We're too depressed and cynical to produce a boom and bust.
Pessimism is like fertilizer for the stock market. And there is plenty of it right now.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
This article is entirely free to read.
The S&P 500 is up 650% from its GFC low in March 2009. Over the past 6 months alone, it’s up 26%. Its forward P/E ratio is now 22x, about 30% above its average of 16x over the past two decades. With such a momentum and such a valuation, it’s natural to question the sustainability of this bull market.
When stock prices rise, they can do so in anticipation of fundamentals improving beyond current expectations. Or they can do so due to irrational investor exuberance in a pure sentiment run. The former is typically sustainable. The latter is not. The former must be respected. The latter must be avoided.
Markets are always carrying out price discovery. The resulting volatility is not a bad thing. Investing is about bearing volatility. Accepting volatility earns a risk premium over time. An asset without volatility cannot sustainably earn more than cash. That is why buying and holding broad indices like the S&P 500 or the MSCI World is a strategy with a positive expected value.
Every once in a while however, various forces converge into a perfect storm and create a proper crash that goes far beyond typical volatility. Investor exuberance is a central ingredient in such a cocktail.
When I carry out my macro research, I am usually very data focused. I put a lot of effort looking into investor positioning, fiscal flows and monetary policy. Today, I want to complement that with a more qualitative and philosophical perspective. I want to talk about sentiment more broadly in our economy and how that may inform us about downside risks. Perhaps you don’t agree with much (or even any) of it, since some of it inevitably alludes to some of my political views. But either way, I believe it will be some worthwhile food for thought for you.
My hypothesis is this: A generational crash like 1929, 2000 or even 2008 is only possible in an optimistic society that is excited about the future and complacent about its risks. 2024 lacks these features.
TLDR Summary
A crash requires euphoria. And euphoria requires optimism about the future. We had that in the 1920s and 1990s, which were prosperous times where people believed in the positive effects from the proliferation of technology. Today, pervasive cynicism and pessimism manifests itself in various aspects of life in general and markets in particular.
Speculation on AI infrastructure is cynical because investors are not betting on a technology breakthrough directly. They are merely betting that companies will keep trying. NVIDIA shareholders won’t get dividends from great calculations happening on their GPUs. Those would accrue to their customers. Nobody is bidding up Tesla who’d be a prime candidate.
Speculation in crypto is cynical and pessimistic because hoarding some piece of digital rock is the precise opposite of betting on human ingenuity and innovation. Bitcoin is not progress. It is not hope. It's based on an archaic understanding of economics. People buy unproductive pure store-of-value assets because they are afraid of the future. They are afraid of a collapse in the value of productive assets. They fear anarchy and a civilizational downfall. While some do believe in the technology of Bitcoin and its promise of an alternative financial system, those buying 2nd tier sh*tcoins are fully aware these are ponzis. How much more cynical can it get?
Pessimism about the future also manifests itself outside of financial markets. Many of us believe we will cross some sort of climate tipping point in a few years that will end the world. Fearing emissions, some are even opting out of procreation. Choosing one’s own extinction as the ultimate sacrifice to please the gods of a new religion that took the void left by Christianity.
This is not (yet) the roaring twenties or dotcom. This is more like fin de siècle in the late 19th century. That was a time of disillusionment with technological and cultural progress that gave rise to nationalism and socialism both of which burned the world in subsequent decades. This analogy scares me as a citizen. But it makes me happily buy the dip as an investor. Because as a true child of my time, I am cynical, too.
A crash requires euphoria. And euphoria requires optimism about the future.
The 1920s harvested the fruits of the rapid industrialization of prior decades which allowed for a widespread adoption of consumer goods like automobiles, radios and household appliances.
As I framed it in the article above:
The 1920s were boom times, the extent of which we can barely fathom today. Yes, the internet and its mobile iteration have disrupted our life a lot. But think about someone from the late 19th century living to 1925. No horses, candles or the iceman anymore, but cars, light bulbs and refrigerators. A new urban middle class discovered the sweet life of being a consumer.
People’s lives got much more comfortable in a very short period of time and they were optimistic about the proliferation of technology. They had not seen the destructive potential of it yet.
Similarly, the 1990s were also a time of prosperity. It all gravitated around the microchip which made existing businesses more productive and allowed for new businesses to form. If boomers are leaving one legacy to us, it’s that they completed much of the commercial scaling of information technology. Economic growth rates were staggering and inflation was not a problem. In fact, 1994/95 is the prime example of a soft landing. The one the Fed is currently trying to achieve.
Where is optimism these days?
There is a bit of exuberance in AI infrastructure and in crypto. But let’s think for a moment about how cynical these investment themes are.
AI Infrastructure
If you were really excited about the potential of AI, would you long NVDA 0.00%↑? Or would you long TSLA 0.00%↑?
People betting on NVIDIA (or SMCI 0.00%↑ for that matter) are not really onboard with the idea that there is value to be found in more compute. They simply bet on people trying to find it. It does not matter for Jensen Huang whether all those computations on his GPUs generate an attractive return. That risk is born by his customers and their shareholders. A Tesla investor needs AI to work for his investment to pay off. The NVIDIA investor simply needs Tesla and other companies to keep trying.
And to the extent people do believe that is the moment of AI, many do not focus on its economic potential. Instead, they fear some sort of doom scenario that will end society. There is a weird subculture online that is YOLOing all their money away in anticipation of the singularity. You might find the screenshotted post below bizarre, but it received 550k views and 1k likes, which is a lot for an account the size of Cate Hall (18k followers today, probably less a year ago).
If the AI singularity was indeed near, it would mean we are close to a point where computers outperform humans in virtually any task. Wouldn’t that massively shift economic value from labor to capital? Isn’t that all reason you need to NOT p*ss away your capital?
Crypto
Instead of buying ownership stakes in successful businesses providing important goods and services, many people rather long crypto sh*tcoins perfectly knowing they are ponzis that are ultimately worthless.
In Nov/Dec'22 (i.e. before the recent bull run, the numbers are probably more extreme now), the CFA Institute surveyed ~3,000 investors in the US. Per this survey, almost 60% of Gen Z and Millennials owned crypto, about 20% more than individual stocks. More than 25% owned NFTs, more than those owning ETFs, which is the most obvious passive investment choice for wealth building and wealth preservation.
A majority of the under 40 year olds in the US rather hoards some piece of digital rock rather than taking an ownership stake productive assets in the US to participate in human ingenuity and technological advancements. What will happen to equity flows when these people are finally disillusioned by crypto?
Crypto’s center of gravity is Bitcoin. Bitcoin is not progress. It is not hope. It's based on an archaic understanding of economics predicated on the idea that hoarding a monetary asset is supposed to earn a positive real return while not providing any value to the economy. It's precisely not betting progress, but the opposite. People buy unproductive pure store-of-value assets not because they are optimistic, but because they are pessimistic. They are afraid of the future. They are afraid of a collapse in the value of productive assets. They fear anarchy and a civilizational downfall. I know many of you are bullish on Bitcoin and cannot understand my point of view. Ask yourself, why you are really bullish on it. Isn’t it the above?
Since this data is survey-based, we can't be sure about consistency, truth/accuracy and level of representativeness of this data. But I find the results quite telling.
You might perceive Bitcoin as a risk-on asset because it correlates strongly with the likes of Nasdaq. But in the long run, pure store of value assets underperform in periods where productive assets perform well and vice versa. When measured in US Dollar, Gold peaked in the late 1970s, the early 2010s and in 2010s. All of these happened in the middle of or shortly after important recessions or challenging economic times.
Financial markets are a mirror of society. Pessimism is pervasive.
Overbearing cynicism and a lack of optimism are deeply embedded in our Zeitgeist. The climate crisis is the best example for that. Many of us believe the world will end because we will surpass some sort of climate tipping point in the next few years. Personally, I have no idea about climate science, but I am often baffled with how much certainty we believe we can forecast and modulate global climate within a decimal point of a degree decades down the road.
Conviction about climate doom is widespread. Many people make individual consumption choices to save a few kilograms of emissions here and there which is completely irrelevant in the grand scheme of things. Some are even opting out of procreating fearing emissions.
Choosing one's own extinction as the ultimate sacrifice to the god of a new religion that filled the void left by Christianity (the membership rates of which are plummeting in the West). To be fair, family planning is about more than emission fears. People also fear that children are not affordable or they have a different idea about a fulfilling life or they don’t find the right partner on time. But whatever everyone’s personal reason not to have children is, it’s certainly not due to an overbearing optimism about the future. Unsurprisingly, mental health issues are off the charts, particularly in young people. Another manifestation about the pessimist pandemic.
Fin de Siècle
I have thought a bit about what historical precedents there may be to this epoch. The late 19th century seems to be fairly comparable to today. It was a time of widespread pessimism, particularly in Europe. People felt disconnected from technological progress because rapid industrialization and urbanization led to likewise rapid social and cultural changes that challenged traditional values. There were concerns about a decay and degeneration of society.
It was also a time of political instability as nationalism and socialism were on the rise which was precursor of the events of the early 20th century. The 2nd and 3rd volumes of Karl Marx’ Das Kapital was published in 1885 and 1894.
I sense a similar dissatisfaction today which may lead up to similar disruptions. It’s concerning from my perspective as a citizen. But as an investor, it’s one piece to puzzle that suggests that this is not a bubble forming right now. We have to respect the signal that is embedded in the latest stock market momentum. It’s most likely simply a prophecy for a strong cyclical upswing, in the US and abroad.
Interestingly, Fin de Siècle resolved with a strong bull market. The S&P (or more precisely its hypothetical precursor) consolidated for most of the 1880s and 90s. And then it ran 150% from 1897 to 1906 (which by the way culminated into the 1907 financial crisis). Pessimism seems to be a decent fertilizer for the stock market.
Sincerely,
Your Fallacy Alarm
Briliant insight - quickly google search shows there was a preciptous drop in fertility rates back then as well, which further strenghtens the analouge
Great article with intriguing insights! I agree with you on the cynicism of Bitcoin/cyrpto investors(speculators?). 10 years of constant promises that it will change the internet and economy forever has gotten old. At this point, you are swimming against a cult craze that will expire itself eventually. Keep up the great posts!