There are a number of classic signs of speculative fever in the capital markets, and they are all currently present.
Valuation: P/E ratios have moderated somewhat due to strong earnings, but they remain in the top 5% of historical experience. Companies with no earnings and uncertain prospects are able to raise capital easily, and IPO valuations seem disconnected with fundamentals.
A predominant narrative: AI and crypto dominate the markets and the media. Remember the Internet in the late 1990’s and housing in the early 2000’s? Railroads and radio were also the talk of the town in their respective eras.
Retail participation in the markets and FOMO: Massive flows into single stock and single sector ETFs, meme stocks, cocktail party conversation dominated by financial markets, heavy trading activity by retail investors, “buy the dip,” social media as the prime source of information, narrow market leadership, predominance of momentum investing, ridicule of skeptics (“they just don’t get it”) and huge growth in online betting and prediction markets.
Risk appetite: Investors are comfortable moving funds to ever riskier and/or lower quality assets: “retailization” of alternative assets, explosion of private credit, narrow credit spreads, hot IPO market, and relaxed underwriting and lending standards.
Leverage: Option trading, flows into leveraged ETFs, and margin debt.
I could add a number of additional examples for each of these categories, but I’m sure you get the picture. These are indications of extreme optimism, “new era” thinking, and a sense that it is easy to make money. The field of Behavioral Finance has identified confirmation, overconfidence, narrative fallacy, recency, and herd instinct as biases and prejudices that can cloud our thinking resulting in unwise decisions. They contribute to speculative excess, and all are present.
The best way to illustrate what is going on is with hard data, so I have included the following graphic which plots margin debt versus the S&P 500. Note that the two track each other closely, and further, peaks tend to be contemporaneous. The recent trajectory of both series is stunning; margin debt is literally “off the charts.” Unfortunately, this doesn’t tell us when it will all end because peaks are only visible after the fact.
It is difficult to know whether we are in a speculative bubble because bubbles always start out with a reasonable premise and at least a kernel of truth. In this case, AI will change the world, corporate earnings are incredibly strong, AI capital spending is boosting the economy, and fiscal policy is highly stimulative. Markets have a number of tailwinds! So, what’s a poor investor to do? Because market timing is incredibly difficult to get right, those with balanced long-term investment programs should stay the course. However, anyone considering joining the speculative fray may want to think twice. And, those who do jump on the bandwagon should do so with only a modest portion of their net worth.