Bubble, bubble, toil & trouble
With apologies to William Shakespeare, signs of a bit of froth and frenzy have begun to be acknowledged in markets this last week. As we have previously noted, liquidity is the fuel for such episodes, and as long as liquidity remains abundant, we should expect more, rather than less, evidence of irrationality.
So, this blog post isn’t a prediction of impending doom, as much as it’s a journal entry in the latest boom’s transition to a possible bubble.
When investors are pouring into risky assets like meme stocks, cryptocurrencies, and unprofitable companies, it should always cause you to sit up and pay attention. But you can ignore the descriptions of “near-euphoric rebound” and “meltup”. All that’s happening is investors are speculating and trying to make a fast buck because conditions support such activity – liquidity is abundant, inflation is stable (for now) and growth is positive (also, for now).
Meanwhile, experts like Ed Yardeni, whose price-to-earnings (P/E) charts we find immensely useful, were quoted in the Wall Street Journal, thus, “A lot of us thought the [spring] correction had to do with the fact that valuations were rather stretched back in January and February, yet here we are. It’s almost like a slow-motion melt-up.”
So it’s understandable that many in the market will point to the frenzied market activity and cry ‘the sky is falling’. But while periods of speculation that artificially inflate asset values, often precede corrections, they aren’t causal. It is important to make that distinction.
Meme stocks and short squeezes
The resurgence of meme stocks, reminiscent of the 2021 GameStop and AMC Entertainment craze, is a reasonably reliable indicator of market exuberance. Retail investors, rallying together on social media platforms like Reddit and X to create buzz, are targeting heavily shorted stocks to trigger short squeezes, where short sellers are forced to buy back shares at higher prices, further driving up stock prices.
Kohl’s, the embattled department-store chain, saw its shares surge almost 40 per cent one day last week, after doubling at the open. Similarly, Opendoor Technologies, a real-estate platform, jumped 150 per cent in one session last week. Other stocks, like GoPro (up over 50 per cent) and Krispy Kreme (up about 20 per cent), also soared without catalysts.
Meme-stock traders often target companies with high short interest, like Kohl’s, where nearly half the shares outstanding are sold short, according to FactSet and the Wall Street Journal. Growth and profits aren’t relevant either. Kohl’s revenue has been declining for years as consumers shift to online shopping, and its bonds are trading at steep discounts amid concerns about its longer-term viability.
Unprofitable? No problem.
In another sign of irrational exuberance, investors are heavily buying shares of profitless companies. According to analysis published by the U.S.-based Bespoke Investment Group, of the 33 stocks in the Russell 3000 that tripled in price since April’s market bottom, only six generated a profit in the last year.
Cryptocurrencies too
The cryptocurrency market is also surging, with Bitcoin and Ethereum reaching record highs. Here, however, enthusiasm is partly based on the Trump administration’s pro-cryptocurrency policies and the growing acceptance by and improving access for mainstream financial institutions. It also doesn’t hurt that publicly traded companies like Trump Media & Technology Group, which recently accumulated US$2 billion in bitcoin and bitcoin-related securities, are also offering access to investors to the bubble by essentially transforming their shares into leveraged bets on crypto.
Wall Street will sell what Wall Street can sell.
Reminiscent of the SPAC (Special Purpose Acquisition Company) Initial Public Offering’s (IPO) of the early 2020s, today, almost 60 companies are pursuing “bitcoin treasury strategies,” amplifying risks simultaneously in the crypto and stock markets. Such practices could deepen selloffs, but the trend continues unabated.
Sure, stretched valuations raise flags, but…
For those of you concerned that this could lead to a broader financial crisis, remember that for contagion to happen, the bubbling and crashing assets must be held in large amounts by ‘structurally important’ financial institutions. That doesn’t seem to be the case here.
High valuations across the market are worth noting. Palantir is trading at more than 100 times revenue and over 420 times net income. Meanwhile, the S&P 500 is trading at 22.5 times its one-year forward earnings, compared to a 10-year average of 18.8. technology giants like Nvidia and Broadcom appear particularly expensive relative to their earnings. Meanwhile, the equity risk premium – the gap between the S&P 500’s projected earnings yield and the yield on 10-year Treasurys – is near zero, indicating that stocks offer little extra return compared to lower-risk bonds. That situation is rarely sustainable.
Other warning signs
Despite the market’s optimism, economic indicators suggest a little caution too. U.S. private-sector job growth has fallen to its lowest level in eight months, hiring there has slowed, and reports are that college graduates are struggling to find jobs. Economists worry that a sharp labour market slowdown could curb consumer spending and halt economic growth, adding to the fears of tariff-related inflation slowing consumption.
Surging meme stocks, ultra-high P/E ratios and a cryptocurrency frenzy, point to a market bubbling away. While the current rally has lifted indices out of April’s tariff-driven lows, the speculative behaviour and disregard for fundamentals suggest that investors are again throwing caution to the wind.
As traders continue to chase high-risk assets, their buying pushes prices higher and further gains depend on the greater-fool principle. While none of this means a correction is imminent, I am reminded of Warren Buffett’s instruction to be fearful when others are greedy.
Protecting yourself
While selling stocks and moving into cash might seem like a natural conclusion, getting the timing right, is always difficult. Not only do you have to get the ‘sell’ timing right, but buying back in is also an equally uncertain challenge. Therefore, an increasing number of investors are turning to asset classes beyond equities to generate returns uncorrelated to markets, that may provide a more restful sleep when public markets fluctuate. Private Credit – without exposure to property developers – and alternatives such as arbitrage funds, could potentially help to preserve capital and produce income.
Find out more by speaking to David Buckland, Rhodri Taylor or me, here at Montgomery.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
