Are markets broken as so many claim?

I derive little satisfaction in not being alone in my frustration at today’s so-called ‘broken’ markets. Yes. I know the markets are not the same thing as the economy, but when you have for example the EU Stocks 50 index making new ATHs this week while the German economy is in a very rare deep-ish recession, surely you have to conclude that the markets are to some extent broken, as is the German economy[mepr-hide rules=”30786″ unauth=”message”]

The numbers coming out of Germany are indeed worrying with commercial real estate in a deep slump and forecasts of a 0.5% GDP dip this year with widespread gloom in business sentiment that most blame on the anti-business government stance that has kept energy prices sky-high.

So how to reconcile this real-world economic gloom with the record high stock euphoria? They seem incompatible. And that is because they are – but only if you fail to recognise that society has many layers each working their own incentives.

The wealthy stock-owning and money manager class are obviously loving these markets and are as bullish as hell! And they are those with the bullish fervour with AI stars in their eyes. But lower down the income scale where direct stock ownership is less common, high taxes and job uncertainty (especially in AI-threatened tech) rule.

And dissatisfaction with our rulers are widespread – and is growing among workers. In the US, Biden’s popularity ratings have hardly budged off the lowly 44% mark despite record high stock indexes.

Social mood is diverging along wealth lines (as it always does) and when the split becomes too much for those underneath to bear, we get revolutions.

It is the tax-paying mass of workers that drive the economy. not the money managers and social sentiment on the former is far from levels that could justify the current high stock valuations.

So, with this stark divergence, either the economy will suddenly and unexpectedly catch up with shares, or vice versa. In the long run, stock levels do reflect the economy as the temporary extremes of P/E are always corrected (a reversion to the mean) – or at least they always have.

To explain the ‘broken’ markets, some are pointing to the extreme levels of ‘passive investing’ where new money is being funnelled into stock indexes (of which there are a myriad including AI) rather than into individual shares by ‘active’ fund managers looking for undervalues issues. That is being said to cause the distortions. But the fact remains that even so, there is a tsunami of funds buying index ETFs at present – mainly in Big Tech. And Big Money talks.

With many indexes pushing new ATHs, this surge is usually an overture to a late-stage buying climax prior to a major correction. And last week, such a buying climax may have appeared. on the charts.

I have based my market analysis work on the principle that extreme bullish sentiment always produces tops (and vice versa). But so far since the October lows, that law has been set aside as many normal sentiment measures have been off the scale for some time.

As I asked last week, are we in a new investing era where the old rules no longer apply? Can the AI buying frenzy continue?

It is easy to infer that, isn’t it? While Nvidia and the SS (Super Six) are screaming ever higher, it is very tempting to abandon all restraint and go with the FOMO flow. But that would be like abandoning the Law of Gravity and to suppose that Galileo standing atop his Leaning Tower of Pisa would have dropped the ball and expected it to fly up to the heavens. Only a hydrogen or helium filled ball could do that (other light gases are available).

So shall we get back to reality and observe that while the focus is primarily on AI and especially Nvidia (and Super Micro Computer!), not every Big Tech share is performing like gangbusters.

Far from it. Here is a previous EV darling Nio that has come a cropper from the impact of market forces

At one time, EV shares were the toast of the town with visions of massive profits from the government-mandated electric transition from fossil fuel. They were seen as investment no-brainers. Not any more.

Here is an interesting comparison the chart between Nvidia and a former Big Tech bubble share Cisco during the 1990s in the dotcom era:

Just like Nvidia, Cisco had become the largest share in the Nasdaq 100 growing earnings 150-fold by the year 2000 when it reached the top at $82. And just like Nvidia, this was no meme stock like GameStop being pumped and dumped in a company with negative earnings.

No, this was a computer company going to take over the world with growing real earnings per share. That was the consensus at the $84 peak. So, will the same occur with Nvidia or is there another four years of bull market left (see last week’s blog)?

Another lesson from the Cisco Affair is that even growing earnings at the $84 top did not prevent the bear from appearing.

And to emphasise the message from the Cisco/Nvidia comparison, here is an overlay of today’s S&P 500 (white) with the historic 1929 Dow 30 Industrials (red)

Circumstantial evidence for sure, but a glance at these two charts must be viewed before contemplating buying today by any rational investor. In fact, they should at least inspire bulls to lighten their Big Tech holdings.

And for bears, last week qualifies as a buying climax with a new high and a close below the low of the previous week. The last time such an event happened at the end of a strong rally phase was last September and then before that one notably in late December 2021 just prior to a savage 36% decline in the Dow.

In early December, I posted a chart showing the 2-year cycle high in Dow market highs

Since then, the Dow has rallied to the 39,000 area and well into new ATHs. The Dow made its high on Monday 12 February at the 39,020 level – a whisker away from an exact hit on the Big Round Number 39,000.

If February does mark the ATH then since it lies slightly outside my Dec/Jan window, can we allow it as a hit? After all, we are dealing with the possible top of a multi-decade bull market (at least since 1929) and bullish momentum remains strong where time lags can be expected.

And as if by coincidence, other stock indexes also made their ATHs at Big Round Numbers: the S&P at the 5,000 mark and the Nasdaq at the 18,000 level.

So with the Dow last week making its ATH on Monday and the Nasdaq 100 possibly completing a weekly buying climax on Friday, can I ask are we there yet?

Here is the 5-min chart of yesterday’s Nasdaq action

In the morning, the market pushed up to a new ATH at 18,030 at 11 am UK time and then proceeded to move lower on no new discernible news. Then at 1:30 pm the hot US CPI data was released and it fell further. By the end of the session, the index was down by over 1% and had carved out an excellent five down/three up.

This is the kind of short term Elliott wave signal I have been looking for (interminably, it seems). And I had spotted a similar pattern in the Dow and S&P earlier in the week.

My bottom line: Try as I may, I have yet to find a negative economic case set out for the ‘booming’ AI economy to come. It seems everyone is all in. But so far, massive profits from its use have not yet appeared. Yes, the shovel-sellers such as Nvidia are making massive earnings. but have the gold diggers struck the Mother Lode yet?

Also, where is the competition to Nvidia from the other AI computer chip makers? Profit margins available are huge and it is inconceivable for others to avoid this opportunity – unless they see a dead end for the industry. Hmm. Remember, with the proliferation of very convincing deep fakes, can anyone really trust what they see in a video any more?

Yes, the scope for AI in medicine is real especially in diagnosis and radiography. But a mass adoption of AI to displace humans (except in art) appears elusive. Musk once said that AI will make all humans redundant in the workplace. Remember, apocalyptic forecasts rarely work out to the point of never! After all, we are still here (climate disaster promoters please note).[/mepr-hide]