Wild Bull Market or Bubble?

Here we are on July 4, fire cracker day, when we get to celebrate America’s beginnings…a good time to go back to basics.

Rule number one for investors: know what market you are in.

Is this a wild bull market or a mania, a bubble set to pop? It makes a huge difference. Unfortunately, bubbles always end in disaster. For confirmation, see the manias of 1720, 1772, 1825, 1873, 1929, 2000 and 2007. The only consistent winner was gold.

When a bull market ends, it’s because a recession is coming, the economy is slowing down and the Fed has been raising rates. Investors sell stocks and flee to the long end of the bond market because they expect a period of low-to-no growth. Interest rates fall, the yield curve flattens, helping the economy to recover. Demand for short-term money declines as investors no longer borrow to speculate. It’s all quite rational.

But when a bubble pops, investors flee into short-term instruments; liquidity is king, the dollar soars, debts are liquidated, default risk is a major concern and most interest rates rise. Margin clerks emerge from the woodwork and take control. The ruling emotion is panic.

Bull markets end when the perception of earnings growth disappears. Manias, on the other hand, end when the market runs out of buyers. So, which is it?

Where are we in 2017? Look around. The stock market is supposed to be the great humbler but new records are coming fast and easy. The Dow Jones Industrial Average is up 8% for the year and flirts with a record high practically every day. Bonds are no fun, since the yield curve is flattening and three-month Treasuries yield 1%. So money flows to stocks.

Andy Kessler writes in the WSJ that a friend of his used to run a large-growth mutual fund. In the dot-com mania of 1999, tens of millions of new capital would flow in every single day. Trying to figure out where to put it, he would consider the new batch of initial public offerings and then, inevitably, he just would buy more Yahoo or America Online or Cisco or, what the heck, Yahoo again.

Today, money is flowing into exchange-traded funds. But because ETFs are weighted by market cap, that money flows into the biggest names: Facebook , Amazon, Apple, Microsoft , Google. These are the classic momos, the momentum stocks. That’s what’s working now. What could possibly go wrong?

The economy isn’t picking up, earnings aren’t growing, but all will be well anytime soon because business is being transformed by mobile, cloud and artificial intelligence and President Trump is going to cut taxes. But who doesn’t already know that? On the flip side, debt has never been higher, the Fed is raising rates and central bank balance sheet growth is beginning to slow. Does anyone care?

In less than a year, at least 50 companies, including one named Mysterium, have raised hundreds of millions of dollars via something called Initial Coin Offerings, selling a percentage of a new crypto-currency service in exchange for other digital coins. That’s a modern version of the infamous blank-check company that ended in tears in 1929.

Pundits pore over charts of volatility and put-call ratios. Forget that. Just look around. Are investors exercising care and good judgment?

Real investors survey the landscape and look for signs of a market gone mad. In one week in late 1999, the hedge fund Andy Kessler used to run had two groups from the Middle East each insisting on wiring them $500 million. He knew what that meant. His fund politely declined and started returning money to existing investors.

How about a few months back when a CNBC host insisted that Uber was a bargain at a $68 billion valuation because it’s a ‘disruptor’? Or when Amazon bought Whole Foods for $13 billion and its stock went up the same day by more than that amount? Or when Tesla missed its numbers yet again and the stock rose anyway because the analysts were thrilled to hear that Elon Musk planned to retire on Mars? Or when the price of a bitcoin, backed by nothing but software tripled in a year to $3,000 each? Or when Hertz stock rose 14% on news of a deal with Apple for a self-driving car that doesn’t exist?

Do you think just maybe this is a bubble?