The Bubble Has Burst, But It's Not Over Yet
History might be the biggest risk to this market, but there are still reasons to stay invested
I don't believe the market can be consistently timed. But the market can be occasionally timed. At ultimate peaks, the insanity is obvious. Here’s an incredible table from an updated version of Jeremy Siegel’s Stocks For The Long Run, highlighting the craziness at the 2000 peak:
Anyone in that market with any sort of training or experience knew the end was nigh. What catalyzed it for me personally was a conversation with a relative on Christmas Eve 1999, in which he told me he had purchased a material amount of stock in a supposed Internet company called BigHub.com. And though I didn't know that BigHub was a penny stock promotion taking advantage of precisely this kind of investor, it was clear at that point that there (almost literally) was no one left to buy Internet stocks.
It was clear, certainly in my North Carolina town, that in 2006-2007 the housing market had gone nuts. Houses were being resold for 30% or 40% profit within months and house “flipping” was a national obsession. In mid-2006, a group of awful condos built around the corner listed for more than our home was purchased for. Once again, there seemed to be no possible buyers left, at least at the price points being asked.
And it was obvious in the fourth quarter of 2020 and the first quarter of 2021 that retail-favorite growth stocks had become disconnected from reality and valuation. In retrospect, it might have been the official announcement on Feb. 23, 2021 of the merger between Churchill Capital IV and Lucid Motors (LCID) that marked the top. The rally in what was then CCIV stock, which followed accurate reporting on the merger valuation, was best explained, and likely only explained, by the fact that buyers that day literally didn’t understand how SPAC mergers worked.
In some respects, the bubble that started in Q4 2020 has popped. In many others, it’s still going.
It’s Really Been A Stupid Market
I tweeted this earlier this month, and it's bothered me ever since. The tweet almost certainly is not incorrect, but it is incomplete.
We are seeing an insane amount of graft in this market, certainly. But that's not a surprise in a bull market. Add on the sheer lack of anything to do for much of 2020, and (depending on your persuasion) interest rates at zero, and it's not surprising that scammers are feasting.
But it might be more true that what many of us — again, myself included — have not quite appreciated is the unbelievable amount of stupidity that has dominated this market, particularly over the last 25 months.
Dogecoin, created as a joke, hit a peak market capitalization of $100 billion. (The very idea that a crypto has a "market capitalization" itself could be considered inane.) The SPAC bubble was littered with ideas that made no logical sense, with Lottery.com (LTRY) being one of my favorite examples. (Long story short, LTRY pitched itself as a play on the growth of online lottery services, when in fact it simply resells lottery tickets online at massive markups to customers attracted through an enormous affiliate network. In a wonderful echo of the 1990s, LTRY bought a domain name to supposedly take advantage of online sports betting growth as well. The stock peaked at $16+ post-close and remains overvalued at $3.50.)
Retail investors didn't care to understand the economics of sports betting, the nature of the electric vehicle market, or the multi-decade history of failure at green energy plays like Plug Power (PLUG) and FuelCell Energy (FCEL). During the “meme stock” craze, they piled into not just weak, but ridiculous businesses: failing chains, an Australian lingerie concern (because its ticker was ‘NAKD’, natch), a micro-cap headphone manufacturer.
The fundamental errors across the market (to be fair, hardly limited to retail investors) stem from rather garden-variety bubble behavior. But the last two years have added something else — a staggering sense of arrogance and importance. Investors in the 1999 equity market or the 2005 real estate market thought making money was easy — but not necessarily that they were smarter than the professionals. (To be fair, in both cases many of the professionals were egging them on.)
To coin a phrase, this time has been different. A struggling, unprofitable movie theater chain has roughly 4 million retail shareholders based on a conspiracy theory that is insane by the standards of conspiracy theories. Assume that base is roughly two-thirds US (and the figure is probably higher); that means that more than 2% of US households own AMC stock despite there being literally zero fundamental case of any kind. So committed are the ‘apes’ that AMC is now renting out its meme-ness.
There are, still, thousands of Twitter accounts dedicated to "trading" the market, based on at best a perfunctory understanding of that market. Combined, those accounts have probably three years of professional experience, $3 million in total bankroll, and somehow millions of unique followers. Reddit’s investing forums are a staggering cesspool of ignorance and groupthink (the platform’s algorithms literally keep contrarian views out), yet those forums have become so powerful that institutions actually are tracking them.
Crypto enthusiasts and Tesla ‘stans’ aren't just content to make money. They need to claim to be a part of a world-changing mission at the same time. NFTs are the apotheosis of the "greater fool theory," and almost proudly so. Web3 not only is looking to normalize Ponzi schemes, but to turn customers into owners.
Across the board, there is a staggering sense of entitlement. Early adopter of an online platform? Well, not only should you get to enjoy the service you've found, but you should get paid for your time (and your ‘likes’). Read about Bitcoin on a Reddit forum? You're set to profit.
Your stock goes up? Tell your Twitter followers you're a genius. It goes down? Must have been hedge fund manipulation. After all, whether it's equities, crypto, options, or just using a product, the profits should be easy.
Where’s The Bottom?
Admittedly, this may just all be an old man yelling at the cloud. After all, there were message boards full of nonsense in 1999, too.
But there does seem to be a layer on top of the usual bubbly behavior, and that can't be ignored right now. After all, market history teaches us two lessons.
The first is that a bottom can't be reached until the novices are run off, properly chastened. (Yes, that’s an incredibly condescending point, and an unfortunate one as well. I stand by it regardless.) Housing didn't bottom until the house-flipping shows were off television. Gold didn't bottom last decade until the "We Buy Gold" sign-spinners left their corners and the constant drumbeat of TV ads petered out. After the plunge from the 2000 NASDAQ top, equities didn't reverse until CNBC ratings hit the lows (and stocks peaked again when those ratings did the same in 2007).
Right now, the novices aren't gone. They sure as @#$@$! aren’t properly chastened. They're still on Twitter and in AMC Entertainment (AMC) and GameStop (GME) and "HODLing" their inane cryptos. Indeed, Robinhood (HOOD) is expanding trading hours to capture on precisely this demand. On the announcement, HOOD stock gained 24% on Tuesday, adding ~$2.6 billion in market cap in the process. That rally itself shows much power novices retain: the news shouldn’t have resulted in any gains, given that Robinhood said in late January that expanded hours were on the way this quarter.
The second lesson is that it's exceptionally difficult to avoid the impact of those novices. The stocks they favor will bring down the rest of the market. The S&P 500 was almost exactly halved from its March 2000 high to its 2002 low. That's despite the fact that the poster children for the late 1990s bull run were not in that index.
And if we’re close to a top, it could be a long way down. Before falling ~50%, the S&P 500 rose 582% from the October 1987 low to the March 2000 high, a timespan of twelve and a half years. From the March 2009 bottom to the January 2022 high, the S&P climbed 609% in just under thirteen years. History has essentially repeated on the way up, and it will be ugly if it does so again on the way down.
In short, I don't believe this market is at a bottom — or even ready to bottom. Like many experienced investors, I see a real risk of a sharp plunge over the next 12-24 months. I'm actually far more sanguine than most about the obvious risks. There is some kind of transitory effect underpinning scary inflation numbers; the 10-year Treasury has moved sharply but still yields just 2.5%, roughly where it was before the pandemic; Russia is losing; and elevated mid-term oil prices rely on discipline from drillers, something history tells us simply won’t last.
But those risks certainly are real. The lessons of history, at least in my opinion, are scarier.
Staying Invested — And Cautious
Admittedly, this seems like terrible sentiment ahead of the launch of an investing Substack. But there are some mitigating factors in terms of the forward outlook for US equities, and some reasons why it's still worth looking closely for long ideas as well as short trades.
First, it is worth noting that "the market", as far as many retail investors are concerned, has crashed. The ARK Innovation ETF (ARKK) is as good a proxy for those portfolios as any, and it's down ~56% from last year's peak. Dogecoin is off more than 80%; many fad-driven altcoins have for all intents and purposes disappeared. EV stocks, sports betting plays, de-SPACs...most of the retail favorites have been significantly re-priced. Some of that garbage is no doubt still too expensive, but the bubble at the very least has significantly deflated.
Second, it’s dangerous to compare this environment to anything in the past, whether in terms of investments or anything else. These are unprecedented times, at least by modern standards. Many of the novice investors are going to exit simply because they have other things to do and/or offices to which to return. It’s possible that the damage of the retail bubble remains roughly contained. Indeed, the bubble has been deflating for more than a year now, yet, as I write this, the S&P 500 is up 17% over the past twelve months.
Third, this analysis admittedly isn't exactly detailed, or quantitative. This discussion is to some degree just the apocryphal taxi cab driver with an anti-social media rant thrown in. And let’s be honest: these kind of “things you only see at the top” have been around for years. It certainly felt like the busted IPO from WeWork (WE) in September 2019 might signal the end of demand for growth at any price. There was another ~18 months to go.
There's a vast oversimplification in this analysis. And, indeed, the same simplification can be used to underpin a contrarian case for being bullish, simply because it’s so easy to be bearish. This still ‘feels’ like a market at the top, while Ukraine + Fed + politics + whatever combine to create a more logical, realistic case for a crash. Indeed, the snapback rally in equities over the past two weeks seems to have been greeted with near-universal skepticism and designated as a “dead cat bounce”.
Fourth, non-garbage stocks have been impressively resilient. At the moment, the S&P 500 is down less than 5% from its highs despite the myriad short-term reasons to sell. (Even the Russell 2000 isn’t technically in a bear market, off ~15% from its top.) It's certainly possible that the TINA (There Is No Alternative) catalyst is holding, and will until bond yields normalize. But it's also possible that there's enough quality in US stocks, in particular, from a long-term perspective that investors are more willing to ride out short- to mid-term storms.
Finally, and most importantly, even in a bear market, there is value to be found. For a few years, from a fundamental perspective it's been legitimately difficult to even find good ideas to start due diligence on, let alone take a position in. The best businesses were too expensive; the cheap stocks were usually junky companies.
There are more opportunities now, without question. There are going to be a few multi-baggers undeservedly pulled down by the wreckage in tech subsectors. There are going to be enormously profitable shorts in energy names (come on, are you really telling me this time is different?) and in stocks whose fair value has not yet been "priced in" even by massive declines from past highs. And there are good businesses that are 10% or 20% cheaper — a price reduction that matters when looking to compound value over time.
Certainly, long ideas right now may well have catalyst problems, or they may simply prove to be too early. But from a long-term perspective, being early in 2001 or in the beginning of 2008 was not a bad thing. And there are strategies — dollar-cost averaging or using options at a time of elevated volatility — that can mitigate some of the timing risk here.
It's also possible to get market-neutral or even net short; it's definitely not too late to short many of the garbage names, even well off the lows. There are dozens of currently publicly-traded stocks that are going to zero, and the cooling of the meme stock/short squeeze trend seems to mitigate some of the trading risk in those names.
So personally, I'm not taking my ball and going home until 2024. I don't recommend investors do so, either. But this does seem like a time to still to be cautious, to nibble on quality instead of betting aggressively on a market-wide bottom. That sense is going to inform the ideas we bring you and the strategies we recommend. As nervous as we are about the market, we’re excited to bring you the first of these ideas on Sunday morning.