"One of the frustrating things for people who miss the first rally in a bull market is that they wait for the big correction and it never comes. The market just keeps climbing and climbing. It feeds on itself in frenzied fashion and propels prices considerably higher for six months or so, and sometimes longer." - Martin Zweig
Before we start, I wanted to announce I am officially famous. Jim Cramer quote tweeted me on Twitter this week, which was really awesome. While this opened a floodgate of hate comments for me, it was really cool to be recognized by one of the most iconic names in investing.
“We need a pullback” - Me, as the market doesn’t pull back.
For a few weeks now I have found myself saying that the market “needs a pullback” before it can go higher, and yet every day it seems to go higher. Each day it seems the investor base becomes more divided, with one half screaming “higher we go” and the other half warning of a crash ahead. While it is true that often the bearish argument of an upcoming market selloff sounds more intelligent than any bullish sentiment, it is almost always wrong.
I believe we have a lot further to go in this bull market, and no, it isn’t just because Nvidia beat earnings expectations this past week and soared higher, once again. I believe this because things have to get a lot crazier before they can settle down. Let me explain.
The Graham-Style Bull Market
Benjamin Graham (no relation, unless you’re a potential employer, than we are super duper related) in the Intelligent Investor laid out the five characteristics that all bull markets are defined by, and are as follows:
A historically high price level.
High price / earnings ratio.
Low dividend yields as against bond yields.
Much speculation on margin.
Many offerings of new common-stock issues (IPOs) of poor quality.
Looking back through history, even after Graham wrote this, these five characteristics pretty much hit the nail on the head for bull markets. So which of these characteristics do we have in the markets right now? Let’s go through them.
1. A Historically High Price Level
Well we know this is true for the markets right now. It feels like every other day we are hitting a new all-time high, with over 10 already racked up this year for the S&P 500, and it isn’t even the end of February.
2. High Price / Earnings Ratio
Depending on who you trust, the current forward P/E ratio for the S&P 500 is roughly 22x. The long-run average is 18. If you back out the top 7 stocks you get a P/E closer to 18, but still the market isn’t cheap. There’s a lot of caveats to this, but we can check the box of a high price / earnings ratio for the markets, although there’s no saying it can’t go higher from here.
3. Low Dividend Yields as Against Bond Yields
Maybe the most dated of these characteristics, but it definitely fits the current mold. A quick check to any given S&P 500 index fund tells us the current dividend yield of the index is roughly 1.58%. In comparison, the 10-year U.S Treaury Bond yield is roughly 4.33%. This lower dividend yield against bond yields has been a trend in the 21st century, and I would attribute this to faster growing tech companies taking up the majority of market indices, and might not be as useful as in Graham’s time. Nevertheless, this checks out today.
4. Much Speculation on Margin
While margin rates are slowly ticking up as the market rallies, we have not gotten to outlandish speculation on margin yet. Much speculation is taking place in Nvidia call and put options, with billions betting on the stock’s price movement daily, but we have not seen margin become an area of concern in the markets just yet.
5. Many Offerings of New Common-Stock Issues (IPOs) of Poor Quality
And here’s the characteristic I want to focus a bit more on. Near the end of the bull market in 2022 we saw Rivian IPO and quickly hit a market capitalization of over $120 BILLION. At this point Rivian had barely produced any cars, and had almost no revenue. Today Rivian under a $10 billion market cap, and questions about their future continue to be raised (while I don’t own it, I am rooting for them as I love their product).
There are many more examples of questionable IPOs of this era, but there is no doubt that this is an example of a bull market that ended with a string of poor quality IPOs. This is what this market has yet to see, and I do think it will be some more time before we start to see a wave of IPOs. While we recently got news of Reddit’s IPO filing (Turns out this is definitely a low quality IPO, with almost no growth and no profitability. But don’t worry, they’ll use AI!), I do expect we will see some ridiculous IPOs before this party is over.
As long as rates remain elevated the IPO window will remain relatively closed, which in a weird way could be a positive for the market. However, I have no doubt that when it opens up there will be a wave of “AI” companies that raise billions for no good reason. Until we start getting companies promising AI in our clothes or shampoo or some crazy stuff like that, any argument this bull market is coming to an end is foolish in my eyes.
Drink the Kool-Aid, but Be Careful
“The trend is your friend”, “Don’t fight the tape”, “Buy high, sell higher”. There are countless Wall Street mantras that preach being optimistic when investing and to listen to what the market is telling you. Of course this doesn’t mean to go all in margin and buy stocks at any price, but maybe at least let your winners ride a little while longer. If you’re an index fund buy and holder don’t change your investment plan, and if you pick stocks keep looking for opportunities, but don’t get carried away.
It’s easy to get caught up in the commotion that is Wall Steet, and sometimes that is okay. Every so often check in on the five characteristics listed above, and maybe if you start seeing some ridiculous IPOs, use of margin, and mass euphoria overtake sentiment ask yourself if you think there is a reasonable expectation you could get Stock ABC at a lower price.
Warren Buffett always reminds investors the market will crash again, there will be another bear market, and it’s good to always be prepared for when it does finally come. That said, the market generally goes higher. Don’t sit on your hands waiting, instead ride the market higher until it starts to feel uncomfortable. If you start to see warning signs back off a bit and reasses the situation.
I think we still have a lot higher to go. In December I shared my price target for the S&P 500 of 5500 by the end of 2024. It’s totally meaningless, but a fun exercise. Will we get there in 2024? Time will tell, but I’ll be drinking the kool-aid until we do.