Galiga: Market Bubble Forming, We’ve Seen This All Before

Right now, people are betting on how many hard-boiled eggs this market can eat in an hour. The “smart money” and the financial press is spinning 50 as completely impossible. The crowd seems to wholeheartedly agree. Place your bets now. And hint: bet wisely.

In previous reports I warned that the excitement among investors over a pro-trade Trump administration is driving an exuberance which is forcing the Dow to new records almost on a weekly basis. This is happening in spite of the underlying assets and financials not changing all that much since the Obama administration. Sure, employment numbers are looking much better, but those are just a function of business leaders increasing payroll based on the same attitudes driving the stock market.

This is precisely the sort of irrational trend I’ve been warning about that could take the Dow to as high at 30,000 in the very near term. And other financial institutions have begun to take notice of the same thing, albeit months too late. According to a recent Bloomberg story, “Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop.”

Pointing to the intramarket correlation factor — which describes the rise and fall of stock, bond and option prices in relations to each other — there is a growing phenomenon of a decoupling of those relationships wherein the price of trades continue to go up independently of each other.

So what’s driving them up if not the mutual increase in prices? The answer is really nothing but pure trader speculation. And now it’s even worse than that: it’s speculation on speculation. In other words, prices are increasing because investors continue to expect prices to increase.

That’s a very dangerous environment for markets because, again, there’s nothing solid underpinning that speculation. As Bloomberg points out, investors are seeking out “excuses to stay bullish,” which means they’re ignoring all the fundamentals which might otherwise bid them to exercise caution and restraint.

And what’s most concerning is that the charts are looking eerily similar to what they revealed in the run-up to 2007, which should give pause for concern to everyone. Anyone still remember 2007? All was rip-roaring great until it was not. Discussed in hindsight, 2007 was described as a bubble(s) bursting. Anyone see much mention of the word “bubble” in the modern press describing 2017? Not much. Instead- to me- it’s practically deja vu, looking like the return of the same kind of “irrational exuberance” before the bubble burst.

If it’s not obvious, I’ve been around for a while. Perhaps you have been too? We both know that direct experience is a great educator if we learn the lessons… and remember them. One of the things that makes me a profitable trader is a completely objective ability to call a spade a spade. I do not forget the past or readily subscribe to Wall Street spin of “…but it’s different this time.” Contrary analysis says that when just about everybody is buying and spinning any and all reasons to keep buying more, it only takes a little bit of selling to set off a correction. Just think about it: in any situation where there is almost all buyers and practically no sellers, which way do prices have to go? And when those buyers are finally just about all in?

Toward the ends of extreme scenarios like that, what do things look like? In the increasingly bullish scenario, everyone looks for just any additional reason to “buy more.” Good news supporting the cause is amplified and bad news is mostly ignored or “shrugged off” seems to be the most popular phrase spun in the investing press today. And that’s what things increasingly look like to me. The tangible stuff on which record markets should be built is mostly lacking. Fundamentals- that is BUSINESS fundamentals- are generally about the same as they were months ago. The business data that matters most isn’t painting any pictures that all is particularly great and gaining strength, except the SUBJECTIVE (aka massaged and/or amplified) data that helps support the cause of finding any reason to encourage buyers to buy more.

Where does this lead? We already know… because history has shown us again and again, and again. Where does this always lead?

Imagine yourself at an auction. A desirable item is up for bids. You want it. The guy next to you wants it. The lady next to him wants it. The whole room wants it. And they want it bad. The auctioneer is rolling and bids are fast & furious. How do all such auctions play out? No matter how much enthusiasm there is to own the item at the beginning of the auction, eventually the bidders start thinning out. Once someone bids up to as much as they have- they’re out (much like once investors are basically “all in”, they can’t “buy more” no matter how bullish they feel because there’s no more spare funds to use). The richer among them who still have some spare funds bid, push the “market” higher… and higher… and higher. A few around the room may start gasping in almost disbelief that “treasure” has been (irrationally) bid up to such a record high. And then those with the last remaining spare cash bid their final, “all in” bid. Going. “Anyone else (have any other spare cash to throw at this thing)?” Going? “This market is going to the moon. Better buy more now.” Going. “You don’t want to miss out on a market that is only going higher!” Going. “Anyone else? Anyone?” Sold!

Now think about the modestly different auction that is the stock market. The desirable item is only an idea of either “good returns” for the “half full” crowd or “don’t miss out” for the “half empties. The bidders are not bidding for just a single thing. ALL of them are going to “win” their own auction within THIS auction because the item for bid is available in practically unlimited supply (it’s just virtual pieces of paper stored in some computers on the exchanges. It is incredibly easy to make more virtual paper should all of the existing virtual paper get purchased). The perceived value in unlimited supply is mostly an idea that others will want to pay more for your virtual paper some time after you buy it at near record highs now. In other words, current fundamentals & data that underpin the value of the virtual paper is NOT supporting the idea that it will be worth more in the future. Instead, it’s mostly just the frothy enthusiasm of fellow bidders wanting to believe records will be broken again and again IN SPITE OF conflicting fundamentals and data… and throwing their spare cash at it because they are so convinced.

Perhaps it WILL be different this time?

Where have I seen that before?

And when the last buyer bids… and when the last of those with spare investable cash finally go all in such that there’s pretty much no one else to buy, what happens? What is the only thing that can happen when there’s no more money left to buy in? The auctioneer drops the hammer and proclaims “SOLD!” Beware that hammer.

One of my favorite movies of all time is a Paul Newman classic- Cool Hand Luke. If you haven’t seen it (or haven’t re-watched it in a while) I encourage you to let Newman and a terrific supporting cast entertain you for a couple hours as soon as you can spare those hours. In my opinion, it is truly an oldie but a goodie. Why can’t they make movies like that one anymore?

There’s a particularly relevant scene in that movie that illustrates this message. In the movie, Newman as Luke is basically an especially “cool cat” prisoner. In today’s movie-making mentality, he’s almost an amazing, mythical super-hero without a cape or mask and doesn’t even need any CGI special effects to work his wonders. He and a few friends set up an irrational- maybe impossible- task that he can eat 50 (that’s FIFTY!) boiled eggs in ONE hour.

I love the scene because it is a show within a show- the visible or public show that Luke will try to eat 50 eggs and the private show of how those who compelled by the “public” show can be exploited to make a few people richer. Even Luke’s closer friends in the movie initially scoff at the possibility to throw gas on that fire: “NOBODY can eat 50 eggs.” On cue(?), another suggests the monetary exploit by triggering bets among the public. And the game is on. The beginnings of the game (a clever setup?) goes something like this:

What you don’t see in that clip is the part that helps illustrate the point I’m making today. Shortly thereafter, the public show (Luke attempting to eat all those eggs) is underway. Everyone is enthralled and following this “market” closely. Even during the hour, bets continue to be placed. Luke’s close friends are taking the seemingly-crazy side that he can do it. Just about every other “buyer” is betting that he can’t. Bet (buyer) after bet (buyer) is stacking up against Luke but there’s still a little money sitting on the sidelines, not yet committed.

Well before 50, Luke stops eating. His belly is puffed out, full of eggs. He looks like he may have about reached his limit. He roams around the room. He seems almost sickly. It looks bad-to-worse for the “smart money.” There’s far too many eggs still to go in far too little time… and Luke already looks like he’s about to bust.

New bets fly. There’s just no way he can do it. And the show within the show culminates when Luke’s closest friend leans in and whispers that ALL available cash is now bet. There are no more buyers to be wooed. Every single prisoner is “all in.” The auctioneer’s hammer stands ready to fall.

What happens next? Luke’s appetite for eggs magically returns and he rapidly runs toward the record goal. If you haven’t seen this classic movie, let this be the point where you stop reading so I don’t spoil the final outcome of this scene for you. Assuming just about every reader has probably SEEN it, I’ll assume finishing the tale isn’t really a spoiler…

Luke- the “smart money” side of the market- wins and all the irrational gamblers (investors) on the wrong side of that bet lose. This particular “market” crashes as soon as the 50th egg goes down. All the buyer’s bought and only selling can follow. In this case the selling is represented by the “smart money” switching into a mode of loan officer: loaning the overly exuberant up to just minutes ago what was their own money back… with interest obligations of course. And a new game is afoot. And that game too is probably another that we all know too well if we can take a moment to recall history.

What happened before the 2007 bubble burst? Every “prisoner” was buying in with all they had. And what happened after the burst? About every “prisoner” was having to beg & borrow to find enough dollars to try to squeak by and/or recover from their losses. The “smart money” of 2007 didn’t even need to suffer through Luke’s bellyache.

As I watch these markets achieve record after record mostly on exuberance and hope more than anything very tangible, I see Luke playing his market, vacuuming in whatever spare cash can be sucked in. Sometimes he stops eating eggs and looks a little sickly to lull in some fence-sitters (“buy the pullbacks”). But the same game is in play. When everyone is just about “all in,” there’s only one way for the market to go. It won’t matter how bullish everyone will be at that point. Collective sentiment does not make markets go up, buying dollars push markets higher.

For those married to only bull-market momentum (that is, those who only know how to profit on a RISING stock market) their losses will be painful… AGAIN. For those that that know how to make money in both rising and falling markets, big moves up or down can be some of the most profitable trades of your life. While many will lose in a crash, there are a few that know how to make a lot of money quickly as stocks or markets crash.

Now, you may read this and think I am extremely bearish today. But that’s not true. WHAT I AM IS EXTREMELY EXCITED. Why? Because I developed my skills over my lifetime to make money both ways. In short, I LOVE volatility. Big swings up or down are especially profitable and it doesn’t really matter to my methods whether the markets rise or fall. What matters is anticipating those peaks and valleys and using the right kinds of trades to take maximum advantage of them. It doesn’t even have to be whole market movements either. The very best profits are in the individual stocks that can rise or fall much more dramatically than whole markets.

Does this mean I’m hoping markets will crash and people will lose a lot of money? Of course not! My work is always focused on trying to help everyone make more money. I hope everyone grows as rich as they possibly can. But hope doesn’t make markets only rise. And history shows markets never move in just one direction forever. When markets are at extremes, they NEVER just keep pushing the bar to greater extremes. They turn. They ALWAYS turn. So while I’ll HOPE- perhaps right with you- that no one ever loses another nickel in the markets again, we both know what will really happen, don’t we? This particular game is just not made to work like that. Most of those prisoners had to LOSE that bet so that the “smart money” could win.

Between here and DOW 30K, I anticipate plenty of lucrative volatility. Markets and stocks will roar higher and crash, over and over, and I look forward to helping my followers take great advantage of all of those events. My team and I are working on something- (to quote from Cool Hand Luke again) A “WORLD SHAKER” SOMETHING- to directly help my followers do just that. If you are interested in learning more, send me an email at: [email protected] and I’ll be in touch about that very soon. In the meantime, I’ll continue to offer broad views in this column AND welcome requests from you as to what topics you might like to see me cover in future editions- just send them to that same address.

Ask away, I LOVE to help people learn and prosper.

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