What Will Pop This Market Bubble?

Have you noticed that, no matter what happens, the markets seem to keep going up?

The S&P 500, Dow, and Nasdaq hit all time highs in February 2021, despite the precarious state of the U.S. economy.

The Nikkei just passed 30,000 for the first time in more than 30 years.

All of this is happening as infections and deaths from SARS-2 hit all-time highs as well, with no end of the pandemic coming for months, years, or possibly ever…

The economy, too, currently seems to be held together by shoelaces and bubblegum (by which I mean: the situation seems precarious and untenable). 

A new report by the Federal Reserve reports that consumer debt just hit $14.6 trillion, pushed by a record-breaking rise for mortgages in the housing market.

Motivated by historically low interest rates, mortgage debt passed $10 trillion for the first time and rose at the fastest pace in the fourth quarter since 2006.

(Astute readers will recall that a housing market and mortgage bubble triggered the Great Recession in 2008.)

Government debt is exploding, too, and so are projections.

Right now, the Congressional Budget Office is predicting that U.S. government debt will hit 107% of GDP by 2031, the highest it has ever been…

At the same time that consumers and the government are loading up on debt, the chairman of the Federal Reserve just announced that U.S. unemployment figures are wrong.

The official, published U.S. unemployment rate for January 2021 was 6.3%.

But according to the Federal Reserve Chairman, Jerome Powell, the true unemployment rate is closer to 10%.

Here’s how Powell explained the discrepancy: 

“Published unemployment rates during Covid have dramatically understated the deterioration in the labor market… Fear of the virus and the disappearance of employment opportunities in the sectors most affected by it, such as restaurants, hotels, and entertainment venues, have led many to withdraw from the workforce. At the same time, virtual schooling has forced many parents to leave the work force to provide all-day care for their children. All told, nearly 5 million people say the pandemic prevented them from looking for work in January.”

The recovery is uneven across society, and the damage sustained by certain markets during the pandemic and quarantines is not repairing quickly or at all. 

For that reason, the labor market is not expected to reach its pre-pandemic size until 2024.

Simply put, U.S. citizens have more debt than ever before…

And an enormous number of them don’t have a source of income… or any immediate prospect of getting a source of income.

In addition to that, an abundance of government cash printing (i.e., “liquidity”), a strong appetite for speculative risk, and a “fear of missing out” has combined to fuel asset bubbles. 

Because of government stimulus resulting from the SARS-2 pandemic, the supply of money in the economy relative to inflation has been exploding. 

[Inflation is an estimate of the purchasing power lost in a given currency. The higher the inflation, the less someone can buy in a market.]

Just look at this chart comparing the growth of money supply in the U.S. economy compared to the rate of inflation:

As you can see, the amount of money in the U.S. economy has increased 25% over the past year… over 2.5 times any other point in the last 30 years. 

Many economists love to scream about how printing money always leads to inflation…

But as you can see above, money supply and inflation seem uncorrelated. 

This is just one of many things economists get consistently wrong because economics is largely an unscientific discipline and inflation is very poorly understood.

However, there is one thing a lot of free money tends to inflate… 

Asset prices. 

If you want to find unsustainable hyperinflation in the economy, one only needs to look at U.S. tech stocks, cryptocurrencies, and margin debt that’s leading to the speculative frenzies that have been hitting the market recently.

Valuations are at 1998 dot-com bubble levels in some tech names, while the broader markets are consistently trading near all-time highs.

But we’ve been in a similar situation recently…

In the May 2020 issue, I described the phenomenon commonly called “disconnected markets.”

One way to understand this phenomenon is with the adage: “The stock market is not the economy. And the economy is not the stock market.”

What that means is: economic data tells us little to nothing about what will happen in the stock market in the future.

And the stock market’s performance tells us little to nothing about what will happen in the overall economy.

This is nothing new. 

Just consider the recession of the early 1980s. In 1982, the U.S. unemployment rate started high and finished higher. It entered the year at 8.6% and concluded at 10.8%, its highest level since the Great Depression (until 2020).

Not only was unemployment rising, but seasonally adjusted gross domestic product fell every quarter of 1982.

But despite all this bad economic data…

The S&P 500 gained 21.6% in 1982, well above its average.

No matter what timeframe, dataset, or stock indices one looks at… there is little to no correlation between U.S. economic numbers and stock market returns.

So why is the stock market doing so well right now?

This answer is pretty simple…

The value of stocks really only measures one thing…

Whether investors (especially big institutions) are buying or selling.

That’s it. 

When big banks and hedge funds and investors think they can get better returns elsewhere, they sell stocks. 

When they think stocks (“equities”) have the best risk/reward proposition, they buy stocks.

Large amounts of selling drives prices down; large amounts of buying drive prices up.

And right now, financial institutions and retail investors keep buying, which means the asset bubble keeps inflating.

Because of economic setbacks, the ongoing threat of SARS-2, the explosion of debt, and the inflation of an enormous asset bubble…

All signs are pointing to the overall stock market having a dismal decade. 

Take a look at this chart below:

Each of these different indicators are used to predict bubbles in the stock market…

And they do that by comparing certain financial metrics and seeing how well they predicted stock market performance over the following 10 years. 

As you can see in the chart above, no matter what indicator you look at, it’s statistically unlikely that we’ll see the S&P 500 return 5% or more per year for the next 10 years.

In fact, with levels being what they are, in all likelihood we’ll see the market decline over the next decade. 

I’m currently writing a book called “The Dead Decade” about the dismal economic situation we’re facing, and the few small pockets of the market likely to experience growth despite it.

But longtime readers should already be familiar with all this…

There is often huge variability between the performance predicted by valuation indicators and the actual returns. 

For example, in 2009, the CAPE ratio (one of the indicators in the chart above) predicted that the market would return about 10% per year on average between 2009 and 2010. But the market actually returned 15%. 

That means the CAPE model was inaccurate by about 50%. 

Why the difference?

Because the CAPE doesn’t account for innovation. It also doesn’t account for the historically low interest rates we’ve been seeing for the last decade. And it also doesn’t account for the supply-and-demand for stock investments — the thing that actually determines stock prices.

The important takeaway here has to do with having an “opportunistic mindset.”

Let me give you an example of what I mean…

I recommended financial technology company StoneCo (STNE) to subscribers when almost everyone in the media was still crying doom and gloom about financial companies due to Covid.

Readers who bought then recently sold out at a 72.99% gain in a matter of months.

Why was I able to find these great stocks while everyone was panicking?

Because while the financial news was telling one story, I was looking at the actual data…

The key is to be greedy when others are fearful and fearful when others are greedy.  

And these are only a couple examples.

I also recommended readers buy Construction Road Partners (ROAD), CRISPR Therapeutics (CRSP), and Editas Medicine (EDIT) during the pandemic. Readers recently sold those at gains of 53.31%, 127.37%, and 190.53%, respectively.

Did you invest in these stocks or any of the other winning picks I’ve made since the pandemic began?

I hope so. 

This is what I’m talking about when I talk about having the right investing mindset…

Even in a bubble, even in dangerous economic conditions, there are fantastic, safe long-term opportunities you can capture.

I’m hoping you take this advice seriously… especially while things are looking scary in the economy and the market.