The Death of Risk

Risk is real (I swear!)... 'Nobody knows' why stocks are up... A bullish contrarian indicator... Liquidity magic... The death of risk... Your portfolio is more speculative than you think... There's always something to do...

There really is such a thing as risk... 

I promise you it's real, even if the market fails to recognize it at any given moment – like right now, for example.

U.S. stocks are priced as though they will never fall again. At a cyclically adjusted price-to-earnings ("CAPE") ratio of 38.79, the S&P 500 Index is now more expensive than it was at the October 2021 peak of 38.58. A 25% decline in the index followed (accompanied by a 36% decline in the Nasdaq Composite Index).

The CAPE ratio has been higher than right now only between December 1998 and October 2000 – the final run-up and peak of the dot-com boom and the first seven months of the bust.

Stocks are flying up high in the thin air. That makes it more likely they'll take an extended breather soon... But I also realize they could also fly even higher for longer than I'd ever have believed. At this point in my life, it's hard to shock me with market action.

If you want to know why the market is so buoyant, the Wall Street Journal might have the best answer...

A story like this is what our old friend Enrique Abeyta might call a "despite" moment.

The article essentially reports that stocks are up despite tariffs that economists fear will cause a recession.

But during his hedge-fund career, Enrique noticed that the word "despite" was a contrarian signal. Often, it would suggest that the prevailing trend (up or down) would continue.

Since the WSJ says the market is soaring despite "a torrent of bad news," I have to take it as a bullish sign.

That doesn't mean stocks are a good buy right now, at least as measured by the S&P 500. They're way too expensive for that to be true. It simply suggests that the sentiment in the financial press is still a little too negative, and that's often a sign of further gains ahead.

The article oddly includes two seemingly contradictory ideas... The writer acknowledges that it's impossible to predict short-term market action, then expresses surprise that stocks are up so much this year.

I've been hearing some folks say that valuation doesn't matter... and stocks just go up because of a magic, nebulous thing called liquidity...

I'm not saying nobody knows what liquidity is. I'm sure folks like hedge-fund legend Stan Druckenmiller know what they're talking about when they use the term.

But these days, I hear it thrown around too often without being defined. Don't worry about crazy-high stock valuations because of, you know, uh, liquidity.

Liquidity measures how easily you can buy or sell a stock without changing the market price. It's complex, but it mostly comes down to having enough trading activity to meet the needs of buyers and sellers.

When you buy five shares of Berkshire Hathaway (BRK-B), your trade won't change Berkshire's stock price. There's plenty of liquidity for you. When Berkshire buys $5 billion worth of a mid-cap stock, no such luck. Berkshire's transaction will move the share price.

If you're wondering what this has to do with stock valuations, congratulations... You're seeing right through the nonsense.

The smartest thing I've ever heard said about liquidity was by "Acid Capitalist" Hugh Hendry, who said it rises and falls with the S&P 500.

That makes sense to me. From individuals to professional traders to banks (including some central banks)... nearly every investor in the world owns the S&P 500.

When the index's value falls, everybody in the world has less wealth to borrow and spend against. When wealth depends on a valuation multiple, a lower valuation multiple erases wealth.

I don't define wealth that way... But based on their behavior, everybody else in the world does. They spend when they feel rich and save when they feel poor.

An exorbitant valuation means everybody has a lot of wealth to borrow and spend against. But here's the other piece... It means this borrowing and spending depends on some of the highest equity valuations in history remaining that high indefinitely.

Liquidity isn't a justification for high valuations. It's a symptom. Investors are buying more stocks because they feel richer, and this trading activity boosts liquidity.

By the same token, what do you think will happen when investors don't feel so rich? Nobody wants to think about that part.

To investors today, risk is dead...

Every bear market is a buyable dip. Crashes and long sideways markets can't ever happen. That's all in the past, or so the stock market seems to believe.

As long as folks keep buying S&P 500 index funds in their 401(k) accounts and as long as the Federal Reserve lowers interest rates every time the market drops by more than 20%, every dip will be just another opportunity to get rich in the stock market.

But when a trend looks so obvious, its days are numbered.

I imagine BusinessWeek magazine plotting a cover story called "The Death of Risk." It would be the perfect counterpart to its famous August 13, 1979 edition...

Published near the end of the sideways market of 1966 to 1982, this article said inflation was destroying the stock market, so you should put more money elsewhere.

It perfectly captured the prevailing bearish sentiment at the time. And it was perfectly wrong.

The market bottomed for good in 1982 and then went on one of history's most epic bull runs, ultimately peaking at the height of the dot-com boom.

It was a buy signal for stocks and a sell signal for gold – the AI mania-like asset of that time.

Again, this article came a couple years before the final bottom. And if BusinessWeek published "The Death of Risk" tomorrow, it wouldn't mean stocks can't keep rising.

But the longer investors go on treating risk as a thing of the past, the more it will bite them later.

Most folks don't think risk is real until after it has done its damage...

It's just too hard to be cautious or bearish or even just thoughtful about making new investments when markets keep hitting new all-time highs. Near-record valuations have lost all meaning for most folks. They don't see stocks as either cheap or dear. They see them merely as rising or falling.

Risk is about probabilities... And by buying at all-time-record valuations, many folks are locking in a permanent capital loss, or will at least have to endure one for many years.

That's what history suggests, at least. Folks who bought the Nasdaq at the dot-com peak saw the value of their capital cut by nearly 80% by the end of the crash. They didn't break even for another 15 years. Same thing for folks who bought stocks at the 1929 peak, except that it took 25 years to get back to even.

The point isn't so much that the value would go sideways for a decade or more. It's that the returns on stocks bought at soaring valuations are doomed to be lousy for years to come.

It's not so much that you'll lose money. If you can wait out the downturn and keep investing when stocks are cheap, you'll do great.

But the closer you get to retirement, the more of a problem bear markets and sideways markets become. Nobody wants to retire with 50% less wealth than they thought they'd have. And nobody wants to watch their net worth go sideways for a decade or two after getting cut in half.

The older you are when all this happens, the more dependent you are on the market to pay your bills and the less time you have to recoup losses. I fear too many retirees and soon-to-be retirees are staring straight into a massive market conflagration. I'll be thrilled if I turn out to be wrong.

Your portfolio might be full of garbage... 

Longtime readers have heard me warn how common index funds are heavily weighted to hyper-valued "Magnificent Seven" stocks like Nvidia (NVDA) and Tesla (TSLA).

And as I share almost every Friday, the overall S&P 500 is at bubble-like valuations.

When you buy an index fund, you're often investing in stocks you'd have never considered on their own.

And that applies to much worse trash than just an overpriced yet profitable tech giant. 

Consider this example... The $10 trillion passive money manager Vanguard is now the biggest shareholder (via client-held index funds) of Strategy (MSTR). It now owns 8% of the company.

Formerly known as MicroStrategy, the company's main business activity is borrowing money and buying bitcoin. It owns about 608,000 bitcoins, worth roughly $70 billion today.

Yet Strategy's market cap today is roughly 65% higher than that, at around $115 billion. As the Financial Times put it recently...

A bitcoin in a box is valued higher by the market than a bitcoin, so by raising money to buy bitcoins and putting them in boxes, a company can raise more money to buy bitcoins to put them in boxes.

"Bitcoin in a box" feels as magical of a wealth-creation scheme as garnering eyeballs and clicks was at the peak of the Internet boom. Sooner or later, you have to create real wealth or your company tends to disappear off the face of the Earth.

Borrowing money to buy an asset doesn't create anything but debt and risk, no matter how wonderful it feels before the market stomps it out of existence.

That's not what you want to own... either by buying Strategy shares or by buying an index fund that holds them.

The market's best opportunities are often where no one is looking...

Veteran Wall Street Journal reporter Jason Zweig recently commented on the risk and opportunity in stocks...

He noted that the five biggest U.S. stocks have a market value of nearly five times that of the entire Russell 2000 small-cap index – the biggest gap since at least 2000.

He also noted that over the past 10 years, small-cap stocks have returned roughly 6.6% per year, 7.3 percentage points less than large-cap stocks – the largest such gap since 1935.

Zweig states the basic contrarian case for small stocks...

Money always chases performance, and big stocks have all the momentum – burnished by the artificial-intelligence boom. But what if AI turns out to be a bust, it fails to meet expectations or the biggest stocks end up stagnating? Then investors who didn't give up on smaller stocks will be rewarded.

So maybe if you're looking for a good way to diversify your 401(k) out of the S&P 500, you should turn to small-cap index funds that buy the Russell 2000 Index or the higher-quality S&P SmallCap 600 Index.

By Zweig's analysis, buying small caps today feels like buying banks, homebuilders, and mining stocks in 2000. They were among the biggest laggards during the dot-com boom, as investors focused more intently on technology stocks.

Today, the laggards include just about anything outside the biggest names in the S&P 500 – especially small stocks.

Nothing underperforms forever. And when it seems like everyone expects the market leaders will never lose, that's a great time to start pivoting into the highest-quality laggards.

This situation is what you should generally expect...

When investors are more focused on one asset class than they've been in recorded history (on par with the dot-com peak), at least one other one ought to be neglected enough to provide a great opportunity to outperform the favored class.

Small caps aren't the only place you should look. Mining stocks are very likely in the early stages of a long bull run, and they're cheap relative to big caps. My own personal accounts are loaded with natural resources stocks.

I try to keep in mind the title of Christopher Risso-Gill's book about the late, great global value investor Peter Cundill: There's Always Something to Do.

It's true. There is always something to do. There's always something somewhere that's about to spend the next year or two or 10 outperforming other assets. You'll often find, as Cundill did, that it takes a serious bit of digging and diligence to find it.

But if building a lot of wealth over the long term is your goal, it's well worth the effort.

New 52-week highs (as of 7/24/25): Allegion (ALLE), Altius Minerals (ALS.TO), Broadcom (AVGO), Alpha Architect 1-3 Month Box Fund (BOXX), CBOE Global Markets (CBOE), Cameco (CCJ), Cambria Emerging Shareholder Yield Fund (EYLD), Comfort Systems USA (FIX), Franklin FTSE Japan Fund (FLJP), Intercontinental Exchange (ICE), Lynas Rare Earths (LYSDY), VanEck Morningstar Wide Moat Fund (MOAT), Ryder System (R), ResMed (RMD), ProShares Ultra Technology (ROM), TransDigm (TDG), Uranium Energy (UEC), Global X Uranium Fund (URA), Veeva Systems (VEEV), and Vanguard S&P 500 Fund (VOO).

In today's mailbag, more thoughts about tariffs... Keep your notes coming. As always, send your comments and questions to feedback@stansberryresearch.com.

"While I am not in favor of Trump's tariff ideas, and his way of going about getting what he wants, it is tiresome to hear his opponents cite how 'free trade' has enriched us and the world. Saying 'Free trade' has existed since WWII is an oxymoron of the highest degree. We have subsidized the world since WWII by agreeing to their ridiculous tariffs and defending our allies, with Europe and Japan receiving the greatest amount of our largesse. The world's refusals to follow our example of low tariffs and freedoms in society leading to economic growth and upward mobility has only increased their dependence on us." – Subscriber Robert B.

Good investing,

Dan Ferris
Medford, Oregon
July 25, 2025