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Markets are Bubblelicious

The last time I witnessed the formation of a market bubble in 1999, it was as thrilling and awe-inspiring as observing a select group of Mag 7 stocks reach trillion-dollar valuations today. A quarter-century ago, internet stocks were the center of attention, with valuations soaring to bubblelicious hyper-speculative heights. Any company vaguely associated with the burgeoning internet sector saw its stock price skyrocket. Currently, the market's momentum is fueled by the anticipation that artificial intelligence, or AI, will revolutionize the world, much like the internet did decades ago.

Over the past decade, a significant portion of the market's returns has been generated by a small number of large-cap technology stocks within the S&P 500 or NASDAQ Indexes. As investors have increasingly funneled capital into either these indexes or a select few companies, the influence of these entities on market cap size and performance has only grown. This creates a self-perpetuating cycle of rising stock prices, as a greater share of each invested dollar goes into these few stocks. However, when prices begin to decline due to investors withdrawing from indexes, the largest-cap stocks tend to plummet more rapidly and severely than the broader market, as witnessed during the burst of the bubble in 2000. The average decline of the top 10 stocks exceeded 80%, a staggering loss that is indeed breath-taking.

1987 Market Bottom to 2000 Market Peak
1987 Market Bottom to 2000 Market Peak -- Source: Bloomberg

Comparing the bull market trend of the era with today's market reveals striking similarities in performance. From the bear market low following the 1987 market crash to the end of 1999, the NASDAQ Index surged by 1,629%. In contrast, from the bear market trough after the Financial Crisis in 2009 through March 11, 2024, the NASDAQ Index rose by 1,182%. The speculative phase of bull markets inevitably ends abruptly, leading to potentially catastrophic capital losses for investors.

2009 Nasdaq Market Bottom through Present
2009 Nasdaq Market Bottom through Present -- Source: Bloomberg

The current bull market trend, spurred by the Financial Crisis and the Pandemic, has been supported by zero interest rates, quantitative easing (QE), and extensive fiscal stimulus. In 2021, the Federal Reserve shifted strategies, increasing interest rates by 525 basis points and transitioning from QE to quantitative tightening (QT). As the wave of fiscal stimulus subsides and its impact on economic growth diminishes, the economy and corporate profits have shown surprising resilience, buoying the bull market's upward trajectory. The critical question remains: when will this upward trend cease?

Fed Funds Target Rate and Recessions
Fed Funds Target Rate and Recessions (Jan. 1985 to Jan. 2024) -- Source: Bloomberg

Although investors are hopeful that the Federal Reserve will cut interest rates, bolstering the bull market further, strong growth and employment figures coupled with inflation remaining above target limit their ability to act. They may opt for a couple of 0.25% rate cuts before pausing. The real threat of capital loss looms in 2025 as the economy feels the full brunt of the Fed's historic rate hikes and the absence of additional fiscal stimulus. Until that time, the celebration goes on, but it's crucial to remember that the final phase of bull market performance is always the riskiest to chase.


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Unless otherwise indicated all performance is sourced from Bloomberg.


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