The Stock Market Is Diverging—Is This the Beginning of a Crash?

Half a trillion poured into US Stock

funds this year with half of that an

astonishing quarter trillion in the

fourth quarter alone yeah share

investors bought stocks based on J

Powell cutting rates it's one reason why

the share market went parabolic after

August or at least parts of it did a

blowoff top the numbers are becoming

increasingly hard to ignore now share

prices always go up it's what they do

it's when they don't that you need to

pay attention it's not just that stocks

are overvalued and most investors are

demonstrably complacent they're doing so

for all the wrong reasons like J

Powell's proficiency the major share

indexes have gained 20% for the second

straight year something that hasn't been

done since 97 and 98 and we're already

into troubling numbers the warning signs

are piling up the equity risk premium

has utterly collapsed a sign of

overstretched valuations and complacency

a quarter trillion of complacency at the

very least forward price to sales on the

biggest top bubble names those have

equaled doc highs and despite the

Persistence of the AI bubble and we all

know it is a bubble there continued to

be major divergences all throughout the

markets something had kept Equity

investors out of these specific stocks

and parts of the marketplace for almost

five months now looking at you

Philadelphia and the socks and that's a

big one that you would think would be

all in on the AI Euphoria no matter what

the S&P 500 or NASDAQ has done during

these five months those markets aren't

signing up for semiconductors is there

too much focus on AI even the ECB came

out with a report that said hey we need

to be very careful about what's going on

in the AI Arena over there in the United

States as I said share prices go up it's

what they do there are only a small

number of circumstances when they don't

so if you start to see merces among

major indexes or classes of equities you

have to start paying attention to those

and the AI bubble itself has been a key

counter cyclical force in the global

economy so when it busts inevitably it's

going to hurt whenever that might be

where we start from is that there is a

stock market bubble happening right now

we can see it in all the big numbers

including the annual returns this year

as the Wall Street Journal reported

today US Stocks Roar to another

Blockbuster showing in 2024 and few

expect such a Tor advance in the year to

come the S&P 500 has climbed

24% notching 57 record closes even with

a stumble in the last few trading days

the broad us stock index is on Pace for

its best consecutive years since 97 and

98 at least according to Dow Jones

Market data during the leadup to the

bursting of theom bubble if few people

had expected it this year people were

thinking that stock market would take a

year off after such a Resurgence in

2023 but that's the thing about stocks

they continue to go up until they don't

now a lot of people are expecting it to

repeat this year because of all of the

goldilock scenarios that are supposedly

in every facet in every corner according

to the New York Times on average

analysts are forecasting that the S&P

500 will rise around 10% in 2020

half the rate of the last couple years

but still a substantial return on top of

those two big years and that includes

analysts at Morgan Stanley and JP Morgan

Chase who until recently were bracing

for a downturn they've all shifted which

is not a good sign the chief investment

strategist at brokerage firm Oppenheimer

heads into the new year as the most

bullish on Wall Street anticipating a

2025 gain of close to 20% Which would be

obviously the third straight one stock

indexes continue to be booed by multi

ational Tech giants like apple Microsoft

and Nvidia with investor exuberance for

artificial intelligence pushing up

prices of those already richly valued

stocks which have a big influence on the

market because of their size and this

month broadcom another chip maker became

the latest company to achieve a trillion

doll valuation the tech heavy NASDAQ

Composite is poised for a gain of more

than 30% this year greatly outpacing

indexes like the Russell 2000 which

tracks smaller companies more linked to

the EB and flow of the domestic economy

and already you're starting to get a

warning sign the Russell index is set to

rise about 10% this year far lagging

behind all the rest because despite all

the Euphoria over the AI and the fed's

rate Cuts there's a reason why the fed's

cutting rates and it's in the fact that

the Russell 2000 can't get much of a

bid but the big one though that really

puts the numbers on this bubbly type of

behavior again back to the New York

Times in 2024 roughly half a trillion

flowed into funds that buy US Stocks

more than half of that came in the

fourth quarter after the FED had begun

to cut rates with the two biggest weeks

coming after election day November and

then the most recent fed great cut in

December so the risk here is all of that

complacency in Euphoria placed on the

Federal Reserve oh boy and the incoming

Trump Administration ability the ability

the Administration to deliver on its

promises relatively quickly setting up a

whole bunch of really high expectations

that are not likely to be met therefore

risking a dramatic reversal like we see

in every bubble process and Bubbles

after they reach these proportions the

chances of their bursting go up that

much

further at least one place where

expectations can be met that's at euro

dollar University we're in the final two

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Greater detail and our Deep dive

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all the information at Euro dollar.

University now central banks by Nature

are relatively careful and cautious

especially where it comes to stock

markets given the historical

significance even though there's no

historical relationship between share

markets and mon monetary systems these

days and hasn't been since the 1930s

even so central banks are well aware of

the possibility of stock prices to get

into asset bubble type of territory and

the ECB about a month ago came out in

its Financial stability review with some

pretty sobering warnings on the US Stock

Market including even more sobering

calculations where it comes to the

equity risk premium which I'll get to in

a moment what the ECB wrote was there

are signs that investors may be

underestimating and underpricing the

likelihood and impact of adverse

scenarios as indicated by record low

Equity risk Premia and relatively

compressed corporate bond spreads on

both sides of the Atlantic also

concentration of equity market

capitalization and earnings among a

handful of single names notably in the

United States has increased greatly in

recent years this concentration among a

few large firms raises concerns over the

possibility of an AI related asset price

bubble when even the central Bankers are

warning about a price bubble you know

it's getting to be serious the numbers

are are becoming more and more

undeniable back to the CCB also in a

context of deeply integrated Global

Equity markets it points to the risk of

adverse Global spillovers like we saw in

August should earnings expectations for

these firms be disappointed as such

there's greater likelihood that negative

surprises including sharply

deteriorating economic growth prospects

which they would know about in Europe

sudden changes in monetary policy

expectations given how much buying in

the United States was done on the

expectation that rate Cuts were going to

be somehow helpful for the first time

ever because in the stock market the

beauty contest it's all about sentiment

you never really know when it'll happen

what we know is that as these numbers

get bigger and bigger and bigger and

more and more astonishing the harder

they become to ignore the likelihood of

that turnaround goes up and up and up

and when you marry that sentiment price

for Perfection with a whole lot of

imperfection that we see across the

across the system especially in you know

global economic conditions currency

crisis even just other parts of the

stock market which I'll get to here in a

moment all of it adds up to lots of

risks that are not being appreciated by

markets that increasingly priced for

everything on one thing in this case the

AI bubble to hopefully deliver the

equity risk premium according to the ECB

is calculated as the five-year

cyclically adjusted PE yield for the

Euro stocks or the S&P 500 in the US

minus the 5 year real government bond

yield which is the treasury minus the

inflation swap adjusted rate so when you

do that you see what the what the ECB

puts up here the equity risk premium in

the US market is

astonishingly low huge amount of

complacency especially when you put it

together with ultr low corporate bond

spreads neither the equity Market nor

the junk Market is expecting anything

bad anywhere to ever happen it's priced

to absolute perfection except the

imperfections as I just said are getting

bigger and harder to ignore too so you

put those two things together you've got

Equity markets that are almost record

amounts of complacent and a whole lot of

things to be concerned about that stock

markets are not concerned about and

among those big numbers here's an

article by the mle fool earlier this

month the final reason the AI bubble

will burst in 20125 has to do with the

historically unsustainable valuation

premiums that are currently being being

assigned to Market leading artificial

intelligence stocks over the last 30

years businesses on the Leading Edge of

Next Big Thing Innovations have often

topped out in multiple of 30 to 40 times

trailing 12mth sales this is where

Amazon and Cisco Systems Peak before the

dot bubble burst in 2024 we've witnessed

Nvidia top of price to sales ratio of

more than 40 while paler Technologies is

currently pushing a PS ratio of almost

69 although it's impossible to predict

when investor Euphoria will fade history

has been crystal clear that extended

valuations of this magnitude are not

sustainable over the long run and that's

because as good as those ideas are and

as valuable as the Technologies become

it attracts so much other

noise I mean Amazon had a massive run in

1999 and then it lost about 90% of its

value afterward that's the thing even

Amazon which came to rule the e-commerce

space had a tremendous burst with

everything else because when a new

disruptive technology comes on board or

starts to become people become aware of

it they you can assign any valuation you

have no idea who the winners and losers

are going to be and there's going to be

a vast majority more of losers than

winners until the technology becomes

fully adapted and settled and matures

it's all just a crap shoot and so

everybody can see that there's going to

be value but you have no idea where that

value is ultimately going to land and

the more people are convinced that

they've got it right and that there is

value the more it just sucks in more

people to the same thing and so these

bubbles become self-feeding the more

tantalizing the technology the more it

is to rationalize that you've picked the

exact winners and losers or in this case

it's easy Nvidia or broadcom they're

going to be the winnner so just pile

into both of those when in fact there's

a whole lot more that goes into it and

the bigger these numbers become and the

more complacent investors get the closer

you know it is to the end even if you

can never predict the exact moment in

which it all turns around the

probabilities are now decisively not in

your

favor and I've talked about these stock

market divergences that we've seen

develop really over the last five months

because they're an important signal that

not all parts of the marketplace are

buying into the AI bubble or the fact

that there's nothing to worry about the

biggest one is the Philadelphia

semiconductor index because that is

highly cyclical sensitive meaning that

it is the one place in which share

investors are actually focused on

economic fundamentals because the the

semiconductor business is itself highly

cyclical therefore the perceptions of

conditions in that part of the business

that part of the economy influence share

price Behavior at the specific moments

in time because up until August the

Philadelphia semiconductor index the

socks index had been perfectly

correlated or near perfectly correlated

as much as any Dynamic Marketplace can

be with the S&P 500 they were both in

very close lockstep fashion it was only

around July and really August after the

rebound following the carry trade

reversal that the stocks eventually

diverg with the S&P 500 the S&P 500 all

the all that share price money piled

into to the investment funds in the S&P

500 Index like the NASDAQ and the Dow

Jones Industrial Average they all soared

toward record highs meanwhile the

cyclical sensitive semiconductor index

instead followed the N over in Japan

there's a very close correlation with

those two contrary to the S&P 500 so

while everybody in the S&P 500 was

betting on J Powell and his rate cuts

and then the Trump effect of the

presidential election the semiconductor

index through all of it had has remained

Divergent and that's not the only one we

see other divergences too including an

important one between France and Germany

in Europe the French CAC or CAC index

that one has been lower since the middle

part of may even before the ECB started

cutting rates whereas the German Dax is

closely corresponding now with the S&P

500 drawing in all of that complacent

bubble heavy money whereas maybe the

French index is more economically

sensitive like the socks so like I said

share prices are they go up that's what

they do everybody puts their money in

stocks at least everybody in the Western

World the United States in particular

that's where Americans leave their

savings so stock prices they go up

that's there's absolutely nothing useful

about share prices going up as far as

information it's only when you see that

indexes or parts of the marketplace stop

going up that you should pay attention

say what is going on here with these key

divergences that are persisting despite

all of the purported favorable

conditions for stocks in the economy and

everything else and then you put that

together with these mindboggling numbers

about the share market the comparisons

to the dot bust in particular it's a lot

to say that says pay attention to what's

happening in the equity Market because

if the AI bubble does bust not only does

that add more of a signal to the the

negatives that we already see in the

semiconductor index there's going to be

a tremendous amount of real world and

real economy pain when it inevitably

does and it's with so many warning signs

in the real economy anyway that's more

pain than the real economy can really

handle at this moment in time so

normally stock prices don't really tell

you all that much except for the fact

that people are saving putting their

Savings in it but this is one of those

times where stock market might have a

lot to say

key Global cyclical signals that's the

auto business unfortunately and what

does the auto business have to say