How Long Can The Stock Market Ignore Reality?

[00:00:00] Speaker 1: The market can stay irrational longer than you can stay solvent, but it can't stay irrational forever, right? You are probably already aware of the headlines that stocks are trading at record values relative to the underlying businesses they represent. Some of the most valuable companies in the world to date will take hundreds of years to pay back their investors, and those are just amongst the ones that still bother making a profit at all. The only way this makes any sense is if the future turns out to be some kind of, uh, corporate utopia where our godlike AGI lowers interest rates, doubles consumer spending, and covers every square inch of the planet and low earth orbit with Nvidia GPUs. A slight exaggeration, but only slightly. We have been told that the market is effectively pricing in perfection, which means if things don't go perfectly well, we should be in for a major correction, right? The only problem is that we are currently in an active oil war, our reserves are getting dangerously low, inflation is already coming back up, interest rates are probably going to need to rise, impacting ballooning national and consumer debt, all on top of two years of trade uncertainty, questionable economic results from one of the largest investments in history, the potentially systemic issues in financing vehicles holding it all together, and then as a little cherry on top, we decided to throw another 50% tariff on Canada this week, because it worked out so well the first 12 times. Now, I know none of these are a surprise to any of you watching anymore, but every single one of these events can and will impact companies' top-line revenue, operating costs, and ongoing expenses. So, you know, basically the entire income statement. At the very least, this is a pretty bumpy road towards that supposedly perfect financial future, and a lot of assets, even safety assets, have naturally fallen based on these headwinds. Housing is down across broad parts of the economy and the world, gold has fallen by 25% from its all-time high, and other speculative staples are barely even worth mentioning. But the stock market keeps on chugging. So, is there something behind this endless boom that makes the market immune to all of these problems, or has it just not had the time to look down yet? The Dow Jones Industrial Average closed above 50,000 for the first time ever on Friday. [00:02:07] Speaker 2: The U.S. Housing market is slowly dragging itself into 2026. 30-year mortgage rates hitting their lowest levels since last October. [00:02:15] Speaker 3: We've been going on Zillow lately and just seeing price cut after price cut. Well, it's pretty common. Some record drops is what we're seeing in the metal space as that precious metal rally that we've seen all year long. Gold is now down 5.5% on the month. [00:02:30] Speaker 4: The Trump administration is praying that the third time's the charm when it comes to the president's tariff agenda. [00:02:36] Speaker 2: The White House has launched another escalation of the trade war between the U.S. and Canada. The Dow is over 50,000 right now. [00:02:45] Speaker 1: Okay, so there is a logical temptation to compare today's market to the dot-com bubble of the late 1990s and the early 2000s. Both saw a significant market rally, fueled by speculation over new technology, major infrastructure investment, circular financial dealing, all ultimately giving rise to companies with questionable fundamentals. But that comparison is probably a bit unfair to the dot-com bubble. Back then, the economy was in a much better position. Debt across the board was lower, the market was far less concentrated, there was, at the time, less geopolitical uncertainty, and outside of the dot-com companies themselves, speculation was actually pretty tempered. So, surely we are overdue for a similarly massive correction when we get to the end of this particular fuse, right? Well, maybe. And honestly, if it wasn't for all of our livelihoods tied to this line going up, there is a good reason to kind of want these companies to be put back in their place a little bit. But assuming or even hoping that a crash is inevitable can also tempt us into only reading the information that reaffirms what we already want to hear rather than challenging it. People have been saying that the market is due for a major correction since 2010, and so far, they have been wrong. Being early has also been expensive. The fund manager, John Hussman, has been forecasting a collapse of 40% or more almost every year since 2013. And well, over that period, the market has spent that entire time compounding at roughly 13% per year. Had he actually put his money where his mouth is, he would have wiped out his fund several times over. Now, obviously, this is all easy to say in hindsight. But how is it possible that we can still argue with a straight face that all of this isn't overdue for a correction? Well, a few reasons. The first is the concentration risk. Compared to something like the dot-com bubble, the stock market is significantly more concentrated now. In 2000, the top 10 companies in the S&P 500 accounted for roughly 10% of its total market cap. Today, they account for 40%. Now, that might sound like a bad thing. It's a risk that such a large chunk of the stock market is tied up in these companies. But it also means that a large chunk of the market is tied up in these very large companies. As in, as opposed to hundreds of new pre-profit listings that had a much larger share of the overall market back in the late 90s. Obviously, if one of these failed, the overall impact on the market would be devastating. But they are much less likely to fail, because they all have a real market. That top 10 generates around 30% of the index's actual operating profits. Which was, uh, not exactly the situation with the class of 2000. After the dot-com bubble burst, the market leaders all lost value. But their overall share of market value actually increased as hundreds of companies eventually got acquired, delisted, or went bankrupt. The number of listed companies in America peaked at more than 8,000 in the late 90s. And over the next decade and a half, roughly half of them disappeared. The concentration in the market to date is probably not a great thing for society. But for investors, it might not really be as bad as it might look. We might have put our eggs all in just seven big baskets. But those baskets are far more secure and well-constructed than the hundreds of packing peanuts that made up the market in the dot-com era. Now, let's assume, hypothetically, AI completely flops tomorrow. Take a worst-case scenario where there is definitive proof that we will never reach AGI. And on the same day, China releases another deep-seek-style open-source model that beats the leading American models and can run on a laptop, completely negating the need for those data centers. Well, even in that kind of extreme case, all of the magnificent seven would still make money. Only NVIDIA has a really significant share of its business tied directly to selling the technology itself. Last quarter, 75 of its $81 billion in revenue came from data center hardware. Their financials don't report it in detail. But from the best available sources we could find, the remaining $6 billion came directly from selling a single 50-70 at market prices. So, well, yeah. They would probably take a hit if the AI investment cycle stopped. But the rest of these companies still make their actual money by selling ads, cloud subscriptions, iPhones, and the vague promise of enhanced cruise control. The point is for all of these companies, AI is mostly an expense. If anything, a total abandonment of AI tomorrow would actually improve their earnings. Less money going towards data center buildouts, crazy salary packages, and infrastructure depreciation means they could go back to being an asset like Cashflow Monster doing big stock buybacks every quarter. You know, like the good old days. And yeah. With some outliers, most of these mega cap companies aren't actually that stretched in terms of historic valuation. And that's, again, based on earnings tied down by significant AI expenses. Despite what simple visuals like this and this might suggest, there are still large voices in the finance space that actually consider these companies to be cheap. And again, even if you don't personally think this makes sense, the market doesn't really care what you think. But that also doesn't mean that this can go on forever. So it's time to learn how many works to find out how long the rest of the market can ignore reality. PE ratios are stretched, earnings growth isn't keeping up with prices, and there's no shortage of reasons for investors to be nervous. And yet, the market just keeps climbing anyway, which raises the obvious question. Is this actually fine, or are we all just choosing not to look too closely? The tool I use is InvestingPro from Investing.com, the sponsor of this video. We used InvestingPro while researching this video. We compared a group of stocks in the sector, and it maps every company on a chart by revenue growth against PE ratio. And you can immediately see which ones are priced way ahead of their fundamentals. That is the kind of disconnect you completely miss when you are looking at stocks one at a time. From there, you get your fair value on each stock, which combines multiple valuation models, discounted cash flow, earnings-based, peer comparisons, and shows you whether it is trading above or below the fundamental support. Then, there is the financial health score, which breaks down profitability, cash flow, and growth side-by-side. It also lays out the macro factors driving those numbers, so you can see how interest rates, earnings revisions, and sector rotation are all feeding into the prices you are looking at. None of this tells you what to buy, that is still your decision, but it gives you access to the kind of valuation data professionals pay thousands of dollars a year for. Investing.com is running their summer sale, up to 60% off, the best price of the year. If you use my link below, you get an extra 15% on top of that, meaning the lowest price available the whole year. Use my link in the video description. Okay, so regardless of whether this is an AI boom or bubble, these companies are probably less exposed than the overall economy is. If that technology pays off, great. These companies get to sell high-priced software subscriptions and girlfriend bots as a service, all ultimately expanding their revenue and bottom line. If it doesn't, well, maybe that's also great and these companies can get back to business as usual, cutting out AI expenses and growing their bottom line. Now, of course, these aren't the only companies in the market, and all of the mega-IPOs that were slated for this year don't have the same foundation of real revenue underneath them, but two-thirds of them aren't on the market yet, and the one that is on the market is already repricing itself, which is thoughtful, I suppose. The point is the market is apparently still perfectly capable of repricing something, it just hasn't felt the need to reprice everything. There are certain corners of the finance base that genuinely consider the current roster of the Mag 7 to be cheap. Usually, the biggest companies in the market trade at a significant price to earnings premium over everybody else. This is because bigger companies are, usually, more diversified, they have more brand awareness, and, well, they got that valuable for a reason, usually by dominating their particular market. For most of the last half century, that premium was between 50% and 100%. In plain English, people will generally pay at least 50% more for Google shares, even if they were representing the same earnings as a broad selection of smaller tech or advertising-based companies. To date, the Mag 7 still trades at a higher price-to-earnings ratio than the other 493 companies in the index, but the premium has shrunk to around 10%, the thinnest it has been in more than a decade, and if you exclude Tesla, the gap gets even smaller still. Now, that shrinkage has mostly come from these companies just making a whole lot more money. Mag 7 profits grew 63% in the first quarter of this year, while the other 493 companies grew about 17%. And since they collectively make up such a large share of the market, that would make it very hard for the whole thing to fall too far, right? Well, good value compared to the rest of an extremely expensive market. So yeah, cheap is a relative term, but markets mostly run on relative terms. And the problem for a lot of these investors is that the alternative to buying one stock is usually just buying a different stock, and statistically, these companies have outgrown the economy that produced them. Theoretically, the stock market depends on the overall performance of the economy, because companies are participants in that economy. No matter how revolutionary its products are, a company that can only operate within the city limits of Ardmore, Oklahoma, is naturally limited in how much it can grow. America, fortunately, has a very big economy, but we have even bigger companies. For most of our recent history, public companies had a collective market cap of around 50% to 100% of the country's annual economic output, meaning that the value of all the listed companies in America were worth about as much as America's total annual GDP. Again, this makes sense since their revenue, and by extension their profits, and ultimately valuations, are part of that gross domestic production. Today, the total value of American public companies is currently sitting around 234% of GDP, beating the previous ratio record set in 1999. Yeah, at the height of the dot-com bubble. Warren Buffett once described a version of this ratio as probably the best single measure of where valuations stand. And on that measure, the current market makes 1999 look responsible. So, not a great sign, right? Well, a lot of people are actually arguing the opposite. More than at any other time before, our companies are global. They reach across the planet for their customers, and increasingly for their investors too. When a company's revenue comes from everywhere, a local disruption, a tariff here, a housing slump there, doesn't really matter as much as it did when American companies overwhelmingly sold things to Americans. The relative weight of these companies in our economy also, somewhat perversely, highlights the bulls' last major defense. If current stockholders sold their shares, what would they actually do with that money? The largest group that owns the vast majority of these assets are ultimately wealthy people with more money than they need. According to the Fed's own numbers, the top 10% of American households own about 87% of all the corporate equities and mutual fund shares in the country, the bottom half owns 1.1%. So, the decision to sell or not sell belongs to a fairly small group of very comfortable people who have other ways to access liquidity if they need it, and nowhere else better to invest it in the meantime. If a wealthy holder needs cash these days, the standard move is to borrow against the portfolio and keep the shares. Investors are currently carrying a record $1.42 trillion in margin loans, according to the industry's own regulator. Morgan Stanley CFO Sharon Yashawa spent parts of a recent earnings call pointing out that 18% of their client households now borrow against their accounts, up from 14% five years ago, with lending balances at $186 billion in climbing. And for the few who actually might want out, the alternatives are not exactly making the case. Bonds finally pay decent interest if you trust that rates are done rising, while roughly half of the Fed's own committee is openly talking about hikes. Housing has been falling in real terms for 11 straight months and falling outright in a growing list of cities. Gold was supposed to be the responsible adult in the room, and you already know how that's going. And Bitcoin is currently worth about half of what it was in October of last year. A symptom of having so much financial wealth tied up amongst such a small group is that unlike regular people who might need to sell their assets to cover over shortfalls in other parts of their financial lives, that doesn't really happen with people at this level. So the only reason they would need to sell is if a better investment opportunity came along. And at the moment, there aren't any. Now we have spent a lot of time in this video looking at how much money the collective stock market is worth. But nobody ever stops to ask how much stock market the collective money is worth. The total U.S. stock market is currently priced at around $74 trillion. The M2 money supply, which is basically every physical dollar, checking account, and savings balance in the country is about $22.7 trillion. Asset prices have obviously climbed bigly since the stimulus measures kicking off in 2020, and that has largely been attributed to a lot of money trickling up to people who simply invested it. But even with all of that extra money acting as a denominator down here, the market is still seeing a higher share of it than almost any time before. Last year, the total value of the stock market crossed three times the amount of actual money in circulation, and it has kept drifting higher since. To date, the ratio sits around 3.3. The only time this ratio has ever been anywhere close was the run-up to the dot-com bubble. Now, that's not a great sign. But again, the argument today is that these companies have just outgrown their host economy, and compared to the money in the global economy, their value still looks relatively modest, at least compared to that other bubble. But we should also probably address the curious case of South Korea. The cost be roughly doubled in six months, powered by two chip companies, Samsung and SK Hynix, that between them make up about half of the entire index. These are real companies making real profits with real customers all over the world, well beyond the confines of their home economy. But even still, over about three and a half weeks, their market still fell 25%, complete with repeated emergency trading halts and about $1.7 billion in forced liquidations. For what it's worth, as of this week, the market has bounced back above 7,000, with Citi already calling the whole episode a technical correction and a potential buying opportunity. Now, my good friend Patrick Boyle recently made a whole video about what's going on over there, so I will leave a link to his extensive breakdown if you are interested. But the point is that the market is not infallible, it's just smarter than you are. This video more than any other has the potential to age horribly, but it is worth acknowledging that you are not seeing something that the collective wisdom of the market has missed by pointing out that this all looks a little bit like a bubble. It knows. It's just that the people with more voting power like the other arguments a little more. For now. So, in the meantime, it's worth at least understanding what those arguments are. But if you want a counter argument, we have compiled all of the problems into a rather extensive video over on our compilations channel, so go and check that out next. And don't forget to like and subscribe to keep on learning how all money works.