Bubble? What Bubble? About That Stock Market: Early 2025

Greetings,

As I've mentioned in numerous correspondences, the US stock markets continue to become more overvalued each day the indices rise.

But first, how did we arrive at this point?

Mainly due to excess government spending.* The US Government is ‘deficit spending’ to nearly 2 trillion dollars per year.

*Yes, eagle-eyed readers, inflation is caused by more than deficit spending (beyond the scope of this newsletter), but yes, do include other factors such as Fed Quantitative Easing, Fiscal deficit spending, as mentioned, the US Treasury draining its cash balances via the TGA, (Treasury General Account), and other forms of liquidity injection into the markets/economy. That money has to go somewhere and go into the stock market.

Example of Deficit Spending:

Remember, at home, deficit spending would look like this: you earn $100,000 per year, you spend $150,000 per year, and you are deficit spending by $50,000 per year. Eventually, that catches up, assuming income does not. That’s the most straightforward view of deficit spending.

If not for deficit spending, the US Economy would be in a quantum recession. Let’s review.

US 2025 forecasted GDP Growth: 3.00% (+/- within that range- see above)
US Government Deficit Spending, 2025: 7.00% of US GDP

The Math:

+3.00% US 2025 forecasted GDP Growth
- 7.00% US Government Deficit Spending
____________________________________________________________
= -4.00% Private sector contraction.

Without government spending, we would already be in a hefty recession, as the private sector contracted at -4.00% annually. Excessive government spending is only holding up the economy, which is NOT sustainable.

Reminder: During the Great Financial Crisis (GFC) of 2008-2009, the US Economy ‘only’ contracted by -4.10% to put today’s expected -4.00% private sector contraction into perspective.

Now, about the stock market:

Typically, investors look at the ‘price to earnings’ (or PE ratio) as a measure of value in the stock markets. However, companies can manipulate earnings in various ways. On the other hand, sales cannot be easily manipulated, so the ‘price to sales’ ratio provides a more honest assessment of the overvalued nature of the markets.

Below this price-to-sales chart is the now-famous interview (August 2002) with Dot-Com tech CEO Scott McNealy, who discusses what a 10X price-to-sales ratio looks like from the investor's perspective.

Aw, but the dot-com era companies weren’t profitable, they chortled.

Yet, Intel, Cisco Systems, and Corning (read fiber optic cable manufacturer) were all highly profitable in the stages running up to the top of the internet bubble.

As of a few months ago, Intel ($INTC) has had an annual return since January 2000 of -0.11 % per year. Cisco System, not much better, has a +1.88% yearly return since January 2000.

The past twenty-five-year return of these companies is typical of purchasing grossly overvalued securities. Think of it this way: the investors who sold their Intel in late 1999 captured the next twenty-five years of profit in the stock’s sale price when they sold it. The same applies to Cisco Systems, Corning, and other overpriced dot-com-era stocks.

A well-known quote: “Price is what you pay; value is what you get.” 2000 dot-com era stock prices reflect this quote.

Speaking of quotes, here's another one I share often, the Intel and Cisco Systems twenty-five year price performance demonstrate this quote in spades.

"Risk is not the security, but rather the price you pay for it."

Enter the FAANG/Mag7 stocks of today, 2025.

(FAANG: Facebook, Amazon, Apple, Netflix, Google)

Today, replace ‘dot-com’ with ‘AI’, or artificial intelligence. Just as the internet has proven quite helpful (yes, sardonic understatement) over the past twenty-five years, AI will prove beneficial in the decades to come. It matters, though, how much you pay for that security today as a reminder, I.e., Intel, Cisco System, and Corning over two decades ago.

Should just seven stocks be worth more than the combined global stock markets? You decide. I say no; it’s just another inflated asset bubble.

Even Warren Buffett thinks the stock markets are grossly over-valued.

Warren must be reading the Gratke Wealth, LLC, client newsletters.

‘Uncle Warren, ’ as he is called, has the highest level of cash within Berkshire Hathaway.
What does he know? Yes, sarcasm.

Enter the Warren Buffett Indicator. It measures the total stock market valuation against the US GDP.

Question: Can we be worth (stock market value) more than we earn (US GDP)?

Short-term, yes; long-term, no.

This happens when a government prints money and goes insatiably into debt. That money has to go somewhere. And much of it goes into the stock markets, seven stocks to be more precise.

The ‘factoid’ below (from George Noble, a former Fidelity Mutual Fund manager) has been known for several years. If you subtract the grossly overvalued FAANG/Mag7 stocks, the remaining 493 stocks (which provide a more accurate measure of the economy) have been performing poorly.

S&P 500 2023 return without the Mag7 stocks: +4.10%
S&P 500 2024 return without the Mag7 stocks: +6.30%

As you read, remember that we secured shorter-term US Treasury bond yields between 5% and 5.5% just for 2024. While yields for 2025 are currently lower, they are on the rise again alongside our inflation-hedging strategies. This is why we hold these bonds; why take on the tremendous risk of owning 493 stocks when you can effectively own a risk-free, short-term US Treasury security instead?

All Aboard:

Individual investors (known as retail investors on Wall Street) have never had a higher concentration of stocks as a percentage of their net worth. As we illustrate below, note point five, based on the sage views of Wall Street veteran Bob Farrell

"The public buys the most at the top and the least at the bottom."

Sobering reminder from famed, Wall Street Veteran, Bob Farrell on individual investor behavior.

A few more select charts on the quantum over-valued US Stock markets, and why we do not hold unmanaged (read, no downside risk-controlled) passively managed stock index funds at this point. But there will come a time when stock prices are much lower, and we’ll communicate with clients about pivoting to ‘direct indexing’. A form of index investing with specific risk and tax controls, which a standard stock index mutual fund does not possess. (More on this topic at a later date)

Ten stocks comprise nearly 40% of the S&P 500 stock index!

Lastly, asset and stock market bubbles are not a ’new thing’; note the below from 1841.

The book “Extraordinary Popular Delusions and the Madness of Crowds” was published in 1841

Extraordinary Popular Delusions and the Madness of Crowds is an early study of crowd psychology by Scottish journalist Charles Mackay, first published in 1841 under the title Memoirs of Extraordinary Popular Delusions. Source: Wiki

Yes, I own a copy of this book, it's on my nightstand.

Why Inflation?

You have probably heard me speak about this before, but here it is again: Why inflation?

Part Two: Governments need inflation to pay down debt levels

Lastly, I’ll close with this excerpt from recent Gratke Wealth, LLC musings..

Inflation is not going away. Centuries of history are replete with government-created inflation that is needed to reduce the size of the debt relative to the size of its economy. That’s how this works.

During the 1970s and 1980s, when interest rates were double-digit, the US Government's debt was a ‘comfortable’ 30% to 40% of the national US GDP.

By the late 1990s into the early 2000s, the debt/GDP had grown from 50% to 60%, which was still relatively manageable.

However, after the 2008-2009 Great Financial Crisis (GFC), debt to GDP increased to more than 120% today. The forecast is for higher debt levels.

Governments create inflation by increasing the money supply and stimulating the economy through inflation. Over time, if the government can inflate the economy at a rate faster than they accumulate debts, the ‘debt to GDP’ ratio decreases. The debt never disappears; it is repaid with future devalued, inflated dollars. This strategy dates back to Roman times. This is why athletes bite their medals on the podium- although they probably don’t know why. Romans devalued the silver coin. Biting the coin was a way to determine how much silver was removed, as silver is a soft metal. Therefore, our inflation-hedging strategies are not surprising.

These are incredibly opportunistic times for the well-prepared investor and extremely destructive times for the ill-prepared investor.

After reading this work, one might think we at Gratke Wealth are in the doldrums regarding prospects for future investment return. Hardly. We are just the opposite. As discussed in previous newsletters, there is tremendous opportunity away from traditional investing styles, typically the 60/40 portfolio. The key is that investors need a mindset that allows for investment strategies like our defensive inflation-hedging strategies. Are we kids in the candy store, you ask? Pretty close to it, we are!

Paris Summer Olympics, August 2024, Bite that Medal.

"Following the final, Zhou Yaqin smiled and posed for photographs and videos with the other contestants when an innocent reaction made her appearance viral on social media."

A video showed the two Italian athletes doing the tradition of medal chomp (biting the medal) after gaining victory. The tradition seemed new to the Chinese Olympian as she was seen surprised by the actions. Nonetheless, she followed suit and tried the gesture herself. However, Yaqin seemed hesitant to bite the medal.”

Conclusion: Roman inflation brought you this ‘tender’, heartfelt moment in sport. Sigh

Summary:

Deficit Spending- creates more inflation
Gross stock market overvaluation/concentration
Retail investors, ‘all in’ invested in stock markets at a multi-decade record high valuation
Inflation is needed by governments worldwide to pay down their debt

As always, thanks for reading, and I am glad to discuss.

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