time a dunking was averted….
While markets as measured by indexes seemed calm, there was tremendous intra- market turbulence. During the last quarter, there were a record number of 10% daily moves for individual S&P 500 stocks. On June 13, the NASDAQ 100 rose 0.57% despite 70% of the index names falling.
On days like this, it seemed that Nvidia, whose market cap rose a trillion dollars in only 23 days before losing $700 billion over the next three days, Apple, which continued up despite Chinese and antitrust problems, and an occasional company like Costco, with a 53X earnings multiple despite only a 10% growth rate, were all that held the market indexes up. For the year to date, the bottom half of the S&P 500 has not advanced at all.
Within the “magnificent seven,” even Tesla careened wildly. Year to date it lost over 28%, but then in only seven days through July 3 got it all back.
There were other hints of trouble even in the index returns. By May, the capitalization weighted S&P 500, led by the big winners, had still not outperformed treasury bills since its 2022 high or reclaimed its inflation-adjusted high, although it had reached numerical new highs. For the quarter, long-term treasury bonds earned a minus 3% and gold rose over 4%, more than the S&P 500.
The NASDAQ 100 did well, but recall the math of investing as illustrated by the NASDAQ return around the end of the dot-com bubble in 2000. Having risen 300%, the index then collapsed. Even buying exactly at the moment the index started to rise 300% would not have prevented a subsequent wipe out. Nvidia company executives are currently selling.
Looking beneath the largely reassuring index return numbers, we see the following:
Valuations
At a recent Berkshire Hathaway meeting, Warren Buffett was asked about his $188 billion cash hoard, which he said would probably rise soon to $200 billion. He commented: “We’d love to spend it, but we won’t spend unless we think there really [is] something that has very little risk and can make us a lot of money. I don’t mind at all under current conditions, building the cash position. When I look at the alternatives, what’s available in equity markets and the composition of what’s going on in the world, we find it quite attractive . . .” He did not mention that his favorite valuation measure, market value to GDP, is also now at an all-time high.
Can markets climb even further when they have reached today’s level? They never have in the U.S., but they did in Japan during the late 1980’s bubble there. That bubble actually survived for another two years. On the other hand, after the final collapse, it took thirty-five years for the Japanese market to return to a new high. That is a long time in investment “purgatory.”
Insiders
Only 12% of company executives are currently net buyers.
Supply/Demand/Sentiment
The single most reliable indicator of market vulnerability historically has been the % commitment of individual investors to stocks. Now 42%, this is also an all-time high.
Earnings
Corporate earnings are also at all-time highs, much higher than earlier market peaks such as 1929, 1973, 2000, and 2008. We thus have record multiples on record earnings. This can be contrasted to 1982 when we had the opposite: record low multiples on record low earnings. Following that, the S&P 500 nearly tripled in only seven years.
Concentration
By any measure, the U.S. market is remarkably concentrated. The top ten stocks represent 37% of the S&P 500, a new record. Only three stocks, Nvidia, Apple, and Microsoft, represent 20%. There have been times when a highly concentrated market has broadened rather than fallen apart. This happened last week and could continue, at least for a time.
Economy
We avoid forecasting the economy and instead concentrate more on corporate earnings. It is worth noting, however, that an inverted yield curve and weak leading indicators had previously been contradicted by employment figures, but no longer.
Debt
The underlying problem for China, Japan, and the U.S. is that growth built on debt is not sustainable. Eventually the growth per unit of debt declines to negative while interest payments continue or get worse. Attempts to stimulate the economy through deficit spending or lowering interest rates thus eventually just create even more debt without growth to show for it.
Conclusion
In the past bubbles fooled people because they were so rare. Now they fool people because they have become so common they seem normal. Either way the result is the same: they do not end well. This in turn just creates opportunities.
WRITTEN BY:
HUNTER LEWIS | CHIEF INVESTMENT OFFICER
Hunter Lewis is Chief Investment Officer of Hunter Lewis LLC, as well as a co-founder and former CEO of global investment firm Cambridge Associates. Learn more about Hunter Lewis.