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the world is chaotic the future is never clear historically that's a time to get out the US Stock valuations for example are on the high side this is an oscillating chemical reaction combining certain reactants under the right conditions results in unpredictable swings between colors and while it has nothing to do with the economy or the stock market it's a mesmerizing analogy for how small changes in a dynamic system can produce unexpected circumstances this is the kind of environment we face in 2025 According to some of the most respected people in the world of Finance so what exactly is a stock market bubble are we in one right now and how should you be investing differently than what's worked before that brings us to 2025 what lies ahead I probably titled this video something ridiculous or obnoxious and I do apologize about that but I felt like since I've been away from YouTube for so long I needed to get back into the YouTube algorithm to quote one of my favorite movies nobody I don't care if you're Warren Buffett or if you're Jimmy Buffett nobody knows if a stock is going to go up down sideways or in circles least of all we can't predict exactly when a stock market crash might occur but we can look at the state of financial markets to get a better idea of where we might be in the cycle which is where I turned to Howard marks his understanding of the rise and fall of stocks across history is unrivaled and in January of 2000 he published a memo called bubble.com outlining his concerns that internet stocks and the broader US Stock Market were primed for a cataclysmic crash and just a few months later it began three straight years of negative stock market returns and a cumulative return of just 9% for the 11-year period of 2000 to 2011 this week exactly 25 years after he posted that memo he published this his observations of the similarities in today's artificial intelligence fueled Market to that of previous bubbles but let's first start at the beginning what is a bubble a bubble or crash is more a state of mind than a quantitative calculation people always point to the recent surging of stock prices to say that we're in a bubble and while it's true a crash is usually preceded by strong stock returns there are some other important characteristics highly irrational exuberance outright Adoration of the subject companies or assets and a belief that they can't miss massive fear of being left behind if one fails to participate and resulting conviction that for these stocks there's no price too high when these qualities exist in markets people begin to believe a very dangerous notion that there's no price too high according to Marx while there are of course valuation ratios and calculations that help gauge how expensive the stock market is it's a psychological diagnosis that proves more effective from a simplistic perspective there are three stages of a rising stock market stage one comes right after a crash investors are pessimistic about stocks and expect the pain to continue far into the future stage two is where companies and the economy more broadly begin to show signs of improvement and then in stage three the economy is booming and companies are performing well above expectations stocks rise fast because investor expect ation swing from pessimistic to optimistic and it's here that everyone starts believing that company earnings will never stop growing the important inferences aren't with regard to economic or corporate events they involve investor psychology it's not a matter of what's happening in the macro world it's how people view the developments but stock market bubbles are a very specific type of bull market they're the very rare circumstances where irrationality gets taken to the extreme what causes them could be summarized by one of the oldest phrases in the world of Finance this time is different bubbles are invariably associated with new developments a new technology that's rapidly changing the world or it could be a new investment product that unlocks wild speculation on what was previously considered a safe asset when something new comes along there's no historical context that you can use to easily determine that prices are getting too EXP expensive take the endless number of internet companies that popped up in the late '90s in the TMT bubble the companies didn't have earnings so PE ratios were out and as startups they often didn't have revenues to Value investors could sense that the internet would change the world and that some companies would make billions of dollars from it and that sense was correct look at some of the biggest companies in the world today they were born out of the internet but it's that little kernel of Truth which fuels the bubble as a result new metrics were invented and trusting investors ended up paying a multiple of clicks or eyeballs regardless of whether these measurables could be turned into revenues and profits eventually these metrics did become advertising Revenue at least for some of the companies but at the time guessing how much each website view or click would convert into advertising Revenue was basically impossible and it led to many companies many stocks being massively overvalued Howard marks then shares another bubble he lived through in the 60s which he says gave him a deeper insight into how these things come about I joined the equity research department at First National City Bank now City in September 1969 their primary focus was a group of stocks known as the nifty50 stocks of the best and fastest growing companies in America these companies were considered to be so good that a nothing bad could everen happen and B there was no price too high for their stocks after World War II ended the US economy went through a boom time where lots of Innovations were made in a number of Industries including computers Pharmaceuticals and consumer products and like every previous bubble investors became over optimistic about the profits these businesses could produce the nifty50 were the object of the first big bubble in roughly 40 years in many cases their price to earnings ratios fell from the range of 60 to 90 to the range of 6 to9 that means that from 1969 these stocks fell by 90% over a 5-year period there are some invaluable lessons in this period for the stock market it's not what you buy it's what you pay that counts good investing doesn't come from buying good things but from buying things well there's no asset so good that it can't become overpriced and thus dangerous and there are few assets so bad that they can't get cheap enough to be a bargain but the nifty50 bubble of the late 60s should also draw your attention to the most beloved stocks in today's market the Magnificent 7 Microsoft Amazon Apple alphabet Nvidia meta and Tesla these companies are growing fast and many investors believe they can do no wrong but most importantly they're all expected to be the biggest beneficiaries of a new technological development artificial intelligence so the question is are they in a bubble the first note is that they're certainly not as as expensive as the nifty50 stocks were before their 90% collapse the further good news is that today's leaders don't trade at the PE ratios investors applied to the nifty50 perhaps the sexiest of the seven is NVIDIA the leading designer of chips for artificial intelligence its current multiple of future earnings is in the low3s but it still might be high consider what a price to earnings ratio actually tells us if there's a company for sale that will make $1 million next year and then shut down how much would you pay for it the right answer is a little less than $1 million so that you'll have a positive return on your money the reason we're willing to pay a price for a stock that's many multiples of their next year's or last year's earnings is because we expect that company to be producing earnings and operating for many years into the future paying 30 times earnings for NVIDIA means you're expecting the company to survive for decades and that through those years they'll continue to dominate growing their profits year by year in other words investors are assuming Nvidia will demonstrate persistence but persistence isn't easily achieved especially in Hightech Fields where new technologies can arise and new competitors can leap frog incumbents 25 years ago these were the top 20 companies in the S&P 500 only six of them are still in the top 20 today so some of today's biggest companies will be the biggest companies in a couple of decades time but most of them won't but it's not just the AI tech companies that have been surging in price recently the entire Market has been hot Rising about 26% in 2023 and then another 25% in 2024 the best 2year stretch since the internet bubble prior to 2 years ago 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 those four instances is a small sample mind you the index declined in the subsequent 2-year period the outlier again the internet bubble the market had exceptionally strong years between 1995 and 1998 when the powerful TMT bubble caused the decline to be delayed until 2000 but then the index lost almost 40% in 3 years there are times where an industry specific bubble will spread to the entire stock market and this happens due to a combination of Tailwinds in the '90s it was the internet company's Tech bubble in combination with declining inflation and interest rates an exciting technological revolution in combination with a shift in broader investor optimism you might say that we're in a similar set of circumstances today in the last couple of years we've seen inflation come down significantly and more recently interest rates as well and the market has bounced back in full force after its 2022 crash lately I've been repeating a quote I attri to Warren Buffett when investors forget that corporate profits grow about 7% per year they tend to get into trouble corporate profits have been growing a lot but stock prices have been growing faster which means stocks have been getting more expensive and that cannot go on forever but by far the most interesting part of the entire memo is this chart from JP Morgan it plots the forward price to earnings ratio of the S&P 500 against the subsequent 10-year Market return or in simpler terms it's looking at how the expensiveness of the market impacts future returns for investors and there is a very strong correlation the more expensive the market is the lower returns investors made for the next decade in that 27-year period when people bought the SNP at price to earnings ratios in line with today's multiple of 22 they always earned 10year returns between plus 2% and minus 2% the implication being that if history is anything to go on we should have pretty limited expectations for stock market returns over the next decade but it's not just that stock returns could be weak you might say making plus or minus 2% wouldn't be the worst thing in the world and that's certainly true if stocks were to sit still for the next 10 years as the company's earnings Rose bringing the multiples back to Earth but another possibility is that the multiple correction is compressed into a year or two implying a big decline in stock prices such as we saw in 1973 to 74 and 200202 the result in that case wouldn't be benign that's not a very cheerful thought but I do want to emphasize that none of this is a reason to stay out of the stock market even if stock returns are relatively weak in the coming years we have no idea how it might look there's nothing that says there has to be a stock market crash we could just see weak returns year byye and therefore if you stay out of the Market you just miss out and there's also some pretty important counterarguments to consider the PE ratio on the S&P 500 is high but not insane the Magnificent 7 are incredible companies so their high PE ratios could be warranted I don't hear people saying there's no price too high and the markets while high-priced and perhaps frothy don't seem nutty to me the reason I never ever make investment decisions based on these Broad double predictions is because that implies that you can even tell how expensive the stock market is sure it's definitely on the high side compared to past periods but in order to truly know if it's expensive you'd have to know the profits of all corporations over the next decade and that is just as much of an impossible task as the investors trying to predict the profits of pre-revenue internet companies so the rational choices are either to pick individual stocks where you have a deep knowledge of the specific business or buy an index fund stay the course and accept whatever return the market provides I'm back to weekly videos now so subscribe if you haven't already and check out one of these videos next
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