I don’t chuckle. I have respect for the dollar!

“Greed clarifies, cuts through, and captures the essence of the evolutionary spirit.”

Gordon Gekko, Wall Street (1987)

As we approach the end of one of the best years ever for the S&P 500, both institutional and retail investors are feeling giddy. While institutional investors have directed record amounts of capital to US large-cap stocks, retail investors have continued to pour money into stocks through passive trackers, even as the index has climbed to new highs. Although this is not a cause for concern in and by itself, the strange price action in specific stocks and the resurgence of crypto serve as potential warning signs. While we are not in an “everything bubble,” speculative fever has reawakened. Caveat emptor.

 

US Stocks: Trumped Up

Without getting into the debate about the future returns of the S&P 500, it is clear that US large-cap stocks are expensive today, as evidenced by metrics such as forward P/E, cyclically adjusted P/E (CAPE), or the Equity Risk Premium (the excess return of stocks over the risk-free rate, typically the 10-year Treasury yield), which has now turned negative. However, a closer look at specific stocks reveals that investors' "animal spirits" may be overexuberant. At one extreme is Palantir, a data analytics company and government contractor originally founded by Peter Thiel. Palantir has tripled in value this year, adding $23 billion to its market cap since the election of Donald Trump, bringing its total valuation to $140 billion. Boosted by a loyal fanbase of retail traders, it currently trades at 60x sales (not earnings!) despite “only” growing at 30%, and an astronomical 300x EPS. While undoubtedly a great business, when investors resort to conspiracy theories, such as “Palantir AI will run the US government under Trump,” to justify its valuation, the risk/reward becomes increasingly unfavorable.

Note too that Tesla, owned by Trump’s favorite oligarch Elon Musk, has surged 40% since the election, driven largely by retail investors. The stock now trades at a forward P/E of close to 100, despite its only proven business, electric vehicles, being a relatively low-growth business with mediocre pricing power. Also in this case, investors are pricing in extraordinary future achievements, including successes in businesses such as AI, self-driving cars, and humanoid robots, while being short on visibility.

Finally, at the opposite end of the spectrum, consider the “boring” stalwart retailer Costco. Thanks to its subscription model, Costco has transformed itself from an outstanding general retailer into a compounding machine with robust recurring cash flows. Since the 2022 lows, and on the back of stellar results, the stock’s forward P/E ratio has expanded from 31 to a punchy 50. As Trivariate Research’s Adam Parker points out in the Financial Times, only 37% of stocks that reach 50x earnings outperform the market in the two years following a 10-month period after hitting that multiple. He concludes: “when (a stock) first reaches a price-to-forward earnings ratio of 50 times, … it does appear that the odds of success begin to deteriorate six-to-nine months later.”

 

Crypto

If you think speculation is running hot in US large-cap stocks, take a look at crypto. The total market capitalization of all cryptocurrencies troughed well below $1 trillion in the aftermath of the 2021 bubble, down from a peak of $3 trillion. Having failed to live up to the hype around its “use cases” and plagued by scandals—including the collapse of the “stablecoin” Terra and the fraudulent demise of trading platform FTX—the crypto industry was, until recently, widely considered dead. Yet here we are, at the end of 2024, witnessing what can only be described as a zombie-like resurrection. Bitcoin is setting new records in the mid-$90,000 range, and the overall crypto market cap has surpassed $3 trillion once again. In June 2023, I wrote an article titled “Crypto: An Island Adrift”, in which I concluded that “(crypto holders) may yet be saved from financial purgatory. Regulation may open up the way for institutional adoption, which would see asset managers like Blackrock and Fidelity allocating capital to Bitcoin as “digital gold”, and banks like JP Morgan facilitating the origination and trading of digital assets.” (Link to article) This is precisely what unfolded in 2024. The price of Bitcoin rallied in anticipation of the launch of several Bitcoin ETFs in the second quarter, briefly consolidated, and subsequently soared by 40% to new highs on Trump’s promises of deregulation and the establishment of a Bitcoin strategic reserve (details pending).

So far, the surge in Bitcoin has not been accompanied by a similar rise in so-called “utility coins,” which remain well below their all-time highs. As it stands, the primary use case for crypto continues to be speculation, which explains the decline of the Ethereum protocol—once hailed as the future of finance—in favor of Solana, which is cheaper, less secure, and primarily used for so-called memecoins. As it turns out, crypto speculators favor coins devoid of tangible fundamentals, detached from conventional valuation methods, and driven by short-term hype and social media trends. In this context, Dogecoin, the infamous coin featuring a Shiba Inu dog that surged in popularity in 2021, stands tall once again, boosted by the launch of Elon Musk’s and Vivek Ramaswami’s Department of Government Efficiency (DOGE). I explored this phenomenon of meme “investing” in depth earlier this year in an article titled “Money for Nothing: The Alarming Rise of Meme Investing” (Link to article).

Microstrategy:

Those who believe stocks are richly valued and are wary of the current crypto bull market should take a closer look at MicroStrategy. This week, the company edged into the top 100 largest firms by market cap, reaching $100 billion—larger than Dell or Nike. Under the leadership of Michael Saylor, who once encouraged people to “sell their house to buy more Bitcoin,” MicroStrategy has effectively become a leveraged bet on Bitcoin disguised as a software company. Since 2020, the company has amassed 331,200 Bitcoin—worth over $30 billion. The stock has consistently traded above the net asset value of the Bitcoin it holds, enabling the company to issue stock or convertible notes at favorable prices to buy even more Bitcoin. This process has gone into overdrive this year, as the stock has soared from $65 to $500. As Bitcoin rises, boosting MicroStrategy’s share price, Saylor issues more stock and convertible notes (some with zero-coupon terms!) to buy additional Bitcoin. The circular logic driving this cycle is evident. Yet the mere fact that some argue Saylor has conceived a “perpetual money machine” illustrates just how elevated risk appetite has become.

An ordinary Bubble, with age old biases

In “Reminiscences of a Stock Operator”, Edwin Lefevre observed that “It is a curious fact that although all bubbles are alike, all are different”. Unlike in 2021, the stocks swept up in today’s rally are highly profitable market leaders in their industries, with positive free cash flow and strong balance sheets. Bitcoin, introduced in 2009, has evolved from an outlaw asset to an institutional one. Early investors, most of them retail investors as opposed to professionals, were remarkably rational and prescient in recognizing its potential. It’s what happens next, once the “bull case” has been validated, that is risky. Bubbles arise when people, drawn by the prospect of quick gains, rationally shift toward short-term trading to capture momentum that feeds on itself.

This is a phenomenon known as Fear of Missing Out (FOMO), which amplifies price surges and creates a self-reinforcing cycle—until the bubble bursts. Herd behavior, where most participants act in unison and others follow, assuming the collective wisdom must be correct, has always played a major role in financial markets. Today, however, it is intensified by social media. Once a bubble gains momentum, Confirmation Bias sets in, with investors seeking information that supports their beliefs while ignoring contradictory evidence. During speculative frenzies, this bias reinforces optimism, as participants focus on bullish narratives and dismiss warnings of overvaluation. Speculators typically keep moving the goalposts, creating ever more outlandishly bullish narratives to justify rising prices. For example, consider Michael Saylor’s projected price target of $13 million per Bitcoin by 2045—a valuation that would imply a market cap larger than today’s global GDP (!).

Also at play is the House Money Effect, where investors take on greater risks with money earned through investing than they would with money earned otherwise (e.g., wages). This concept originates from the world of gambling and suggests that a casino player is more likely to take risks with recent winnings than with their original stake. This behavior often results in the player losing both their winnings and more, reinforcing the adage "the house always wins". Throughout this process, speculators’ overconfidence and their illusion of control are rife. In fact, as posited by the Dunning-Kruger Effect, the less knowledge or ability someone has, the more confident they are likely to be. This dynamic helps explain why more than 70% of people lose money on spread betting or why many crypto investors suffered significant losses during the last bull run.

 

Conclusion:

The recent behavior of financial markets confirms Voltaire’s observation that “history never repeats itself; man always does”. Most investors know the basics—average in, diversify, and hold for the long run. Yet few are able to overcome the psychological biases outlined above or to withstand the allure of a nascent bubble. And many are prone to rationalizing their mistakes after the fact. As the old adage goes, “What is the definition of a long-term investment? A short-term investment that went wrong”. The best an investor can do is to remain aware of the self-fulfilling logic of bubbles. If invested, and early, it is wise to be cautious when others are greedy and to take some profits. If not, resisting FOMO may be the best course of action. It is worth remembering that long-term compounding works in investing, and that “a man who can do the average thing while everyone around him is losing their minds is a genius”. Meanwhile, those nihilistic enough to gamble on jokey Memecoins (dog-based or otherwise) should keep in mind the response of Nicolas Cage when asked by Playboy Magazine whether his multimillion-dollar salary per movie made him cackle: “I don’t chuckle. I have respect for the dollar”.