What This Stock Market Frenzy Means for You
I’ve seen this movie — in fact, several times in the past 38 years — and it doesn’t end well.
I saw it in 1987, when the stock market crashed 22% in one day … in 2000, when the dot-com bubble burst … and during the 2008 financial crisis.
With age comes wisdom, and I’m here to tell you that this bull market is not different, despite what others are saying.
Now, I can’t call a top on the markets. To think that anyone can is silly. Markets can stay irrational longer than you’d think possible. Just look at what’s happened with GameStop.
But, at the end of the day, the law of gravity hasn’t been repealed, and trees don’t grow to the sky.
So, I want to share the view on this stock market run-up from where I sit. That way, it’s easy to understand, and you can see exactly where I’m coming from…
Why Are Stocks Rising?
Let’s look at the stock market returns for 2020…
Despite the sharp sell-off in March, indexes closed at record levels. The S&P 500 was up around 18% and the Nasdaq was up 26%. (The Nasdaq is made up of a lot of the FAANG stocks — Facebook, Apple, Amazon, Netflix and Google.)
So, stocks did pretty well. And tech stocks in particular didn’t simply move higher … they exploded higher.
Netflix was up 67%, Amazon was up 76%, Apple was up 82%, Zoom was up 395% and SunPower was up 402%.
The tech-heavy Nasdaq index has now compounded at 23% per year for seven years. In fact, the 12 largest tech stocks soared over 170% over the past year.
Now, what drove all these stocks higher in 2020?
For a good part of 2020, they were around 0.50%. And with interest so low, the returns on bonds and other similar assets are also low. But nobody wants to see gains of less than 1%. So, when there’s no alternative … you’ve got to buy stocks, right?
Well, that’s what everyone and their mothers-in-law were doing during the stay-at-home orders. It sure was fun to buy and sell stocks, especially with government relief checks.
Robinhood, which did a great job of attracting young traders with a cool app and no brokerage commission, saw a surge of volume.
Stock trading became fun, easy and profitable. But it wasn’t safe, not by a long shot. Here’s why…
The Bull Market’s Fuel
The chart below shows margin debt, or how much investors borrowed against their stock holdings.
As of November’s numbers, they’ve borrowed up to the tune of $722 billion. And you can see that as the stock market climbed, so did the borrowing.
Now, it’s fun to make gains with borrowed money … as long as stocks go up.
But when they go down and your stock holdings are worth less, you need to pay that money back because they’re securing your loan.
With so much borrowed money out there, a small decline could easily set off an avalanche as investors have margin calls and sell into a down market. Watch out below when that happens…
All this paints a pretty clear picture to me. I’m just calling it the way I see it.
And when investors forget to ask “How much?” before they buy something … the story doesn’t end well.
I’m concerned that many people are confusing a bull market for brains. They’re overestimating their stock-picking skills and not attributing most of their gains to a rising stock market.
But before you go out and sell all your stocks, hang on a second…
So, What Can We Do?
Can the stock market soar another 100% or so? It sure can. So, I’m not predicting a tech bust like 2000, or an 80% drop in the Nasdaq.
What I’m saying is that now’s the time to exercise caution and prudence. Markets can remain irrational longer than you can remain solvent, so be cautious and flexible here.
To conclude … I’m not predicting where stocks or the market are heading. I’m just giving you what 38 years of experience has given me: a perspective on what happens when markets go in only one direction.
Eventually, the laws of gravity take over, and prices will fall back to Earth. And that’ll give us opportunities to buy great businesses at bargain prices again.
Companies with rock-solid balance sheets run by rock-star CEOs with strong industry tailwinds will continue to generate huge amounts of free cash flow, record earnings and revenue.
And when prices fall again, I’ll be adding many of them to the model portfolio for my Alpha Investor subscribers. They’re the kind of names we stand to make 100% returns or more on in the next few years.
So, you’ll want to join my elite list of subscribers before that happens. That way, you can find out which stocks I’ll be recommending, too.
Founder, Alpha Investor