Earlier, we covered different types of investors, rather market participants, in the U.S. financial markets such as 1) investors, which are rather risk managers and true investors 2) traders that trade based on the opportunities they see, generally short term 3) speculators/gamblers and lastly 4) uninformed/ignorants. As of late, a great majority of participants in the U.S. financial markets have ventured into the last two categories, knowingly or unknowingly.
In a way, it is also conceivable to collapse the other 2 categories outside of true investors and traders into one category – catch all, which includes speculators/gamblers and uninformed/ignorants.
What it means is that without any justifiable calculations of risk-reward ratios, it is simply a hogwash for the third and fourth category. Investors invest based on their calculations that make some sense to others. Traders invest based on some thesis, whether someone else agrees with it or not. Whereas for the other two categories, it is hard to come up with any rational investment thesis outside of it is either hot or someone else is doing it. Hence, it can be summed up as three categories as well for the investor types.
In terms of the asset classes, there are seven different types of asset classes or financial assets trading in markets including cash or cash equivalents such as follows: 1) equities, primarily known as stocks 2) fixed income, primarily known as bonds 3) real estate 4) commodities 5) alternative investments, includes private equity or private credit, new buzz word of late 6) cryptocurrencies and 7) cash or cash equivalents
Any amount of wealth needs to be generated and/or stored into one or more of the above asset classes where each one of them carries its pertinent risk profile and accordingly rewards or punishes the asset holder depending on the choice they made at the time of an investment. Depending on one’s asset class preference and risk appetite, one would invest in one or more of these asset classes. Clearly, the diversification is the key and well-balanced diversification using “super-diversifiers” strategy is the wisest choice one can make across many different asset classes.
As it is known in the investment world, well over 90% of the returns are pre-determined based on the asset class selection alone, let alone the individual components within any given asset class. What it means is that if we put 100% money into cash account then after let us say 50 years, a really long-term time horizon, the account grows only at the rate of low single digit percents. That may barely keep up with the inflation, at best, if not even under-perform the inflation rate.
On the other hand, if 100% of money is placed in the stock market (regardless of which stocks) for 50 years, one is bound to have returns in high single digits if not low double digit returns or even higher in spite of the major markets tantrums or even lost decades along the way. In reality, the returns can be anywhere in between these two ranges such as for the balanced portfolios as most folks tend to diversify across different asset classes and have different levels of risk appetite, patience and tolerance.
This brings us to the central theme of today’s topic: where we are really versus where should we be. We shall be investing in a generally well-functioning stock market barring its manic-depressive behaviors for short term time periods. What we normally do not see is that such manic-depressive time periods do not last long outside of some rare exceptions. Such is an exception scenario occurring right now and appears to have crossed all its prior limits, unfortunately, to surprise, shock and even greatly disappoint many investors of the current age in not-so-distant future.
Mr. Warren Buffett says that the market is a “voting machine” in a short run whereas it is a “weighing machine” in the long run. As a result, stock market rewards nicely for the wise decisions made by investors, yet at the same time, it can ruthlessly punish the investors who made unwise decisions. We have it seen it all – good, bad and ugly and it spares no one, really no one, as it is indiscriminate when it comes to whiplashing someone.
I vaguely remember in late 1990’s or early 2000’s that U.S. was dubbed as a “Prozac Nation” given its increasing rates of mental depression for the young adults in the society and looking back it seems no stretch at all. We all know what has transpired since then with the Opioid crisis. Now, the time has come to dub this nation as a “Casino Nation”, unfortunately, where most everyone wants to gamble away their future without much thinking.
Back to the asset classes…in terms of the size, the first four market types (stocks, bonds, real estate and commodities) are the largest in size in tune of approximately $50 to $80 trillion in terms of the market value whereas the other three asset classes (alternative investments, cryptocurrency and cash) are relatively small yet growing, in single digit trillions.
The global cryptocurrency market recently broke $4 trillion market value for what it is worth, a whole different discussion as it is about the alternate reality! Rather, it is the only asset class, where there is no inherent value assigned to the underlying asset as there is none. Hence, the investment legends Warren Buffet and his pal Charlie Munger dubbed it as a rat poison squared.
For stocks, one can assign some value based on its sales, earnings and cashflow and of course, the balance sheet strength – it is an ownership in the underlying business, hence it is called the equity. For bonds, one can assign the value based on its income stream, hence, it is called the fixed income. Ditto for the next three asset classes – real estate, commodities and alternative investments, there are underlying assets.
The next one is a trouble child – crypto. How do you assign a value to it? Other than simply a hope that someone else will pay more for it someday than what you paid for it. Between the two twin-horse engines of the crypto bandwagon – Bitcoin and Ethereum (aka ether), one can make some argument about ether at least being used for the block chain technology. However, for the Bitcoin or any other cryptocurrency, it is hard to conceive the need if not for the belief that the fiat currencies of the central governments are completely worthless and shall not exist or one fine day, we shall move away from the fiat currencies and adopt only the cryptocurrencies.
As an alternate, if the coexistence is required between the fiat currencies printed by the central banks of the world and crypto then again, the question arises, how do you value them? The dollar is still a dollar; euro is still a euro, so on and so forth. However, what is the value of a given cryptocurrency? How do we assign a value to it?
The last asset class, cash, is of course a solid store of value only gradually eroding with the not-so-small effects, even brutal, of inflation. It often is contrasted with gold, a commodity, which fantastically retains or stores the value in spite of any major effects of inflation.
Now, the heart of the matter…the speculative fever pitch has reached such extremes that it defies all odds and bluntly forces us into disbelief. The most recent stock mania, dot com bubble in late 90s and especially 1999 that burst in March 2000, seems like a child’s play now given what has gone on with the recent manic behavior of the investors. Just to do the basic math, it was about 25 years ago!
As a result of the current investors behavior, it is fair to characterize that our nation has turned into a nation of gamblers, gambling with their future without any regards to reality or history. History never repeats, though, it does rhyme for sure. A “greater fool theory” is in full vogue with most investors reveling in the delusion that they will come out of this unscathed and even well rewarded.
Little do they realize that they are playing with fire, one of the largest, if not THE largest, financial bubble in the modern history. To be more anecdotal, Mr. Jeremy Grantham, of GMO LLC, very large investment firm, opines that it is a super bubble or mother of all bubbles citing simultaneous occurrences of bubbles in multiple asset classes, not just one asset class. His warnings, now for quite some time, may sound like a broken record as they send alarms well ahead of times, though, such warnings if not heeded, can only bring one’s peril, if not a catastrophe.
As an example, the dot com bubble was a bubble in the stock market, only one asset class – stocks. Then came the housing bubble of 2000s, again, only one asset class, that burst in 2008 and yet wreaked the havoc in the stock market with 50% drawdown – from peak to trough. Meaning, that the bubble was only in one asset class category – housing yet, it decimated the stock portfolios. It took a giant economic rescue package named TARP by U.S. congress, close to trillion dollars, which was unthinkable at the time, yet it took close to a decade to come out of the hump for U.S.
All other asset classes except for one were mere foot notes in these two mega bubbles of 21st century. Fast forward to now and we find bubbles in multiple, I repeat, multiple, asset class categories – stock market, housing market and cryptocurrency market. Cryptocurrency market did not even exist in 2008 during the womb of this Great Recession of 2008 as it was later dubbed, which was a tomb of the prior housing mania of 2000 to 2007. In fact, the Bitcoin was born right in the thick of the financial market collapse, January, 2009, out of a sheer distrust of the central banks and fiat currencies.
It is entirely justified now that that Mr. Grantham is so much concerned about this as a mother of all bubbles due to its simultaneous occurrence.
Frankly, bonds were in a bubble category with the trend of steadily declining interest rates over the course of last 4 decades or 40 long years, only to get to near zero interest rate during the COVID time in 2020-21 and then start reversing the trend in 2022, which has for now settled in around 4-5% range, a lot more realistic range of interest rates or rather a “true price of money” than recent memories of most.
For bonds, that is not so much of a bubble category, though, the next stop for the interest rates is much more likely to hang out in the neighborhood of high single digits than hover around low single digits as some fanatics in the current presidential administration expects or rather demands with all their strong arming or even outright threatening of the independent body of Federal Reserve, which would have been completely unthinkable until recently in such a civilized society otherwise known as United States of America. Oh, well, that is yet another topic for some time in future. Low interest rates once again are only a pipedream that can hardly be fulfilled unless we steep so much into the depression.
Super low interest rates, near zero, is not something we shall aspire to have, either by means of depression or to unleash the inflation like what we have done in our very recent memory – 2021-22. Central banks and countries in the advanced economies (read U.S. and Europe) have already paid a huge price for it and we need not pay more any longer. There shall be a fair price of money (i.e. interest rates), whatever the market sets (such as above or below 5%), not the price that the central banks determine via market manipulation only to accomplish the wealth transfer from the poor and middle class to rich and privileged.
Rather, high single digit interest rates may become justified by the interest rate markets and well prevail not only to cure the excesses of the last 40 years in terms of the fiscal debt and deficits, though, even more importantly to pay for the sheer suicidal steps of tariffs, which are nothing but the self-inflicted wounds as of late out of sheer stupidities and whims of our current president surrounded by sycophants. There is no limit to the greed and number of bootlickers in this day and age that it is so hard to believe our own eyes and certainly not in this “once-so-civilized” society.
Like Mahatma Gandhi said: “There is enough for everyone’s need, though, not enough for one person’s greed”.
What it means is that this will be a third bubble to burst in a very short span – the early part of the 21st century – 2000, 2008 and now counting as to when exactly – completely unprecedented in the U.S. financial markets. It is not a question of ‘if’, it is only a question of ‘when’ the third bubble of modern history will burst. Imagine the amount of pain all investors including the young adults and soon to be retirees may have to go through who have made big dreams about the retirement, all in about less than 3 decades or their typical investment time horizon as discussed in a previous post.
Imagine again… getting hit by the lightening, not once, not twice, but thrice in a very short time. Highly improbable, correct? Yet, it may well unveil just that way – same as before, bringing catastrophic consequences to the economy and peoples’ lives. We can only hope that it does not happen. So, let us hope for the best, yet prepare for the worst.
Up next in a future post, we can address the root cause of this bubble – artificial intelligence (AI). At a high level for now, we all know that AI is real, though, few know that the expectations are unreal. It is a gold rush and for the right reasons there is a need for the picks and shovels to mine the gold, though, what is missing is that there is not an unlimited need for that. Nvidia (NVDA) and Tesla (TSLA) are the poster children for this recent bubble that was kicked off by top technology stocks otherwise known as Magnificent Seven (Mag 7) back in 2021. We need not even delve into the meme stocks by discounting it as a side-show for fun!
In case, if you are still wondering and/or not following the markets closely, here is the list of Mag 7 stocks:
- Alphabet (GOOG and GOOGL)
- Amazon (AMZN)
- Apple (AAPL)
- Meta Platforms (META)
- Microsoft (MSFT)
- Nvidia (NVDA)
- Tesla (TSLA)
What is truly surprising that this bubble has lasted this long! Though, to be fair, even the dot com mania lasted several years thru mid to late 1990s, only culminating into its feverish pitch in 1999 later to burst in March of 2000.
Basically, current market is completely unhinged and may fall off the precipitous cliff anytime now as it has done so historically during times like these. Bigger the bubble, worse it gets later. The following quote is generally attributed, though (not confirmed) to the famous British economist John Maynard Keynes: “Markets can remain irrational longer than you can remain solvent”.
Hence, the bottom line is that this is not a place for the wise investors’ playground anymore. It is a high time to take the timeout and take some rest. It is much wiser to cede the playground to the fools and greedy ones out there to see their games playout however way it does. The market has gradually morphed from ‘excited’ to ‘broken’ to ‘sick’ to ‘needing surgery’ category in recent years that unless and until the patient has had a transformative surgery to cure the illness, the “hijacked” market will remain the domain of fool’s grounds or giant casino.
Institutional investors at the cost of retail investors are happy to oblige and they deserve equal amount of blame as an uninformed investor. They should know better, yet they do not. Such is the saga of this day and age.
How exactly we can say that we are near the top if not at the top? That is due to multiple factors as outlined in the previous posts and most importantly, the “mega moves” in stocks. The “alley of successful stocks” is getting smaller and smaller or rather narrower and narrower. Hence, the rise of stocks in 2023 and 2024 was not about the broader market participation of S&P 500 constituents, rather, it was about Mag 7 only, which means “Excluding S&P 493”. Now, even Nvidia fails to lift the market with its earnings results. That has been the phenomenon for last couple quarters. A classic sign of top! When general stops marching, the foot soldiers can go only so far in a war zone.
Above all, the investors are so fidgety that the big swings in certain stock prices or wild gyrations of even 20% to 40% in a day is a common occurrence now which was unthinkable before for the large cap or mega stocks. Such behavior was captive to only small and speculative stocks. It shows how fidgety the market participants are!
The moment someone yells a fire, let alone the actual fire in an uncharacteristically crowded nightclub, aka stock market, where everyone is having so much fun and party like there is no tomorrow, will try to exit out at the same time using a single skinny door then we can easily imagine the tragedy that may ensue with the crowd behavior. Large moves of 30-50% for certain large stocks will not be a stretch of an imagination. We already got a very good glimpse of it all post the so called “Liberation Day”, April 2, 2025 in a matter of few days. This is exactly the psyche of a casino investor, not a cold, calculative and rational investor!
