Two short years ago was a dark time for U.S. financial markets as the Federal Reserve’s crusade against inflation resulted in a record destruction of wealth.  In 2022, U.S. stocks had their worst performance since the depths of the Global Financial Crisis in 2008, the “bear market” erasing almost $13 trillion in market value from stocks.

Fast forwarding, investors with fortitude were amply rewarded, as the S&P 500 finished 2024 up a whopping 65.4% from its bear market low on October 12, 2022.

Indeed, the front-page headline of the December 31, 2024 edition of The Wall Street Journal trumpeted, “Stocks Cap Best Two Years in a Quarter-Century,” as the S&P 500 posted back-to-back annual gains of more than 20% for the first time since 1997 and 1998.

Given the strong performance of the S&P 500, which was driven (more than 50% of the gain) by the spectacular performance of a small handful of mega-capitalization technology stocks (aka the “Magnificent Seven”—Apple, Microsoft, Alphabet (Google’s parent) Amazon, Nvidia, Meta (owner of Facebook, WhatsApp and Instagram)), investors are curious if U.S. stocks are in a “bubble” that is destined/doomed to burst, leaving financial destruction in its wake.

Howard Marks is Co-Chair of Oaktree Capital Management and one of the brightest minds in investing. I’ve referenced his writings frequently and found his most recent memo, “On Bubble Watch,” particularly timely and insightful.

Marks pointed out in just the first decade of this century, “investors had the opportunity to participate in–and lose money due to–two spectacular bubbles.”  The first was the “dot-com” or tech-media-telecom (“TMT”) bubble of the late ‘90s, which began to burst in mid-2000 and the second was the housing/subprime mortgage bubble of the mid-2000s, which started to unravel when a pair of Bear Stearns’ hedge funds collapsed in July of 2007 (leading to the aforementioned Global Financial Crisis).

Bubbles have been around as long as “FOMO” (the Fear of Missing Out) and the sight of your boastful friend, neighbor or brother-in-law getting rich have driven otherwise rational investors to suspend disbelief or even common sense.  Indeed, according to Marks, “a bubble or crash is more a state of mind than a quantitative calculation.”  Thus, financial markets have always been and will always be subject to bubble thinking.

In Marks’ view, “a bubble not only reflects a rapid rise in stock prices, but it is a temporary mania characterized by—or perhaps better, resulting from—the following:

• highly irrational exuberance,
• outright adoration of the subject companies or assets, and a belief they can’t miss,
• massive fear of being left behind if one fails to participate (“FOMO”) and
• resulting conviction that, for these stocks, ‘there is no price too high.’”

“Newness” and “this time is different” causes or permits investors to suspend rationality and engage in bubble thinking, says Marks.  Indeed, bubbles are invariably associated with new developments, such as the perceived unlimited potential of the internet and the financial alchemy transforming subprime mortgages into bulletproof bonds that led to the two most recent bubbles.  If something is new (like artificial intelligence (AI)), by definition there is no history or anything to temper enthusiasm.

Recalling Hans Christian Andersen’s The Emperor’s New Clothes, Marks argues, “Most people would rather go along with a shared delusion that’s making investors buckets of money than say something to the contrary and appear to be dummies.  When a whole market or group of securities is blasting off and a specious idea is making its adherents rich, few people will risk calling it out.” 

There’s always a grain of truth underlying every bubble.  It just gets taken too far.  The S&P 500 finished 2024 up 65.4% from its October 2022 low, but Nvidia (NVDA), which manufactures advanced chips needed to develop AI platforms, was up 1067.7% (almost twelve-fold—to a market capitalization of $3.3 trillion).  Investors are betting on the persistence of both the growing transformative potential of AI and Nvidia’s position as key supplier to the “arms race” in AI.

However, investors forget the “disrupters can be disrupted, whether by skillful competitors or even newer technologies.”  On January 27 investors dumped Nvidia and other AI-related stocks en masse on fears a new Chinese competitor, DeepSeek, had developed a cheap AI platform.  DeepSeek’s claims are difficult to verify, but Nvidia lost almost $600 billion of value, a record one-day loss for any company on Wall Street.

Similarly, the twenty largest stocks in the S&P 500 at the end of 1999 were Microsoft, Cisco Systems, General Electric, Walmart, Exxon Mobil, Intel, Citigroup, IBM, Oracle, Home Depot, Merck, Coca-Cola, Procter & Gamble, AIG, Johnson & Johnson, Qualcomm, Bristol-Myers Squibb, Pfizer, AT&T and Verizon.  By the end of 2024, only Microsoft, Walmart, Exxon Mobil, Johnson & Johnson, Proctor & Gamble and Home Depot remained.

Bubbles are obvious only in hindsight, but Marks observes “investors treat the leading companies—and pay for their stocks—as though the firms are sure to remain leaders for decades.  Some do and some don’t, but change seems to be more the rule than persistence.”

Be careful!

The opinions expressed in these articles are those of the author as of the date the article was published. These opinions have not been updated or supplemented and may not reflect the author’s views today. The information provided in these articles are not intended to be a forecast of future events, a guarantee of future results and do not provide information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular stock or other investment.