Warning Light Flashing Red

Not everyone has an IRA or 401K invested in the stock market, for those who do, the red warning light is flashing red: markets have reached historic extremes on numerous fronts.

Just like in 2000, proponents claim "this time it's different." Back then, the claim was that since the Internet would be growing for decades, dot-com stocks could go to the moon and beyond.

The claim the Internet would continue growing was sound, but the prediction that this growth would drive stock valuations into a never-ending bubble was unsound.

Once again we hear reasonable-sounding claims being used to support predictions of a never-ending rise in stock valuations.

What hasn't changed is humans are still running Wetware 1.0 which has default settings for extremes of emotion, particularly manic euphoria, running with the herd (a.k.a. FOMO, fear of missing out), and panic/fear.

Despite all the assurances to the contrary, all bubbles pop because they are based in human emotions. We attempt to rationalize them by invoking the real world, but the reality is speculative manias are manifestations of human emotions and the feedback of running in a herd of social animals.

Here's a chart of financial assets as a percentage of Gross Domestic Product (GDP). (below) Note that in the "Glorious Thirty" years of the postwar era of broad-based prosperity, financial assets were around 3 times GDP.

This ratio increased with every one of the three bubbles since the mid-1990s: the dot-com bubble in 1999-2000 (Fed Bubble #1), the subprime bubble in 2007-08 (Fed Bubble #2), and now the Everything Bubble of 2020-21 (Fed Bubble #3). Financial assets are now 6 times the size of the "real economy" (GDP), an extreme beyond all previous extremes.

This reflects the dominance of financial assets based on extreme expansions of debt, leverage, and speculation.

The red warning light of extremes in sentiment, valuation, etc. can flash for quite some time, but as I've noted over the years, speculative bubbles often display symmetry: those that spike higher tend to collapse in a mirror-image of the manic rise. This symmetry isn't perfect, of course, just as correlations are rarely if ever perfect, but as a generality, bubbles tend to display symmetry as manic greed slips into doubt and then cascades into panic. (see chart below)

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Disclosures: None.

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