Economists sound the alarm on valuations as stock market approaches bursting point
THERE is no reason to believe that the global stock market will experience a major bust in the foreseeable future. The presence of a stock bubble, however, is crystal clear for all to see.
“Currently, we are going with the bullish flow, but we recognise the risk once (technical indicators) start to indicate deteriorating tape conditions and a worsening environment,” said strategists at research firm Ned Davis Research in a note to clients.
“We have yet to see the kind of excesses reached in 1999 and 2000, (which was) the culmination of the ‘irrational exuberance’ identified by (former US Federal Reserve chair) Alan Greenspan in 1996,” they added.
Most strategists concur, however, that “pockets” of the stock market are comparable to the extremes seen in 1999.
It’s clear that extreme situations have arisen in artificial-intelligence (AI) stocks and cryptocurrencies, areas where the parallels with the dotcom bubble are the strongest.
The likes of Nvidia, Palantir and MicroStrategy are trading like small caps, with all three roughly doubling in a matter of months, and Nvidia poised to become the world’s most valuable company in the coming weeks if it continues to gain momentum at the current rate.
Nvidia’s price chart is developing the same sort of “parabolic” shape evident on the charts of Amazon.com and Cisco Systems – two giants from the dotcom age. This is when the gradual increase on a stock-price chart from 2021 and 2022 starts to get steeper in 2023 before becoming a near perpendicular climb in 2024.
As a result, the valuation of these companies is astronomical, by many measures.
“The growth rate of Nvidia is also astronomically high,” said JD Joyce, president of Texas-based financial advisory Joyce Wealth Management. He added that the AI boom differs from the dotcom boom because the leaders are highly profitable.
“With investors trying to predict the future, it’s ultimately about earnings,” said Joyce, pointing to an exponential rate of quarter-to-quarter earnings growth over the last year as the main reason for Nvidia’s exponential stock gains.
“Currently, Nvidia seems to be the face of AI. If you look back over time, and you look who market leaders are in different segments of time, the sustained outperformance is not unusual.”
Amazon.com crashed in 2000 but it did eventually regain those improbable heights, albeit only more than a decade later.
Crypto and memes
In another landmark moment for the bubble watchers, Bitcoin prices recently eclipsed their previous heights. The cryptocurrency has yet to find a raison d’etre beyond being a speculative investment.
As with Nvidia, the market capitalisation of the digital coin has added roughly US$1 trillion in less than 12 months. Unlike the Nvidia situation, nothing palpable has changed in broad bitcoin dynamics.
No country in the world has followed El Salvador’s attempt to make Bitcoin a national currency, and businesses are still loathe to accept crypto as legal payment.
On the stock market, the most overvalued and highest risk securities are the “meme stocks”, firms whose valuations bear no discernible relationship to the underlying business.
These companies are, if anything, riskier than bets at the casino – because there are no rules to the meme game.
Trump Media & Technology, the parent company of former US president Donald Trump’s Truth Social social-media company, is valued at about 600 times its 2023 revenue of less than US$5 million, even after a crash of 30 per cent earlier this week.
Observers say that Trump Media may be the only multibillion-dollar company with a grimmer financial outlook than GameStop, the original meme stock.
The pool of investors for Trump Media overlaps with the group of users of Trump’s Twitter-like messaging service, which they are using instead of Reddit – the latter being where most meme traders assemble.
These investors are consciously mimicking the successful short squeeze that caused GameStop stocks to rise many-fold in 2021 before coming back down to earth in recent months. In this strategy, bullish traders target a stock where short-sellers have concentrated positions – such as GameStop and Trump Media.
The short-sellers may have a better fundamental argument. Truth Social has too few users and the number is not growing. People are now buying games online rather than going to the mall and renting them from GameStop stores.
But it’s much more expensive to bet against a company than it is to buy stocks in it. So the meme traders stage orchestrated buying raids, which push up the price of the stocks and generate unsustainable losses for the short-sellers.
To exit their trade, the short-sellers are forced to buy back shares, driving the price of the meme stocks yet higher, which generates another round of losses and emboldens the bulls.
Red flags
In the early stage of a stock-market bubble, the phenomenon is hidden from plain view. Then things start to get silly and veteran strategists start to wave the red flags. That’s where the market is right now.
Several prominent strategists are already sounding the alarm about valuations.
Paul Dietrich, an economist at brokerage B Riley, recently warned that the S&P 500 was “bizarrely overvalued”, given the fact that most economists were still calling for a slowdown of some kind, which would curtail earnings. Dietrich made the observation in a research note titled “The stock market bubble is about to burst – Watch out!”
The other Wall Street player working against the rally is Father Time. The bull market is about 17 months old, which is hardly ancient.
The nature of bubbles is that, the quicker they inflate, the less time they get before they eventually pop. The broad S&P 500 index rose 27 per cent in 2023 and is on pace to rise by a similar increment this year. Common sense suggests that it is bound to get tired by 2025 at the latest.
