Valuations do not provide an environment for “intelligent investment” here, nor do market internals provide an environment for “intelligent speculation.” Aside from very minor tactical shifts, the main opportunity that investors have in the current environment is the opportunity for baseless gambling.
Record stock prices here are the product of a) record valuation multiples that have been inflated by a decade of zero interest rate policy, times b) record earnings that embed distorted profit margins inflated by trillions of dollars of temporary deficit spending. Investors are paying top dollar for top dollar.
By relentlessly depriving investors of risk-free return, the Federal Reserve has spawned an all-asset speculative bubble that we estimate will provide investors little but return-free risk.
There are certain features of valuation, investor psychology, and price behavior that emerge, to one degree or another, when the fear of missing out becomes particularly extreme and the focus of speculation becomes particularly narrow. We’ve suddenly hit a motherlode of those conditions. Emphatically, this is not a forecast. It's a statement about current, observable conditions.
Speculative psychology is the only thing standing between an hypervalued market that continues to advance and a hypervalued market that drops like a rock. Our best gauge of that psychology - the uniformity of market internals - remains divergent enough to keep market conditions in a trap-door situation.
The current perceptions of investors about their own "wealth" are out of line - to a historic extent - with the economic fundamentals that are available to support the claims.
There’s no question that persistently deranged and activist Federal Reserve policy has required investors to adapt. But the form of that adaptation is crucial. The thing that 'holds the stock market up' isn’t zero-interest liquidity, at least not in any mechanical way. It’s a particularly warped form of speculative psychology that rules out the possibility of loss, regardless of how extreme valuations have become.
A remarkable feature of extended bull markets is that investors come to believe that steep market losses are impossible. None has so thoroughly nurtured that illusion than the bubble we find ourselves in today.
When the time comes to ask the question – 'What triggered the crash?' – remember that this is the least important question. The important question to ask is 'What drove the bubble?' That's where the lessons are. The most egregious role will - or should be - assigned to the Federal Reserve.
Equilibrium is like conservation of mass – every purchase is also a sale; every security that’s created must be held by someone until it is retired; the shortfall of one sector must be the surplus of another. Once you insist on thinking in terms of equilibrium, it becomes obvious how many discussions in economics and finance are incoherent.