Investing during a mega-bubble is hard.
In a mega-bubble, the assets most folks want are very likely the worst ones to buy, while the most advantageous assets hold the least appeal.
At this moment of the ongoing mega-bubble, it’s even more difficult, because some of those advantageous assets have gotten more expensive… making it harder to figure out which assets are overvalued, and which ones are still attractively priced.
Mega-bubbles are tough for emotional reasons, not technical ones. Analyzing companies doesn’t suddenly become more complex in a mega-bubble. But pulling the trigger on buy and sell decisions gets much, much harder.
The enthusiasm for the most popular assets plays right into human beings’ fear of missing out (“FOMO”). They don’t want to feel stupid by failing to get rich while others around them are apparently getting rich. Their neighbor (or favorite social media personality) owns Nvidia (NVDA) and has made a 20 times profit on it… So they want to own it and make 20 times their money, too.
Right now, the hot stocks everybody wants to buy are those related to artificial intelligence (“AI”). But folks are playing right into the mega-bubble… and taking on far more risk than they understand.
The Cocktail Party Indicator
The FOMO about AI that’s all over social media today is a classic Stage 4 mania, according to legendary investor Peter Lynch’s “cocktail party” indicator.
In Stages 1 and 2, people aren’t very interested in stocks. They’d rather talk with a dentist about plaque. But as I explained in a recent issue of the Stansberry Digest:
By Stage 3, the market is up substantially, and the dentist is alone in the corner while a crowd encircles Lynch. Guests corner him all night asking for stock picks.
In the fourth and final stage, everyone at the party is obsessed with the market. But this time, guests don’t want stock picks. They want to give Lynch picks. Everybody he meets has a different stock to pitch, including the dentist. Lynch looks up all the picks the next day and, sure enough, they’ve all soared. He writes:
When the neighbors tell me what to buy and then I wish I had taken their advice, it’s a sure sign that the market has reached a top and is due for a tumble.
Spend a few minutes on just about any social media platform and you’ll find the smuggest traders on Earth telling you why it’s stupid not to buy Nvidia shares on every dip. That’s a classic Stage 4 mentality.
You won’t catch me predicting exactly when, but the market is setting itself up for at least a substantial correction, if not a full-blown bear market.
We could also be in for a serious crash, like what happened in October 1929 at the start of the Great Depression, when the Dow Jones Industrial Average fell 48% in 50 days… or in September 2008 during the great financial crisis, when Lehman Brothers went bankrupt and the stock market fell 29% in 30 days… or in March 2020’s pandemic panic, when the S&P 500 Index fell 34% in about a month.
As I tell my readers, our mantra is, “Prepare, don’t predict.” And so, today, I’ll share a few steps that I believe could help investors prepare should the worst come to pass.
The first step is avoiding – or at least being very wary of – four assets most exposed to the mega-bubble.
1. The Mag 7
I’ve frequently pointed out that the Magnificent Seven (or “Mag 7”) tech stocks – Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), Meta Platforms (META), Microsoft (MSFT), Nvidia, and Tesla (TSLA) – are extremely expensive and unlikely to provide good returns over the next several years.
As I wrote on February 14:
With the Mag 7 trading at an average of more than 40 times earnings, it seems that investors don’t believe this group of tech stocks will do anything but continue to soar. They’re guilty of extreme optimism, much of it based on a widely hyped, highly uncertain category of investments…
The Mag 7 are very likely making the same mistake their competitors made when they initially disrupted their markets. Apple started out in a garage in California and went on to disrupt the personal-computing market. Alphabet and Meta originally disrupted competitors from college dorm rooms.
Today’s high Mag 7 valuations show no trace of worry that a similar disruptor is working in a garage or dorm room somewhere. Alphabet and Meta seem particularly vulnerable to disruption, given that their products are free to users and that competitors face no meaningful barrier to entry…
Anybody can potentially write a piece of code that revolutionizes a whole business, after all.
2. Semiconductor Stocks
Today, the Philadelphia Semiconductor Index (“SOX”) is showing heightened volatility after rising 85% off its 2023 lows.
The index is currently trading about 22% below its July 10, 2024 peak. And it has had at least five declines of between 11% and 25% since last March.
Take a look…
Large declines of this kind are nothing new, either. The SOX behaved similarly around the dot-com peak and lost 84% of its value in the ensuing bear market.
Investors seem to have forgotten since then that the semiconductor industry is every bit as cyclical, volatile, and risky as industries like biotech and mining.
Semiconductor companies similarly attract huge amounts of capital when times are good, leading to an oversupply of production capacity that ultimately floods the market and causes prices to fall.
3. Capitalization-Weighted Indexes
Most folks with 401(k)s and other retirement accounts have some type of exposure to S&P 500 or Nasdaq funds.
Those are capitalization-weighted indexes. That means the stocks in those indexes are weighted by the size of their market caps. If you invest in a cap-weighted index fund, you’re putting the most money into the biggest stocks and the least money into the smallest stocks. Most times, this isn’t a problem. But now is not most times…
Not long ago, the top 10 stocks in the S&P 500 – which includes the Mag 7 – hit a record 37% of the index. So, investors who have S&P 500 funds in their 401(k)s are mindlessly putting more than a third of their investment dollars into the 10 most expensive and popular stocks.
That’s too much, and history has shown that it’ll likely lead many investors to underperform over the next decade or more. Investors should explore alternative assets and equally weighted indexes.
4. Almost Every Cryptocurrency
Today, there are more than 11,000 cryptocurrencies with a total market capitalization of $3 trillion. Bitcoin (BTC) makes up 58% of that, at $1.75 trillion. No other cryptocurrency even comes close. The next-largest crypto by market cap is Ethereum (ETH), at just $263.9 billion.
Nearly all the rest are more likely than not to eventually be proven worthless, no matter how large their market caps are today. That may well be the point of the crypto market. It’s a place where scrappy innovators can experiment with ideas to see what they can use cryptos to do in the real world.
But the crypto market is also loaded with plenty of pure garbage for garbage’s sake. For example, the Dogecoin (DOGE) cryptocurrency – created as a joke to make fun of crypto speculation – currently has a market cap of almost $30.6 billion. And “meme coins” like Hawk Tuah (HAWKTUAH) and Peanut the Squirrel (PNUT) have silly origin stories.
I suspect that when the equity-market mega-bubble finally pops, many cryptos will go to crypto heaven and we’ll find out which ones have real value.
Don’t forget that when the Nasdaq fell 36% from November 2021 to December 2022, bitcoin fell 76% during the same period. Those who allege that it’s a store of value or a currency still can’t demonstrate either function. Good stores of value and good currencies aren’t that volatile.
Prepare, Don’t Predict
I said at the top that our mantra is “prepare, don’t predict.” Nobody buys an insurance policy or installs an at-home generator because they hope to use it. They do it because they’ll be glad to have it if they need it… and by the time they do need it, it’ll be too late to get it.
Avoiding these assets is only one part of what you should do to prepare. Finding assets that are worth buying is another.
I recently published a list of “anti-bubble” recommendations to members of The Ferris Report.
Anti-bubble assets are those that investors have been ignoring while buying up bubble assets. These assets tend to be out of favor compared with bubble assets – meaning they’ve performed poorly in the recent past, and most investors expect more of the same in the near future. They also tend to be demonstrably cheap.
If you want access to these names, you can learn more right here.
Good Investing,
Dan Ferris
Editor, The Ferris Report