Transcription
I do think it's time for some caution. It does seem that that stocks are expensive relative to what I call fundamentals or you might call reality. People go from uh neutrality to liking stocks to liking them a lot to liking them a ton to liking them too much. And uh that's the continuation that creates u bubbles and you know we're we probably in the early days of that.
What if I told you that everyone is wrong about the stock market? Markets always feel the safest right before they become the most dangerous. Howard Marks calls it one of the biggest paradoxes in investing. And today I'll show you why Marks believes investors are getting it wrong and where the real bubble might actually be forming. Listen to Howard Marks explain.
>> I want to start, we want to start with a central question that you pose yourself. Why are asset prices so strong in the face of what you view as net negative developments? Howard, can you share your thoughts with us?
>> Uh, I'm glad to be with you this morning. Of course, as as the quote you just put on the screen uh indicates, um, you know, it this is all just feeling and and uh and uh an opinion. None of this is factual, but it it it does seem that that stocks are expensive relative to what I call fundamentals or you might call reality. And uh you know the outstanding reason I think is that um you know there hasn't been a serious market correction in 16 years. So uh people get out of the habit of uh of of thinking about market corrections. uh the biggest single mistake I've been thinking a lot what is the biggest single mistake investors make and I've concluded that it is that they conclude that that the way things are today is the way it'll always be and the things that have been happening will always continue to happen whereas uh reversion to the mean is is much more likely so I just think that it's worked very well uh being being an equity uh investor has worked very well doing it on leverage has worked even better. Uh concentrating in a few stocks has been gone very well. Uh investors are by nature optimistic and that optimism dies hard and uh and u you know um uh I just think that the fluctuations of the market are mostly related to psychological fluctuations. Uh and uh and people go from uh neutrality to liking stocks to liking them a lot to liking them a ton to liking them too much. And uh that's the continuation that creates u bubbles and you know we're we probably in the early days of that.
>> When you talk about liking Howard uh maybe liking these assets a little bit too much. Can you put into perspective the last time you saw this type of environment that left you thinking maybe some of the opportunities aren't as as great uh when it comes to buying some of these assets at current valuations? Is there another time that this sort of reminds you of in any capacity?
Well, I guess Lisa, uh, the last time was probably around 90 uh 97 when when the market was uh kind of falling in love with tech stocks and um you know uh the market was rocketing along. People were not worried about the level of valuations. People were extremely optimistic about the opportunities for the internet. Um and um you know Alan Greenspan famously cautioned uh that there might be uh irrational exuberance. Um u now I picked 97 uh because even though Greenspan was concerned about exuberance the market went on to rise for another two and a half to three years. Uh so remember I said we're in the early days. We're not we're not at a critical at a nutty uh valuation. Uh I'm I'm certainly not ringing the alarm bells as the quote that you had on the screen uh said. No reason to think there'll be a correction soon, but the point is that things are expensive >> and they may go on be they may go on to become more expensive, but the fact that they're expensive should not be lost.
Howard Marks often talks about bubbles as part of the market cycle. In his book, Mastering the Market Cycle, he explains that markets aren't perfect machines that always make sense. Instead, they're driven by people, and people are driven by emotion. That's why markets can go to extremes and swing back and forth between fear and greed. A bubble starts forming when excitement and optimism become stronger than logic. And investors convince themselves that this time is different. The seeds of a bubble happen at this point in the market cycle. At first, things usually look good. The economy might be getting stronger. A new technology might be catching on, or interest rates might be low and money easy to borrow. These sparks make investors feel confident. Stock prices start to go up, and those gains make everyone believe they were right to be excited. Then, momentum takes over. Rising prices attracts more buyers, and those buyers push prices even higher. Each step makes people more confident that the trend will continue forever. And pretty soon, the focus shifts away from whether an investment is actually worth the price. The only thing people care about is how fast it's going up and how much they might miss out on if they don't jump in. This happens here on Howard Marx's visual of the market cycle. This is where the bubble really starts to inflate. And here's the thing. Millions of investors are watching these same warning signs right now, wondering if they should sell everything or keep buying. But Howard Marks himself says the solution isn't trying to time the bubble. It's finding quality businesses trading below their intrinsic value, even in overheated markets. That's exactly what we do at Investor Center Research. Every month, our team delivers institutional-grade deep dives on a mispriced, high-quality business. We're talking 40 plus hours of research distilled into clear, actionable analysis. Plus, platinum members get full access to our model portfolio, so you can see exactly how we turn this research into positions. Right now, we're offering up to 35% off annual memberships. If you want to invest through the cycle with conviction instead of fear, check out the link below or scan the QR code on screen.
Now, back to what happens when these bubbles inevitably reach their peak. At this point, caution disappears. Traditional measures of value are ignored. Past market lessons are brushed aside and new rules or ways of thinking are invented to justify why prices can only keep climbing. That's when bubbles really inflate. When excitement replaces careful thinking and the crowd believes nothing can go wrong. A bubble really shows itself when prices no longer match the true value of what's being bought. People pay more and more not because the asset is worth it but because they believe someone else will pay even higher later. Howard Marks often says, "You can't know the exact day a bubble will pop, but you can recognize the warning signs." And those signs are clear. Extreme excitement in the market, people ignoring risks, and prices rising far beyond what history or fundamentals can justify. The peak of the bubble is at this point in the market cycle. In times like this, markets feel unusually safe. It seems like nothing could possibly go wrong. But that safety is an illusion. Sooner or later, reality takes over. Companies don't deliver the results people expected. Money becomes harder to get and the market cycle shifts in the opposite direction. Marks calls this one of the biggest paradoxes in investing. The moment when risk feels the smallest is often the moment when risk is actually the greatest. When everyone is confident, careful thinking disappears. And it's in that environment when investors feel most comfortable that bubbles peak and the fall becomes almost unavoidable. The move from euphoria to complacency usually starts when reality fails to keep up with expectations. At the peak, prices are based on perfect assumptions. Endless growth, cheap money, or flawless execution. But even small disappointments, weaker earnings, rising interest rates, or tighter credit can shake that confidence. Once cracks appear, momentum slows, and the first doubts creep in. Here, the market has already peaked, but investors don't fully realize it yet. Prices are starting to slip, but people explain it away as temporary. Optimism is still high, and many believe the upward trend will soon return. Risk is rising, but most participants don't see it. Next, the decline becomes harder to ignore. Earnings or economic data start to disappoint. Investors feel uneasy as prices fall further. Some still hold on, hoping for a rebound, while others begin to worry that things aren't as strong as they thought. Confidence gives way to doubt. This leads to what investors refer to as a capitulation. People essentially give up on the stock market, claiming it's too risky or not a good investment. This is the emotional low point of the cycle. Selling accelerates as investors give up hope of recovery. Fear dominates and many sell at deep losses just to escape. Pessimism is everywhere and markets may trade below fair value. Ironically, this is also where the seeds of the next recovery are planted because risk aversion is extremely high and prices are beaten down.
While this is a theoretical example, it is shocking how this dynamic plays out in real life. Take a look at this chart of the NASDAQ index during the dotcom bubble. In the years leading up to the bubble, you can see stock prices rise at a strong, steady rate. As excitement built, stock prices increased dramatically until the peak of the bubble was finally reached. It then took 3 years of decline until the bottom was finally reached. Notice how there are many points along the way where investors got excited about a potential recovery only for them to be disappointed as the market continued to fall.
There is a very important nuance in what Howard Marks is seeing in today's stock market that you need to understand. When Marks talks about bubbles today, he doesn't focus on the magnificent seven that dominate the headlines. Instead, he highlights something more subtle. The elevated prices across the rest of the market where ordinary companies are trading at extraordinary prices. Listen to what Howard Marks has to say.
And Howard, I think a lot of people point to in terms of the echoes of the late 90s the tech sector of the market as being the most overvalued. What I thought was so interesting about your memo is that that wasn't your take. That that wasn't your bigger concern in the market at a time when people are counting on a certain robustness of growth and a certain kind of inflationary backdrop. Why is it that tech isn't the focus of your concern this time around?
um a tech contributes to the aura that surrounds the markets and a lot of people have been citing the fact that the so-called magnificent seven stocks like Amazon and Alphabet and uh have been contributing disproportionately to the rise and they responsible for more than seven stocks uh their dollar gains have been responsible for more than half of all the gains in the 500 stocks in the S&P. pay 7 out of 500. Um, but they're great companies. They're at high valuations. I I think that I can't say those valuations are excessive. But the other 493 stocks are quite highly valued. Not as highly as the Magnus 7, but nobody says they're the same quality companies. Quite highly valued relative to history. And it is the it is the uh the fact that high valuations are being applied to more average companies that I think's more alarming than the fact that exceptional valuations are being applied to exceptional companies.
As of the making of this video, the so-called Magnificent 7 stocks have grown to be so large that they account for roughly 1/3 of the entire S&P 500. Put another way, Nvidia has a market cap of $4.32 trillion. I went through the entire list of the S&P 500 companies, and you would have to add together the market caps of the companies ranked 500 through 279 in order for that combined market cap to equal that of Nvidia. That is 226 of the largest publicly traded companies in the United States that have to be added together just to equal the current value of Nvidia. And these 226 companies include companies that are household names such as Domino's, Southwest Airlines, Campbell Soup Company, Clorox, Estee Lauder, Craft Hinds, and United Airlines. This dynamic has led many people to call the Magnificent 7 stocks the epicenter of the bubble. For example, as of the making of this video, Nvidia stock trades at a trailing PE ratio of around 50 times. People will point to this high PE ratio as evidence of a bubble in these stocks. Howard Marks disagrees. Yes, Nvidia stock is trading at a high multiple, but Marks argues that this doesn't tell the entire story. Nvidia has a profit margin of a staggering 62%. That compares to the median S&P 500 company of 12%. Additionally, Nvidia has grown revenue at a 70% annual growth rate since 2022, and that growth rate is projected to remain above 40% over the next few years. The numbers are even more impressive when you look at earnings per share. Since 2022, Nvidia has grown earnings at nearly 100% per year. That is a doubling of earnings each and every year. That earnings growth rate is projected to remain above 50% for the next few years. This hits directly at the point Howard Marks is trying to make. Calling a bubble based purely on a high PE ratio is foolish. Instead, you also have to consider the ability of that company to grow its earnings. One way to do that is through what is known as a PEG ratio. A PEG ratio compares the PE ratio of a company to its earnings growth. Calculating it is simple. You take the PE ratio of the stock and divide it by its earnings growth rate. To demonstrate Howard Marks' point, let's compare the PEG ratio of Nvidia to that of Eaton, a company that most people have never heard of. Eaton makes electrical equipment and as of the making of this video, has a market cap of 143 billion, making it the 78th largest company in the S&P 500. Also, as of the making of this video, Nvidia has a PE ratio of 50 times compared to Eaton at 28 times. This would lead most people to say Nvidia stock is overvalued compared to Eaton. Not so fast. For Nvidia, it is expected to grow earnings at around 40% for the next few years. This gives it a PEG ratio of 1.25. On the other hand, Eaton is expected to grow earnings at around 14% for the next few years. This gives a PEG ratio of two. Based on this simple analysis, it's actually Eaton that is overvalued and not Nvidia. Here is howard Marks described it in his most recent memo. Because of these companies greatness, referring to the Magnificent 7 companies, their stocks are highly valued and there's a popular perception that their elevated valuations are responsible for the S&P 500's unusually high average PE ratio. The fact is their PE ratios average out to roughly 33. This is certainly an abovea figure, but I don't find it unreasonable when viewed against what I believe to be the company's exceptional products, significant market shares, high incremental profit margins, and strong competitive modes. Rather, I think it's the average PE ratio of 22 on the 493 non-magnificent companies in the index, well above the mid- teens average historical PE for the S&P 500. that renders the index's overall valuation so high and possibly worrisome.
In the end, Howard Marks reminds us that bubbles aren't just about eye-catching headlines or a single group of stocks. They form when prices across the market drift too far from reality, fueled by confidence and emotion. The Magnificent 7 may get all the attention, but the bigger concern could be in the quieter parts of the market where average companies trade at above average prices. That's why Marks stresses the importance of judgment over formulas. A high multiple doesn't automatically mean a bubble, just as a low multiple doesn't always mean cheap. What matters is the balance between price and growth, value and risk. For long-term investors, the lesson is simple. Instead of chasing euphoria or panicking in fear, focus on finding businesses whose fundamentals justify their price. That's how you avoid being swept away by the cycle and how you come out stronger on the other side.
If you made it this far in the video, it's obvious you are serious about investing. Since that is the case, you'll want to check out this video here about the one thing that is keeping legendary investor Warren Buffett awake at night. I will see you over there.