Emotion and Fact
The stock market’s vertical rise on April 8 and thereafter is impressive, but year-to-date returns still pale by comparison with gold and gold miners. The latter are still the y-t-d winner.
At one point in the first quarter, Nvidia was down 49% for the year and is now up 22%.
It may be helpful to keep in mind that markets are often paradoxical and will do whatever is necessary to fool the greatest number of investors. Spiking markets of the sort that arrived on April 8 tend to occur more often in bear markets than bull markets.
In noting the above, it is always important to remind ourselves that markets are not malevolent beings toying with us. They represent our own mass emotions. And in time emotion, no matter how gripping, must finally acknowledge logic and fact, including the undeniable fact that earnings cannot grow to the sky and that higher valuations mathematically reduce future returns. Conversely, future returns rise if the market falls.
Given these facts, high market valuations (today we have the highest ever) are always an accident waiting to happen. This is all the more true in today’s environment of truly unprecedented illiquidity and leverage. While illiquidity and leverage may support sky-high valuations on the way up, they tend to contribute to panic on the way down.
When the bubble bursts, and it is undoubtedly a bubble, investors will be desperately seeking cash with which to pay their bills or pay their debt in order to save their assets. Most of them will not be able to obtain the cash they need.
Ironically, desperate people will sell their gold, the most solid form of cash, to get paper cash, but in the past this has been a temporary phenomenon on the way to higher gold prices. At the moment, gold is also vulnerable for another reason, namely, that it has gone up so fast, which has attracted momentum buyers, including formula driven algos, who will sell at the first sign of a serious retreat. This too tends to be temporary.
Some Other Facts of Possible Interest
Some 43% of Russell 2000 companies are unprofitable.
Half of June’s very positive employment gains were in state and local government. Manufacturing jobs fell.
Commercial real estate loan rates currently exceed cap rates (the cash return on the building). Mortgage defaults are increasing.
Nvidia insiders have sold $1 billion of stock over the last year according to the Financial Times.
President Trump says the Federal Funds Rate is at least 2% too high. Although higher than in many other countries, the rational, respected, and bi-partisan Taylor Rule would seem to put it a bit higher.
Fed chairman Powell says that he cannot reduce rates because the Trump tariffs pose a threat of inflation. Tariffs are not, however, always inflationary. They can be deflationary if they reduce trade and consumption or profit margins.
First quarter earnings came in better than expected. But that may be because demand was pulled forward by tariff fears. US imports increased 41% in the first quarter.
Wall St. now expects corporate earnings to advance 10% in 2025 and 14.5% in 2026. The latter would exceed 2021’s record 13.8%. Since sales are not expected to grow nearly as much, this implies yet more expansion of profit margins, which are already at historic highs. Historic earnings together with historic multiples of earnings do not support sustainable bull markets.
Venture and private equity funds are still unable to return cash to investors as promised. In the case of private equity, they are sometimes pulling out cash by loading even more debt on portfolio companies, which is financed by private credit which is in turn financed by banks.
Private equity woes have been further complicated by the Trump administration war on the best endowed universities.
Harvard takes a 69% overhead charge (available for general operating expenses) on the $13 billion in federal research grants it has been receiving. Deprived of this revenue source, it would above all need cash, but has only a tiny amount in its endowment fund, the majority of which is in illiquid investments.
Faced with this same dilemma, Yale has reportedly either sold or is seeking to sell $6 billion of private equity investments in the secondary market. This market already significantly discounts fund reported prices by at least 25%, suggesting that reported prices are not credible.
Vanguard of course has chosen this moment to promise to expand private equity opportunities for its small investors.
As of last year, Moody’s reports that U.S. life insurers have entrusted a full third of their cash and other investments to private credit, where covenants, financial quality, information, and even returns have been scarce. One can only guess at the size of the bailout that might be required for both insurers and banks financing the private lenders.
Included in Trump's Big Beautiful Bill was a provision called Invest America. This legislated that every baby born in the United States between January 1, 2025 and December 31, 2028 (presumably only citizens) would be given one thousand dollars to be invested only in the S&P 500. The Republican House and Senate’s comfort with this provision is not a good omen for the S&P 500.
WRITTEN BY
HUNTER LEWIS | CHIEF INVESTMENT OFFICER
Hunter Lewis, co-founder and former CEO of Cambridge Associates, is currently Chief Investment Officer of Hunter Lewis LLC.