An Increasingly Risky Economic Picture

The stock market continues its strange journey. Frankly, the indices are highly misleading in that their volatility has been quite subdued, while the underlying activity of the individual components has been anything but calm. The broader S&P500 index is having a great year, but its performance has been highly distorted by the Magnificent Seven, which collectively have had a great run until very recently.

Even this is misleading, however, as very recently the Magnificent Seven haven’t been so magnificent. Alphabet and Apple are down more than 10% from their recent highs, META is down about 8%, Tesla is down 40% from its highs last summer, Amazon and Microsoft are down about 4% from their recent highs, while Nvidia is up about 85% on the year. Combined they comprise almost 30% of the S&P500, so their performance distorts the overall performance of the broader market.

This past Friday we saw some price action in Nvidia, the superstar of this group, that was truly astonishing. With no real economic news, Nvidia shot up 5% in early trading before dropping 13.5% in a violent sell-off. That might be more understandable in penny stocks, but Nvidia has a market cap of roughly $2.2 trillion!! There is nothing “normal” about this sort of market behavior in terms of economic fundamentals. As I have pointed out in previous write-ups, this market is being driven by wild, speculative, momentum-based energy, and this crazy market behavior might continue for a while. Modest market corrections will not stop this frenzy. It will take something far more dramatic to force people back to their senses.

As we learned in 2000 and 2008, speculative price action can push markets a long, long way, and drive things to totally distorted valuations. Stepping in front of highly speculative, momentum-based markets can be a very dangerous strategy unless you are very skilled and know how to structure limited-risk option strategies to play for reversals.

The current environment shares many characteristics of a wild mob, as it is essentially a wild mob mentality that is required to push a de facto bankrupt stock like Carvana higher until it has risen 2200% from its recent lows!! That’s right. Carvana shares dropped 99% from their highs, and the company was effectively bankrupt. Since then, its stock has exploded higher from $3.78 to $80.00. Why? My cynical explanation: more buyers than sellers. Why are they buying? Because the price is going up, attracting still more speculative players. Forget earnings. Forget balance sheets. This is a perfect example of too much liquidity in the system chasing after dumb ideas. As you will see in the economic figures below, Carvana’s earnings and balance sheet don’t justify price action remotely similar to what we are experiencing.