Despite How It Looks Today, I Won't Be a Fool Forever

Full-speed back to bear town... Investors are 'all in' right now... A better mood than at any point in this bull market... Nobody is worried about what comes next... Learning to trade options while driving down the road... Animal spirits are in charge today... Despite how it looks today, I won't be a fool forever...

Last Friday, I (Dan Ferris) promised not to fill my weekly Digest with bearishness...

And I came through with not one but two – count 'em, two! – long investment ideas.

Now, having convinced you that I'm capable of making buy recommendations this late in the most epic bull market of all-time... I'm heading full-speed back to bear town today.

When it comes down to it, it's really hard to keep track of any decent amount of financial market data without seeing the massive financial bubble we're living in...

Don't forget about the current valuation of the benchmark S&P 500 Index. As I've noted numerous times over the past year or so, it's more expensive than it has been in history... at slightly more than 3 times sales. (The dot-com bubble peaked at 2.3 times sales.)

And just look at the average investor's desire to dump money into the market these days... The "meme stocks" are all the proof you need. We'll dive deeper into this whole idea today.

It's like watching an amateur poker player smile at his hand and push all his chips to the middle of the table when he was just baited by one of the world's greatest "sharks"... He thinks he's about to win, but you and everyone else knows he's about to lose.

Let's begin today with a July 2 post on Twitter from Financial Times writer Robin Wigglesworth...

This is WILD. If equity fund flow[s] continue at the current pace, this year will see greater net inflows than the preceding 20 years COMBINED.

"Fund flows" means money going into mutual funds and exchange-traded funds. And Wigglesworth followed up that initial post with a series of others. First, he noted...

Best first half for the global stock market in nearly four decades, and the seventh best of the past century.

And then...

Best first half of a year for commodity prices in nearly five decades, and the fifth best for the past century.

Wigglesworth also noted that bond fund flows are up, too... The benchmark 10-year U.S. Treasury note's yield has fallen from 1.74% in March to 1.3% recently. That means investors are bidding bond prices higher (since bond prices go up when yields go down).

Stocks, bonds, commodities... investors are "all in" right now. No wonder flows into mutual funds and exchange-traded funds could be on pace to make the past 20 years look tame.

And the effect on the overall mood of investors is palpable...

We'll focus on the stock market, since investors are most in love with that particular asset today...

We can confirm that idea by looking at TD Ameritrade's Investor Movement Index ("IMX"). According to the online brokerage firm's website...

The IMX is a proprietary, behavior-based index created by TD Ameritrade designed to indicate the sentiment of individual investors' portfolios. It measures what investors are actually doing, and how they are actually positioned in the markets.

The IMX does this by using data including holdings/positions, trading activity, and other data from a sample of our 11 million funded client accounts.

The IMX reached 9.08 at the end of June – its highest reading since its January 2010 inception. The previous peak was 8.59 in December 2017. That time, the S&P 500 peaked about nine months later... and then fell roughly 20% through Christmas Eve in 2018.

Both peaks have been dramatic events, with sentiment bouncing off multiyear lows less than two years prior. Take a look...

A random sampling of clients from one of the largest online brokerage firms strikes me as a great place to find out what individual investors are doing and how they're feeling. And...

They're in a better mood than at any other time during the longest bull market in history.

People buy when they feel good... They feel good because stocks have gone up... Stocks go up because folks are bidding them higher.

Around and around it goes... where it stops, nobody knows.

This isn't about calling the top or predicting when this unprecedented good mood from investors will end. It's about noticing that... nobody is worried about it.

In fact, despite this being the most expensive market on record, individuals are just sitting around thinking about all the money they're going to make starting right now... and continuing indefinitely – if not forever. They all seem to think the good times will never end.

French investment bank Natixis recently issued the 2021 edition of its annual Global Survey of Individual Investors...

The company surveyed 8,550 investors in 24 countries. Each respondent had minimum investable assets of $100,000.

Based on the results, Natixis said the gap between individual and professional investors' expectations for long-term investment returns has widened "dramatically"...

Individual investors who were surveyed expect to make inflation-adjusted returns of 14.5% per year over the long term. Meanwhile, professionals expect to make 5.3% per year.

In other words, individual investors expect a 174% greater result (14.5% compared with 5.3%) than professionals. That's 53 percentage points above last year's expectations.

I've heard it said that the only legitimate function of market predictions and return projections is to make astrology look respectable. I don't disagree, but still...

The real point isn't the specific numbers or whether they'll come true. It's the extreme difference between individuals and professionals' expectations – how optimistic individuals all over the world are right now. (Remember, Natixis surveyed investors in 24 countries.)

Both groups are likely to be wrong. But one group is very obviously much more aware of the risks than the other and has tempered its expectations accordingly. The other hasn't.

It reminds me of an anecdote from the dot-com era. I've mentioned it before, but it bears repeating today...

A couple went to a financial adviser in the late stages of the dot-com bubble. The adviser was bullish and excitedly told the couple that they could expect to make 20% per year in the stock market if they bought the funds he recommended. The couple was disappointed, though... And they replied, "No, we want to make 100% a year."

The dot-com bubble fueled irrational expectations.

Likewise, expecting 14.5% per year after inflation over the long term, when equities are trading at their highest valuations in recorded history, is far too optimistic.

But maybe I'm being too dismissive of the herd of individual investors...

Maybe they're all really geniuses.

For example, maybe buying left-for-dead companies like movie-theater chain AMC Entertainment (AMC) and video-game retailer GameStop (GME) was such a genius move that a simple fool like me just can't ever hope to understand how brilliant it truly was.

And if they're all geniuses, then maybe I'm making too much out of the widespread financial speculation we're seeing... The market is filled with speculators every single day, year after year. Speculation is normal. A lot of people speculating doesn't mean we're in a bubble.

That's correct... Speculation is so common in financial markets that it's barely worth noting. Increased speculation doesn't automatically indicate a bubble. That's true... almost all the time. But like any discussion of the overall market... it's a different story at the extremes.

I believe the current speculative mood is too extreme...

There's simply no way this is anything other than a bubble. Veteran Wall Street analyst Richard Bernstein (who we cited last week, too) agrees. He recently explained how you can tell it's a bubble...

The difference between mere speculation and financial bubbles is speculation resides within the financial markets, but bubbles pervade society. Today, financial speculation is clearly pervading society.

"Pervading society" means you can't get away from financial market speculation. It's ubiquitous in our lives today. A listener to our Stansberry Investor Hour podcast wrote in this week with a typical example...

Enjoying a drink at a rooftop bar at the end of a long workday, he overheard a phone call of someone pitching a trading strategy "guaranteed" to make money in eight out of every 10 trades and to compound at 8% per day... Per day! It's ridiculous.

And here's another example that I saw earlier this week. It comes from the Twitter account of Genevieve Roch-Decter, a chartered financial analyst and money manager...

It's one thing when you can't escape options trading pitches on financial websites... It's a completely different ballgame when you can't escape them when driving along the road.

Bernstein uses another phrase to describe another aspect of the same pervasiveness of financial market speculation in our society... It's one of the five criteria he uses to determine if we're in a bubble – increases in liquidity, leverage, initial public offerings, trading activity, and the "democratization of the market." Last Friday, I said you could see the last one in "meme stock" short squeezes and rising speculative call-option buying.

Perhaps we'll deal with the other four another day, as the bubble rolls on. For now, "democratization" is a two-bit word that means anybody can participate...

Genius or not, all you need is money. And the federal government has given away $850 billion in stimulus checks so far... so everybody has enough money to play the game.

Democratization of the market... speculation pervading society... or whatever else you want to call it... it's clear that individual investors are wielding power they haven't had since the height of the dot-com bubble.

They're back and they're bullish!

Knowing me as well as you must by now, you know where I'm heading with all this...

Who with any amount of market knowledge and experience could conclude anything except that the bullish, happy herd is setting itself up to get crushed? Maybe you think I'm being unfair or too much of a knee-jerk contrarian, but I'm just trying to be realistic...

Think about AMC for a minute...

There is no rational reason for AMC – perhaps the No. 1 meme stock of all, even surpassing GameStop these days – to continue to be valued in the stock market at about $24 billion... That's a valuation of roughly 22 times sales.

The business was in secular decline for at least a decade even before COVID-19 lockdowns shut movie theaters down for the better part of 2020. Then, the company lost 80% of its revenue in the lockdown. It'll never get all that money back. Its business is doomed.

Nobody buying AMC's stock today has the slightest clue what they're doing. Yet to the herd, it looks like it got things right on AMC... so they can't imagine not getting it right.

Their stellar results so far – and the accompanying euphoric sentiment – have set these folks up for huge losses.

Still, you won't catch me predicting when AMC or other crazy speculations will come crashing down...

Human nature is too powerful a force.

Humans don't think about what they should do. They'd much rather put their energy into justifying what they're already doing. It saves them from the burden of having to change their minds.

Those forces move on their own schedule, and I don't want to get run over trying to predict it.

And whether the herd acknowledges it or not, the primary reason these folks are so bullish is simply because stocks are going up. It's not because the herd is smart and its members are reaping the rewards of a lot of deep analysis and thinking... Experience, knowledge, and deep analysis don't allow anyone to conclude that AMC is worth anywhere near $24 billion.

What's really happening is that animal spirits are in charge of the market for AMC shares (and many others)...

The more AMC stays elevated, the more investors will try to justify a clearly unjustifiable market valuation... and they'll be less likely to dismiss the high valuation as the effect of the fully "democratized" bubble market they and their ilk have created.

All the evidence that counts is on the AMC bulls' side... The stock is way up. People who bought the company's shares have made a lot of money. People who didn't buy failed to make a huge sum of money very quickly. And those who sold the stock short got crushed.

What other evidence do you need? What other evidence exists? None that anyone cares to consider.

Now, multiply all of the above discussion by thousands of stocks in the most expensive market in history... As you can see, it's a lot bigger of a problem than you might first imagine.

Hyperoptimistic individual investors today are totally unaware that they're not looking ahead, not doing great analysis, and not making genius calls. They're looking in the rearview mirror, which as we pointed out earlier, is filled with the best performance in the first half of the year that both stocks and commodities have had in decades. No matter where anyone looks or what they've bought, there's nothing but evidence of their own financial acumen.

Or maybe it's more accurate to say investors are in such high spirits not because they're looking in the rearview mirror... but because they're looking at themselves in the mirror.

They see stocks going up. And they would rather think they're smart than simply moving with the herd that's pushing prices higher.

They're oblivious to the fact that they're causing the weather, not successfully predicting it.

Whichever way they're looking, the great herd of investors sees nothing but reasons to feel good, be bullish, and buy more.

And if you think anything but a market crash or a sustained bear market will change their minds, think again...

As long as stocks are high and getting higher, everybody who's buying will point to the money they're making as proof that they're right and bears like me are wrong.

That happens in every great speculative bubble. In his classic work, A Short History of Financial Euphoria, late Canadian-American economist John Kenneth Galbraith identified...

The recurrent and sadly erroneous belief that effortless enrichment is an entitlement associated with what is thought to be exceptional financial perspicacity and wisdom.

In other words, all the hyperbullish know-nothings think they deserve the money they're making. And they believe it's a clear sign that they possess a special financial genius.

Galbraith ended his book by noting essentially what I'm saying today (as well as every other day that I've brought up this topic for the past couple years)...

Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So, alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen.

But who looks like a fool right now – the folks who've bought every crazy speculation and keep making money as they push the market higher... or bearish investors like me?

Except for a brief, hyperbullish stint in mid-2020, I've been bearish on the overall market since 2017...

We've experienced steep corrections since then... But overall, anybody who just kept buying and buying has been right – and bears like me have been wrong. (We'll set aside the 43 new buy recommendations I've made in the pages of Extreme Value during that period... Remember, you can always find value somewhere.)

Since no apparent evidence supports bearishness right up to the current moment, people like me look like the fools right now. But that doesn't mean I'll be a fool forever...

The emotional effects of the market's boom and bust cycles were well summed up in the first edition of value investing guru Benjamin Graham's magnum opus, Security Analysis. It was first published in 1934, after the market crash of 1929 and the Great Depression had ruined many smug fools who had been way too convinced of their own financial acumen.

Opposite the title page, you'll find a mostly blank sheet of paper. It contains nothing but a single quotation from Roman poet Horace's Ars Poetica...

Many shall be restored that are now fallen and many shall fall that are now in honor.

Regular Digest readers know that you'll never catch me trying to time the top of the market... or recommending that you sell all your stocks and go into hiding somewhere.

The stock market just doesn't work that way.

Instead, I'll keep finding attractive equity opportunities for Extreme Value subscribers (we published our latest one today)... and occasionally for Digest readers, like I did last week.

Yet, as foolish as it may seem to the vast, hyperbullish, hyperoptimistic, and at least temporarily wealthy herd of individual investors, I'm still bearish on the overall stock market. And I likely will be until the S&P 500 loses at least 30% (preferably more).

That's when the real value opportunities will arise... And we'll scoop them up hand over fist.

For now, don't sell all your stocks in a panic. But do prepare yourself for a serious stock correction. It might not happen tomorrow or next week... but it always comes eventually.

New 52-week highs (as of 7/8/21): Amazon (AMZN), Costco Wholesale (COST), Invitation Homes (INVH), KraneShares SSE STAR Market 50 Index Fund (KSTR), and Novo Nordisk (NVO).

We'd love to hear if you're bullish, bearish, or somewhere in between. Please send your thoughts, comments, and observations to feedback@stansberryresearch.com. We'll share some of your best responses next week.

Good investing,

Dan Ferris
Eagle Point, Oregon
July 9, 2021