An 'Everything Is Possible' Market
Froth watch... Weighing risk and reward... Remember October 2022?... That's when the bull market started... It's time to think differently... Margin debt is rising... Get ready for a postelection surprise...
Today, we're watching for 'froth'...
That's the dangerous, money-costing type of euphoria that is usually part of a "Melt Up" in the markets.
In this period, many people think nothing bad can possibly happen next...
And then it does.
This idea might seem counterintuitive to some people, but that's the point.
I (Corey McLaughlin) am writing today amid a bull market that began in October 2022 and has seen the benchmark S&P 500 Index return 70%... And the stock market appears giddy with the U.S. election behind us. Everything is a possibility, it seems...
Here's some of the narrative we hear...
Artificial intelligence is going to change the world in ways that nobody can imagine, but everybody knows are going to be profound... Elon Musk and Vivek Ramaswamy are going to cut trillions of government waste through their "DOGE" team... The war in Ukraine will end with negotiations on "day one" of Donald Trump's second term as president.
Meanwhile, today, the tech-heavy Nasdaq Composite Index hit another new all-time high for the sixth time in the past 10 trading days. Almost by definition, expectations for growth have never been higher. The S&P 500 is a fraction from a new high, too.
And today, bitcoin traded at a new high above $107,000, a nearly 150% gain over the past year.
In this context, we'll introduce the "froth watch" by reviewing one market indicator that's a warning sign of dangerous euphoria. But first, let's review why we're on the lookout for trouble even as things look so rosy today.
Don't get me wrong... The good times can keep on going longer than you or I might think...
And that's not a bad thing for people interested in making money.
But as longtime readers know, you don't want to get caught up in the bad part of the crowd that believes nothing can possibly go wrong and buys everything at the top...
It doesn't look like we're quite there, but we could be on the way. As Dan Ferris just wrote in his latest Friday essay, "mom and pop" investors think the stock market is a sure thing in 2025...
In the latest Conference Board Consumer Confidence Survey, 56.4% of respondents said they expected stocks to rise over the coming year. That's the highest result since the question was added to the survey in 1987...
And, of course, right when folks are more confident than ever... stocks' likely future returns have never been worse.
He was referring to valuations, which are at historically high levels that rival stock prices of the 1929 and 2000 peaks depending on how you measure. That's some notable historical context – not of the good kind.
It's time to think differently...
Remember October 2022? Stocks were down 20%. Bonds were having their worst year since the days of handwritten financial records. Inflation was ravaging the country. Bitcoin traded for below $20,000.
Need I remind you that as much as people appear bullish today, "nobody" was thinking about the start of a bull market in October two years ago... at the perfect time to do so?
I remember the days in October two years ago when Ten Stock Trader editor Greg Diamond turned bullish again. It wasn't an easy call to make, given the brutal bear market of 2022 and fears that a recession ahead could drive the market even lower.
Back then, after a series of encouraging reports, forward-thinking investors and traders were beginning to think that the pace of 40-year-high inflation had finally peaked. This would mean that the Federal Reserve – which had been on a rate-hiking spree in 2022 to "fight" inflation – could lower rates again... in a huge tailwind for the economy.
I recall being in a car when the September 2022 consumer price index ("CPI") report came out and the market reversed early-day losses with authority. As we observed that day, the CPI number wasn't conclusive that the trend had turned, but the market indicated belief.
As I wrote that day in the October 13, 2022 Digest...
Markets sure can be perverse.
The benchmark S&P 500 was off more than 1% on today's open, making a clear new intraday low for the year, before rallying to more than 2% in the green by the afternoon. What gives?
We can't say for sure, but if somebody wanted to look at the CPI data from a positive view, they could.
Turns out, that was the moment the 2022 bear market bottomed. In hindsight, it was because the reason that started it – a record-high pace of inflation – was thought to be done.
Greg's readers know, though, that he doesn't necessarily care about the "why."
He trusts technical indicators and "time and price" analysis. After watching market behavior for about two weeks, here's what he wrote on October 27, 2022, in a market update for Ten Stock Trader subscribers headlined "The Bottom Is Confirmed"...
The entire sideways/choppy price action since 2021 confirms that this was a correction within a larger uptrend from the 2020 low.
Does this mean that all stocks will go straight up?
No.
We'll continue to see increased volatility... There's no doubt about that.
But with everything I've highlighted recently, the bear market is over.
Wow, was he right.
Despite a "wall of worry" – constant recession fears, major geopolitical uncertainty, a run on regional banks, and the built-in uncertainty of a presidential election, to name a few investor concerns – the major U.S. stock indexes have been in an uptrend since then.
It has been volatile along the way, yes. But it has been a bull market.
So, what now?...
We can't promise exactly what will happen in the future, or when. However, we can suggest that now is the time to start thinking about what you'll do when the "good times" end. You'll want to protect your gains and limit risk – while also seeking out additional opportunities.
I can't say this enough, and it's a lesson all investors learn at some point (including me): When it feels like you shouldn't manage risk, this is exactly when you should.
Conversely, when it feels like you shouldn't buy anything at all, you can probably find great buying opportunities. Often, in dramatic sell-offs, the buying opportunities can be in the kind of high-quality "forever" stocks that can compound your wealth over the long term, which we love here at Stansberry Research.
And often in times of market euphoria, you start to see signs of concern in the most speculative stuff...
Today, Greg wrote to his Ten Stock Trader subscribers in his Weekly Market Outlook titled "The Bulls Are Running on Borrowed Time." He warned that the market could be setting up to turn lower, at least for specific sectors beneath the surface. As Greg wrote...
All is not right with the market even though some indexes are rallying to new highs.
In particular, he noted several "divergences" – that is, some sectors or individual names going one direction and others going the opposite way while the indexes make new highs. Notably, the semiconductor sector has stalled out, Greg noted, based on the VanEck Semiconductor Fund (SMH)...
Meanwhile, SMH has been in a range and can't break above its July high... The Nasdaq 100 Index and the S&P 500 Index, however, have reached new highs.
I've said it before, and I'll say it again... When a leading sector like semiconductors (SMH) can't keep pace with the major indexes, it's a problem.
This issue has lasted a long time, "which has created a frustrating environment," Greg says. "But now the correlation is turning down, which means SMH could drop as much as 20% over the next few months."
That's just one example... He took subscribers through several other charts and indexes. I can't and won't share those details here. They are reserved for subscribers. But when Greg starts sending warning signals like this, our "radar" goes up...
Especially given the context...
As we mentioned last week, we're seeing signs that the bull run of 2023 and 2024 could be very similar to that of 1997 and 1998 in the lead-up to the dot-com bubble. If the S&P 500 gains at least 25% this year, which it is on pace to do, it'll be the first time it has happened in consecutive years since '97 and '98.
You might say, hey, that's great. It certainly is for your portfolio if you've been invested. Plus, some individual names have done much better than the indexes. And, to be sure, many of our editors' recommendations today remain buys up to certain prices.
This doesn't mean it's time to go "all out" of the market right now. The major U.S. indexes are still in sturdy shape, according to short-term and long-term trend indicators like their 50-day and 200-day moving averages.
And I have no doubt there will be ways to make money in 2025. But today's environment does mean that when you take on risks in the market, you might be chasing less reward than you'd have gotten in the past two years.
At the very least, be aware of the environment...
If this year actually is like 1998, that would make next year 1999. The S&P 500 gained 21% that year, before the market topped and the dot-com boom unraveled beginning in 2000. The S&P 500 lost roughly 46% of its value from the start of 2000 to the end of 2002.
I'm not sure whether things will play out the same this time... I'm also not entirely sure what the trigger might be for a major surprise ahead that could lead to a major market "top," though I suspect it might have something to do with inflation...
Price increases have already been showing signs of reaccelerating over the past two months, yet the Fed appears to be slow to the game again. It's as if central bankers learned nothing from the past several years.
Maybe it's just nothing, a temporary blip... Or maybe prices will get so out of hand again, with a blistering second half of a bull market occurring alongside, that the Fed decides to tackle the problem by raising rates again – not continuing to lower them as the market has hoped and expects today.
Said another way, it's worth keeping an eye out for signals of euphoria – which lead to inevitable busts.
And so, we have plans to share an occasional "froth watch" until further notice...
Today, we'll share just one signal to watch... It's not the only one, and we'll probably have more time to follow up on several in 2025. But today's indicator figures centrally into any discussion about market exuberance.
Investors are building up margin debt again...
At a Goldman Sachs conference last week, Thomas Peterffy – chairman of online brokerage Interactive Brokers (IBKR) – made some comments on what the company is seeing from traders.
Interactive Brokers has more than 3.25 million client accounts and executes more than 3.3 million trades per day. That gives the company, and Peterffy, a pretty good idea of what's going on in the markets at any given time.
First, he noted that Magnificent Seven stocks have made up 70% of trading value on the platform. So markets may still live and die with the big tech stocks. Beyond that, he shared a potential warning sign of market froth...
Peterffy also said that his customers' total margin balances – money that investors borrow to finance their trading – jumped 16% over the past three months.
This anecdote and data aren't confined to Interactive Brokers...
Every month, investment firms are required to disclose the amount of approved margin debt to the Financial Industry Regulatory Authority ("FINRA"), the regulatory body of U.S. broker-dealers.
As of October, FINRA reported total margin debt of $815 billion. That's the highest level since February 2022, right at the start of the last bear market.
That bear market of 2022 wiped out a lot of leverage in the stock market. Margin debt fell from a high of $936 billion in October 2021 to $607 billion by the end of 2022. That's a staggering drop of more than 35%.
But since then, investors have been upping their appetite for leverage as stocks moved higher. According to FINRA, margin debt has bounced back by 34% from that 2022 low.
The double-edged sword of leverage...
When markets are going up, it seems like a genius move to gamble with money you don't have. The more money you put into the markets, the more you make. But during downturns, margin magnifies your losses. And if markets decline quickly, this leverage leads to even more trouble...
At first, the downturn only costs money on paper. You haven't really "lost" money until you have to close your trade for less money than you started with. But if paper losses pile up enough, brokers will request "margin calls." That's where traders or investors must put up even more money than they borrowed to cover the balance of their trade when leveraged trades go the wrong way.
Back in November, Dan wrote about a trend of growing margin debt in a Friday Digest essay. As he said...
What I see here is the rising use of margin debt... with a potentially large runway to increase that usage as the market (potentially) melts up in the coming months.
That's exactly what we've seen so far. Since Dan published that essay, the S&P 500 is up about 6% in six weeks. And the Nasdaq is up even more – jumping nearly 10% over the same period.
It seems like this trend is going to continue. More from Dan...
It all feels like a coiled spring, with stocks ready to bounce higher and deeper into mega-bubble heights than ever before, enticing even more borrowing.
So, stock prices, market valuations, and margin debt are all at or near all-time highs. For now, the party continues. It won't go on forever.
Again, this doesn't mean a crash is imminent...
But it does mean it might pay in the year ahead to "think differently." Our editors and analysts, of course, will keep you updated about any major risks and the potential rewards in their publications.
As our Stansberry's Investment Advisory team recently discussed in subscribers' latest issue, for example... high valuations alone don't cause market sell-offs, but they do suggest less upside. Similarly, margin doesn't cause a crash by itself, but the higher that margin debt goes, the more it can exacerbate a downturn.
We're not the only ones who think this is an important moment for thinking ahead. For more insight into how to prepare for what's next, you may want to hear what our friends over at our corporate affiliate Chaikin Analytics have to say, too...
They are preparing to go live with their annual lookahead exercise for the year ahead. As he does each year, founder Marc Chaikin is sharing a comprehensive "road map" for 2025...
And this year, the 50-year Wall Street legend believes a critical postelection surprise is heading straight for U.S. stocks.
Marc has now traded through 14 presidential election years over his five decades as a professional investor. He has seen patterns repeat themselves over and over and over every four years.
While most Americans have been distracted by the election, geopolitical turmoil, and the market surging to record highs, he recently watched a powerful market signal (with 93% historical accuracy) flash quietly.
Marc calls this the "5X Signal" and believes it will shape the market in 2025. He warns that if you have any money in U.S. stocks, it's a story you can't miss. He's going to reveal everything starting tomorrow.
You can register, for free, to be among the first to hear all the details here.
New 52-week highs (as of 12/13/24): AutoZone (AZO), Alpha Architect 1-3 Month Box Fund (BOXX), Ciena (CIEN), PayPal (PYPL), ProShares Ultra QQQ (QLD), and United States Commodity Index Fund (USCI).
In today's mailbag, feedback on Dan Ferris' latest Friday essay... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.
"As you pointed out in the beginning of the article, [the Conference Board Consumer Survey question asking if 'Mom and Pop' think stocks are going to rise in the coming year has been asked] since 1987. I do remember a very significant event on Wall Street one day in the year of 1987.
"That is the problem; many people do not remember because they are too young or were not in the stock market. They think Boomers are full of it when you talk about gas lines because of oil embargoes... or the Fed's Chairman Paul Volcker using a sledgehammer on the economy to finally kill the inflationary spiral. I personally think that is what will be needed to finally end our current inflationary spiral. Yeah, it has moderated and seems like it is under control. But some of us know it is not." – Subscriber Walter P.
All the best,
Corey McLaughlin with Nick Koziol
Baltimore, Maryland
December 16, 2024