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last month exactly 25 years after predicting the dotcom bubble Howard marks posted a new warning to investors this new memo is trying to answer the question that's on every Investor's mind are we in an AI bubble and to answer we'll Define what a stock market bubble is why it appears and what to do when a potention bubble is brewing in recent years a small number of stocks dominated the S&P 500 and have been responsible for a disproportionate share of its gains the market capitalization of the seven largest components of the S&P 500 represented 33% of the index prior to the Magnificent 7 the highest share for the top seven stocks was 22% in 2000 at the height of the internet bubble it's also important to note that at the end of November 2024 US Stocks represented More than 70% of the MSI World index it is clear that us companies are worth more compared to their peers from the rest of the world but are they in a bubble since bubbles always start in Bull markets Howard marks lat is out the three stages of a bull market a bull market starts when the market is recovering on the hills of a decline here only insightful people can predict the improvements ahead then the second stage is when markets are doing well and most people see the economic improvements and join the stock market lastly the third stage is when companies are doing well earnings and stocks are growing and everyone believes that things can only get better and if everyone believes things can only get better the good news will be priced in and it becomes difficult to find undervalued stocks so Howard Marx argues that bubbles are characterized by Bubble thinking you know psychology is by far the dominant influence on investing in the short run it has very little to do in the short run with fundamentals and this is obvious from the widespread participation in the investment fed of the moment especially from nonfinancial individuals that a bubble is not a period of rising prices it's a period of temporary insanity to me the important thing is not the stretch valuations it's how they got there and it's through this loss of objectivity but what could get investors to a point where they're not thinking clearly anymore and they're willing to risk their hard-earned money money the thing that makes investors lose their composure is new developments this is why the phrase this time is different often appears and that's how investors could get away with crazy valuations there's no history so there's nothing to temper the enthusiasm but the problem is that all the bubbles in recent history involved Innovations which were either overestimated or not fully understood for instance in 1999 investors were sure that the internet will change the world and eventually the internet did change the world so usually there is a grain of truth that underlines every Mania it is just that it is taken way too far so after witnessing the biggest bubbles in history Howard Marx came with a few guiding principles that carried him to the next 50 years firstly it's not what you buy is what you pay that counts the price of what you pay for a stock matters for instance if you bought Tesla in 2021 even if it is a great company right now you would make a profit of 0% in 4 years lastly there's no asset so good that it can become overpriced and there are few assets so bad that they can't get cheap enough to be a bargain meaning don't buy something just because it's cheap it can always get cheaper now that we know his guiding principles let's see his predictions for 2025 when looking forward at 2025 Howard Mark sites a code that guided him through his investing career when investors forget that corporate profits grow about 7% per year they tend to get into trouble if corporate profits grow at 7% per year and stocks appreciate at 20% eventually stocks will be so highly priced relative to their earnings that the risk will be very high actually there were only four times in the history of the S&P 500 when it returned 20% or more for 2 years in a row in three of these instances the index declined in the next two years and in the last two years it's happened for the fifth time with the S&P 500 up 26% in 2023 and 25% in 2024 for the best 2year stretch since 1997 that is why Howard Marx issued some cautionary advices for 2025 he argues that the optimism has prevailed since 2022 with large enthusiasm for AI moreover there's a belief that the top seven companies will continue to be successful moreover as a side note Howard marks Wars about Bitcoin and the fact that its price Rose 465 per in the last two years doesn't suggest an overabundance of caution lastly he presents this phenomenal graph from JP Morgan it shows that there's a strong relationship between the valuation at which you buy and the subsequent annualized 10year return JP Morgan published a table at the very end of the year which showed that if you bought the S&P at today's PE ratio anytime between 88 and 2014 you made between minus 2% and 2% this is very important and it shows that higher starting valuations consistently led to lower returns and with the current S&P 500 p ratio of 22 times he concludes that investors should clearly be aware of today's market valuation but on the bright side while the p ratio is indeed High it is not at an insane level the Magnificent 7 are indeed incredible companies and the narrative that no price is too high is not common today that's why Howard Marx admits that investors could use a defensive strategy but we shouldn't necessarily leave the market I think we would agree that us stock valuations for example are on the high side uh relative to history that would uh tell me to be a little less aggressive than usual a little more defensive but not necessarily to get out moreover he argues that diversifying with bonds might be a compelling investment at these levels so today higho bonds offer 7.3% then you look at the S&P which historically has returned 10 for the last century and Goldman Sachs came out at the beginning of November and said over the next decade stocks will make three so I if you can get low single digigit returns from the S&P with great uncertainty and 7.3 from higho bonds contractually isn't it better however the there is one last metric that screams high risk actually I'd argue that this is where the risk comes from and it is obvious in this graphic these are the R&D Investments made by the Magnificent 7 and the trend is only getting stronger as companies are forced to invest into AI or get left behind together the Magnificent 7 will invest over $300 billion in 2025 and then 300 more but waram Buffett recently told us how difficult it is to get a good return on investment on his $300 billion cash position so if these companies will not see the expected returns from these massive Investments then the stock market is in big danger that was it for me if you want to see a more positive outlook on the 2025 stock market you can watch this next video he
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