Risky Situations

Suspense and anticipation... Folks are taking on more risk than they realize... You'd better hope a bear market arrives sooner rather than later... A manic-depressive business partner... Other risky situations... Downside bets are growing...

Suspense and anticipation are in the air...

And it's not because the market is choppy as it reacts to President Donald Trump's latest trade-war moves or Elon Musk's latest discoveries of fraud, waste, and abuse in the federal government. Well, not directly, at least...

It's because the S&P 500 Index closed yesterday within 1% of 5,700. More than one trader I know believes that price level is important.

The chart below shows why. On the way up, 5,700 provided what technical traders call "resistance," meaning the market failed at first to get above that level. The S&P 500 bounced back down from 5,700 twice before finally breaching it to the upside in September.

It then fell back and bounced back up from 5,700 twice before going higher, showing what technical analysts call "support." Resistance becomes support on the way up, and support becomes resistance on the way down.

The key 5,700 price level is less than 1% below yesterday's close. Today, the S&P 500 dipped below that level in intraday trading but closed above 5,700 once again.

So will the S&P 500 finally breach 5,700 to the downside in the days to come? And if it does, will the index take a steeper dive or turn around and head for new highs?

I don't know. I'm not a technical analyst, and I certainly don't make predictions about short-term market direction. But it makes sense to me that there's an important technical threshold to the downside near the index's current value. It aligns with my ongoing concern that we're in mega-bubble territory and are due for a serious correction, if not a full-blown bear market.

If you're holding a portfolio of great businesses, plenty of cash, some government-guaranteed mortgage bonds, gold, and silver... you're in a great position to crack open a beer, get some popcorn and watch whatever happens next.

As it often is, my primary mission is to let you know that...

Most folks are taking on more risk in stocks than they realize...

We've been watching that risk play out in real time over the past couple of months.

I've mentioned before that big losses can hit even the largest-cap stocks faster than most folks might imagine. Lots of money can fly out of household names in an instant.

Below is a list of large-cap stocks that have taken big, fast losses since the start of the year. All of them happened in 10 trading days or less. All but two happened in five trading days or less. Thanks to a loss of $705 billion in market cap by Nvidia (NVDA), the total lost market cap for the list is more than $830 billion... over an average of about four trading sessions.

CompanyNo. of trading daysLost market cap (in billions)Percent loss

Nvidia (NVDA) 2 $705 -19.6%

Merck (MRK) 9 $42.45 -16.8%

Vertiv (VRT) 2 $19.10 -33.2%

The Trade Desk (TTD) 2 $20.77 -34.4%

Deckers Outdoor (DECK) 3 $7.97 -24.0%

West Pharmaceutical Services (WST) 1 $8.92 -38.2%

Semtech (SMTC) 5 $2.56 -44.9%

Manhattan Associates (MANH) 5 $6.02 -33.4%

Illumina (ILMN) 4 $3.81 -19.3%

Cava (CAVA) 10 $5.31 -35.3%

Credo Technology (CRDO) 3 $5.00 -35.0%

IonQ (IONQ) 4 $5.02 -45.5%

Avg: 4.2 Total: $831.92 Avg: -31.6%

Source: Bloomberg

According to data compiled by Bloomberg, the U.S. stock market has lost roughly $4.5 trillion of value since its February 19 peak.

What's going on?

I think it comes from stocks trading at some of their most expensive levels in recorded history.

The potential for big, fast losses is much greater when market valuations are as exorbitant as they've been in the past year or so.

You see, mega valuations mean that the stock market is predicting these businesses will grow at enormously high rates for many more years into the future – more than it's reasonable to expect.

Without getting into the weeds of how businesses are valued by accountants and analysts, when the market cuts these valuations sharply in a short period of time, it's lopping off the present value of future cash flows it no longer has 100% confidence will arrive.

When expensive hypergrowth companies disappoint investors by reporting less-than-stellar financial results, the market punishes them extra hard because the expectations were extra high.

This is just a function of human nature. You're less likely to be disappointed if you keep your expectations low. You're more likely to be deeply disappointed if your expectations are extremely high.

And there is much more damage to be done. When stocks are near their most expensive levels in history and fall 5% or so, they're still extremely expensive. And if the market bottoms and makes new highs, it's just adding more risk and more future downside.

You'd better hope a bear market arrives sooner rather than later...

The sooner we get a big correction or bear market, the better off investors will be in the long run. Investor, bubble historian, and co-founder of asset manager GMO Jeremy Grantham said as much in a recent interview.

He said the current "super bubble" (what I call the mega-bubble) is the third biggest in history, behind the Japanese stock market and real estate bubbles of the 1980s. When asked if he'd change his market view if the super bubble keeps inflating, he said...

I've always looked at it from the point of view that the longer and the bigger and the higher it goes, the more exciting and dangerous it will be.

In other words, the bigger a market bubble is, the harder it falls. And if this bubble turns around and makes a new high before correcting sharply, it's more likely that its fall will be "more exciting and dangerous."

It would be easier on all of us to endure a 50% down bear market for a year or so than to watch our wealth fall 75% to 80% in value and go sideways for more than a decade (like what happened to the Nasdaq Composite Index from 2000 to 2015, for just one post-WWII example).

Regular Digest readers know I've been worried about this scenario for a couple of years. I hope it doesn't happen because it'll be a nightmare for anybody who thought the stock market was the best place for their retirement savings.

Yes, so far, the market has been a fantastic place for retirement savings. The compounding of the post-World War II era has been spectacular. The S&P 500 is up more than 330 times since 1946. That's about 7.6% per year and turns every $10,000 invested into more than $3.3 million.

But I'm starting to wonder if using the stock market as a retirement-savings utility doesn't program folks to be complacent about risk.

The purpose of the stock market isn't to keep your retirement safe. It's there to value assets. It's where investors and entrepreneurs go when they're ready to let the public markets place a value on their efforts. They sell new shares when they want to finance new businesses and buy back their shares when they want to reward long-term shareholders. Every day, the market's verdict is there for all to see.

The stock market is like a manic-depressive business partner...

Value guru and equity-analysis pioneer Benjamin Graham said the same thing in his must-read classic The Intelligent Investor:

Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly...

You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.

At Stansberry Research, we try to find the true value of the stocks we recommend buying, selling, and avoiding based on company reports about operations and financial positions. So there's no way I'd ever tell you not to put retirement savings in stocks. In fact, I highly recommend it. It's hard to think of an easier way to build massive wealth – as long as you're not in a hurry.

But, again, I must also point out that stock markets weren't designed with retirement programs in mind. They can behave in ways that are bound to give retirees insomnia now and then.

And sooner or later, the stock market will crush egregious valuations based on overoptimistic hypergrowth expectations. In the March issue of Extreme Value (published today), Mike Barrett and I used the story of dot-com darling Cisco Systems (CSCO) to show how bad the damage can be for shareholders of a hyped-up growth stock – even if it continues to be a great business...

[Cisco's price-to-earnings ratio] peaked at more than 200 times earnings in March 2000 and fell to as low as about 10.6 times earnings near the bottom of the financial crisis in early 2009. It has never been higher than the mid-20s since then and has often traded in the mid-teens. It's around 23 today, due to a 40% rise in the share price since last August, but that's still a fraction of its peak level.

We often counsel buying and holding great, cash-gushing businesses like Cisco. But even a great business is no match for a mega-bubble valuation. And some overhyped, exorbitantly expensive businesses aren't even making a profit. Many of them trade at 10, 20, or even 50 or more times sales. When Mr. Market's euphoria morphs into depression – as it always eventually does – they could wind up declining 80% or 90%. Many will cease to exist.

Other risky situations on my mind this week...

I've spoken about MicroStrategy (MSTR) in these pages before...

The software company founded by Michael Saylor issued debt and equity to buy 499,096 bitcoins. I believe its strategy of leveraging its balance sheet to buy a highly volatile speculative asset will end in disaster.

Bitcoin has fallen by as much as 23% since its January 20 high of $109,000. MSTR's share price peaked two months before that... and has fallen by as much as 49.3% since then. That's more than double the bitcoin move.

A 23% drop is nothing for bitcoin. Since 2017, it has had five downside moves of between 27% and 82%.

In a 2022 earnings call, MicroStrategy's chief financial officer said the company would face a margin call if bitcoin traded below $21,000 – about 80% below bitcoin's all-time high.

What would MSTR's share price look like if bitcoin fell to that level? And would its creditors care if bitcoin started trading above $21,000? The MSTR share price would be decimated. Its ability to issue new equity and debt would be long gone.

The most hopeful thing I can say today is that investors are getting scared...

Apollo Global Management economist Torsten Slok reports that investors are "aggressively buying downside protection."

They're buying near record amounts of call options on the CBOE Volatility Index ("VIX"), known widely as the market's fear gauge. They're also buying near record amounts of put options on the S&P 500, akin to buying insurance policies that pay off when markets fall.

Investors buy downside protection when they're fearful of losing money. And as Ben Graham pointed out, you generally want to buy from Mr. Market when he's in a depressive state.

If the S&P 500 breaches 5,700 to the downside soon, I'm willing to bet VIX call buying and S&P 500 put buying will really take off as investors brace for bigger losses.

We'll all find out together whether those downside bets pay off or not.