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On January 2, 2000, Howard Marks published his first memo to garner any reader response, bubble.com (http://bubble.com/) , calling attention to excesses he detected in the market for tech and internet stocks. His newest memo revisits the subject of bubbles. Howard expresses his view that they’re more a state of mind than a quantitative calculation and describes bubble thinking as irrational, often underlaid by a widespread belief that ‘‘this time is different.’’ Rather than opining on whether we’re in a bubble, Howard lists the signs he sees today and suggests how you might think about them . . . just as he did 25 years ago.
You can read the memo here (https://www.oaktreecapital.com/insights/memo/on-bubble-watch) (https://www.oaktreecapital.com/insights/memo/on-bubble-watch).
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Marks argues that while current market valuations are elevated and certain warning signs of bubble behavior exist, the situation is not yet demonstrably a bubble, though the risk of sharp corrections from current levels is significant.
- Bubbles are defined by psychological extremism and 'no price too high' mentality, not valuation metrics alone; today's market lacks the widest participation signals seen in past bubbles
- High PE multiples on leading stocks are economically justified by their superior technological advantages, scale, and margins, unlike the unprofitable TMT bubble firms
- Strong historical relationship between starting valuations and subsequent 10-year returns suggests 2-3% annualized returns are likely from current levels, but risk exists for compressed multiple correction within 1-2 years
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Hans Christian Andersen's 'The Emperor's New Clothes' explains bubble psychology: citizens are afraid to say they don't see a suit of clothes that doesn't exist, because admitting they don't see it would mark them as unintelligent, so the delusion continues unchecked until a naive child points it out; similarly, when a whole market is blasting off on a specious idea making investors rich, few people will risk calling it out and appearing to be a dummy.
“the explanation often lies in Hans Christian Anderson's story The Emperor's New Clothes Khan men sell the emperor an allegedly gorgeous suit of clothes that only intelligent people can see but in actuality there is no suit when the emperor parades around town naked the citizens are afraid to say they don't see a suit since that would mark them as unintelligent this goes on unchecked until a young boy steps out of the crowd and in his naive Tay points out that the emperor has no clothes most people would rather go along with a shared delusion that's making investors buckets of money then say something to the contrary and appear to be dummy”
Many bubbles throughout history have involved innovations that were either overestimated or not fully understood, where the attractions of a new product are usually obvious but the potholes and pitfalls are often hidden and only discovered in trying times, and even a bright newcomer can be supplanted by skillful competitors or even newer technologies.
“the bubbles I've lived through have all involved Innovations as I noted previously and many of those were either overestimated or not fully understood the attractions of a new product or way of doing business are usually obvious but the potholes and pitfalls are often hidden and only discovered in trying times a new company May completely outclass its predecessors but investors who by definition lack experience in this new field often fail to grasp that even a bright newcomer can be supplanted the disruptors can be disrupted whether by skillful competitors or even newer Technologies”
Prior to the Magnificent 7 emergence, the highest share for top seven stocks in the last 28 years was roughly 22% in 2000 at the height of the TMT bubble, making the current 32-33% a historic extreme.
“prior to the emergence of The Magnificent 7 the highest share for the top seven stocks in the last 28 years was roughly 22% in 2000 at the height of the TMT bubble”
In the real world, trees don't grow to the sky, and the discussion of risk in new technologies centers on overestimating fundamental strength, but optimism about the new thing often causes the error to compound through assignment of too high a stock price.
“in the real world trees don't grow to the sky the forgoing discussion centered on the risk of overestimating fundamental strength but optimism surrounding the power and potential of the new thing often causes the error to be compounded through the assignment of too high a stock price”
Charles Kindleberger and Robert Aliber observed that 'there is nothing so disturbing to one's well-being and judgment as to see a friend get rich,' which explains the FOMO-driven psychology that drives bubbles and makes price discipline difficult.
“As Charles kindleberger and Robert Alber observed in the fifth edition of Manas panics and crashes a history of financial crisis there is nothing so disturbing to one's well-being and judgment as to see a friend get rich so to discern a bubble you can look at valuation parameters but I've long believed a psychological diagnosis is more effective”
Only about half of the nifty50 stocks (as enumerated by Wikipedia) remain in the S&P 500 today; while mergers and acquisitions account for some disappearances (not failures), missing leaders include Xerox, Kodak, Polaroid, Avon, Burrough, Digital Equipment, and Simplicity Pattern, illustrating how hard persistence is.
“it's worth noting for example that only about half the nifty50 as enumerated by Wikipedia there is no agreed on list are in the S&P 500 today that figure undoubtedly looks worse than the reality since mergers and Acquisitions cause caused some of the old names to disappear not failures leading lights of 1969 that are missing from the S&P 500 today include Xerox Kodak Polaroid Avon burrow digital equipment and my favorite Simplicity pattern how many people make their own clothing these days another indication of how hard it is to persist”
Bubbles are invariably associated with new developments—technological or financial—including the nifty50 stocks in the 1960s, disc drive companies in the 1980s, TMT/internet stocks in the late 1990s, subprime mortgage-backed securities in 2004-2006, and historically the 1630s Dutch tulip craze and the 1720 South Sea Bubble.
“Bubbles are invariably associated with new developments there were bubbles in the nifty50 stocks in the 1960s more on them later disc drive companies in the 1980s TMT interet stocks in the late 1990s and subprime mortgage-backed securities in 2004 to 06 these relatively recent Manas followed in the tradition of ones like a 1630s craze in Holland over recently introduced tulips and B the south sea bubble in 1720 England concerning the riches that were sure to ensue from a trading Monopoly”
Three factors contributed to investor fascination with nifty50 stocks: first, strong post-WWII US economic growth; second, involvement in innovations like computers, drugs, and consumer products; third, the emergence of growth stocks as a new investment style that became a fad in itself.
“three factors contributed to investors fascination with these stocks first the US economy grew strongly in the post World War II period second these companies benefited from their involvement with areas of innovation such as computers drugs and consumer products and third they represented the first wave of growth stocks a new investment style that separately became a fad in itself”
The nifty50 were the object of the first big bubble in 40 years; since there hadn't been a bubble for so long, investors had forgotten what one looks like—causing them to lose 90% even though these were supposedly the best companies in America, with P/E ratios collapsing from 60-90x to 6-9x.
“the nifty50 were the object of the first big bubble in ru 40 years and since there hadn't been one for so long investors had forgotten what a bubble looks like as a result of the popularity that was conferred on them if you bought these stocks on the day I started work and held them tenaciously for 5 years you lost well over 90% of your money in the best companies in America what happened the nifty50 had been put on a pedestal and investors get hurt when something Falls from it the stock market as a whole declined by about half in 1973 to 74 and it turned out these stocks had been selling at prices that actually were too high in many cases their price to earnings ratios fell from the range of 60 to 90 to the range of 6 to9”
In the 1990s, the S&P 500 was boosted by: (1) the continuing decline of interest rates from their 1980s inflation-fighting peak, (2) the return of investor enthusiasm for stocks after the traumatic 1970s, (3) genuine technological innovation with rapid earnings growth in high-tech companies, (4) new academic research claiming the S&P 500 had never had a long period failing to outperform bonds and cash—together producing 20%+ annual returns for the decade.
“in the 1990s the S&P 500 was borne aoft by a the continuing decline of interest rates from their inflation fighting peak in the early 1980s and B the return of investor enthusiasm for stocks that had been lost in the traumatic 70s technological innovation and the rapid earnings growth of the high-tech companies added to the excitement and an upswing in the popularity of stocks was reinforced by new academic research showing there had never been a long period in which the S&P 500 failed to outperform bonds cash and inflation the combination of these positive factors caused the annual return on the index to average more than 20% for the decade”
A JP Morgan Asset Management graph showing forward P/E ratios and subsequent 10-year annualized returns from 1988-2024 shows a strong relationship: higher starting valuations consistently lead to lower returns, with minor variations but no serious exceptions, and today's P/E ratio of 22 is clearly in the top decile of observations.
“The graph from JP Morgan Asset Management has a square for each month from 1988 through late 2024 meaning there are just short of 324 monthly observations 27 years time 12 each Square shows the forward PE ratio on the S&P 500 at the time and the annualized return over the subsequent 10 years the graph gives rise to some important observations there's a strong relationship between starting valuations and subsequent annualized 10-year returns higher starting valuations consistently lead to lower returns and vice versa there are minor variations in the observ ations but no serious exceptions today's PE ratio is clearly well into the top desile of observations in that 27-year period”
In the TMT bubble, companies didn't have earnings so P/E ratios were unusable, and as startups they didn't have revenues; as a result, new metrics were invented (clicks, eyeballs) and trusting investors paid multiples regardless of whether these measurables could be converted into revenues and profits.
“in the TMT bubble the companies didn't have earnings so PE ratios were out and as startups they often didn't have revenues to Value as a result new metrics were invented and trusting investors ended up paying a multiple of clicks or eyeballs regardless of whether these measurables could be turned into revenues and profits”
A bubble reflects not only rapid price rises but a temporary mania characterized by irrational exuberance, outright adoration of subject companies, belief they cannot miss, massive fear of missing out (FOMO), and conviction that there is no price too high to pay.
“a bubble not only reflects a rapid rise in stock prices but it is a temporary Mania characterized by or perhaps better resulting from the following highly irrational exuberance to borrow a term from former Federal Reserve chair Alan Greenspan outright Adoration of the subject companies or assets and a belief that they can't miss massive fear of being left behind if one fails to participate fomo and resulting conviction that for these stocks there's no price too high”
There is usually a grain of truth underlying every mania and bubble—the internet absolutely did change the world and we can't imagine a world without it—but the vast majority of internet and e-commerce companies that soared in the late 1990s bubble ended up worthless.
“there's usually a grain of truth that underlies every Mania and bubble it just gets taken too far it's clear that the internet absolutely did change the world in fact we can't imagine a world without it but the vast majority of internet and e-commerce companies that soared in the late '90s bubble ended up worthless”
Importantly, of today's Magnificent 7, only Microsoft was in the top 20 from 24 years ago, suggesting that most of these companies represent a new wave of leaders that must achieve what most do not: persistence at the top of the market.
“importantly of today's magnificent 7 only Microsoft was in the top 20 24 years ago”
Even a bright newcomer company can be supplanted by skillful competitors or newer technologies; disruptors can be disrupted, making persistence in high-tech fields particularly difficult.
“a new company May completely outclass its predecessors but investors who by definition lack experience in this new field often fail to grasp that even a bright newcomer can be supplanted the disruptors can be disrupted whether by skillful competitors or even newer Technologies”
A chart from Michael Symbolist shows that prior to two years ago, there were only four times in S&P 500 history when it returned 20% or more for two consecutive years; in three of those four cases, the index declined in the following two-year period, with the exception being 1995-1998 when the powerful TMT bubble delayed the decline until 2000.
“by symbolist has another chart that makes this point it shows that prior to two years ago there were only four times in the history of the S&P 500 when it returned 20% or more for 2 years in a row in three of those four instances a small sample mind you the index declined in the subsequent 2-year period the exception was 1995 to 98 when the powerful TMT bubble caused the decline to be delayed until 2000”
Charles Kindleberger and Robert Alber observed in their book 'Manias, Panics and Crashes' that 'there is nothing so disturbing to one's well-being and judgment as to see a friend get rich,' which explains the powerful psychological pull toward participating in bubbles.
“as Charles kindleberger and Robert Alber observed in the fifth edition of Manas panics and crashes a history of financial crisis there is nothing so disturbing to one's well-being and judgment as to see a friend get rich”
Price-to-earnings (PE) ratios reflect how many years of earnings you're paying for: if the S&P 500's historical average PE is 16x, you're paying for more than 20 years of earnings when discounting is applied, because a dollar of profit in the future is worth less than a dollar today due to the time value of money.
“the price of the s P 500 has averaged roughly 16 times earnings in the post World War II period this is typically described as meaning you're paying for 16 years of earnings it's actually more than that though because the process of discounting makes $1 of profit in the future worth less than $1 today the current value of a company is the discounted present value of its future earnings so a PE ratio of 16 means you're paying for more than 20 years of earnings depending on the interest rate at which future earnings are discounted”
The appropriate price to pay for a company that will make $1 million next year and then shut down is slightly less than $1 million; however, stocks are priced at P/E multiples (multiples of earnings) because investors assume companies will earn profits year after year into the future, making valuation a question of discounting perpetual future earnings.
“what's the appropriate price to pay for a bright future if there's a company for sale that will make $1 million next year and then shut down how much would you pay for it the right answer is a little less than $1 million so that you'll have a positive return on your money but stocks are priced at PE multiples that is multiples of next year's earnings why because presumably they won't earn profits for just one year they'll go on making money from any more when you buy a stock you buy a share of the company's earnings every year into the future”
Stocks were tarred in the TMT bubble bursting and the S&P 500 declined in 2000, 2001, and 2002—the first three-year decline since 1939 during the Great Depression—causing cumulative returns of zero from mid-2000 until December 2011 (more than 11 years).
“stocks were tarred in the bursting of the TMT bubble and the SNP 500 declined in 2000 2001 and 2002 for the first three-year decline since 1939 during the Great Depression as a consequence of this poor performance investors deserted stocks on mass causing the S&P 500 to have a cumulative return of zero for the more than 11 years from the bubble peak in mid 2000 until December 2011”
From his nifty50 experience, Marks formulated three guiding principles: (1) It's not what you buy, it's what you pay that counts—good investing is about buying things well, not buying good things; (2) There's no asset so good that it can't become overpriced and dangerous; (3) There are few assets so bad that they can't get cheap enough to be a bargain.
“my early brush with a genuine bubble caused me to formulate some guiding principles that carried me through the next 50 odd years it's not what you buy it's what you pay that counts good investing doesn't come from buying good things but from buying things well there's no asset so good that it can't become overpriced and thus dangerous and there are few assets so bad that they can't get cheap enough to be a bargain”
Michael Symbalist shows via chart that prior to two years ago, there were only four times in the history of the S&P 500 when it returned 20% or more for 2 years in a row, and in three of those four instances, the index declined in the subsequent 2-year period; the exception was 1995-98 when the TMT bubble caused the decline to be delayed until 2000, when the index lost almost 40% in 3 years.
“by symbolist has another chart that makes this point it shows that prior to two years ago there were only four times in the history of the S&P 500 when it returned 20% or more for 2 years in a row in three of those four instances a small sample mind you the index declined in the subsequent 2-year period the exception was 1995 to 98 when the powerful TMT bubble caused the decline to be delayed until 2000 but then the index lost almost 40% in 3 years”
Today's S&P 500 leading companies are in many ways much better than the best companies of the past—they enjoy massive technological advantages, vast scale, dominant market shares, above-average profit margins, and because their products are based on ideas more than metal, the marginal cost of producing an additional unit is low, meaning marginal profitability is unusually high.
“today's SNP leading companies are in many ways much better than the best companies of the past they enjoy massive technological advantages they have vast scale dominant market shares and thus above average profit margins and since their products are based on ideas more than metal the marginal cost of producing an additional unit is low meaning their marginal profitability is unusually high”
The Magnificent 7 stocks (Apple, Microsoft, Alphabet/Google, Amazon, Nvidia, Meta, Tesla) have dominated the S&P 500 gains in recent years, with their combined market capitalization representing 32-33% of the index at the end of October, roughly double their share from 5 years ago.
“The seven top stocks in the S&P 500 the so-called magnificent 7 are Apple Microsoft alphabet Google's parent amazon.com Nvidia meta on Facebook WhatsApp and Instagram and Tesla a small number of stocks have dominated the S&P 500 in recent years and have been responsible for a highly disproportionate share of its gains a chart from Michael semolist Chief strategist at JP Morgan Asset Management shows that the market capitalization of the seven largest components of the S&P 500 represented 32 to 33% of the index's total capitalization at the end of October that percentage is roughly double the leader share 5 years ago”
Nvidia, the sexiest of the Magnificent 7 and leading designer of AI chips, has a current multiple of future earnings in the low 30s, which while double the post-war S&P average of 16x, is cheap compared to the nifty50's 60-90x range.
“perhaps the sexiest of the seven is NVIDIA the leading designer of chips for artificial intelligence it's current multiple of future earnings is in the low3s depending on which earnings estimate you believe while double the average post-war PE on the S&P 500 that's cheap compared to the nifty50”
Today's S&P 500 leading companies are in many ways much better than the best companies of the past: they enjoy massive technological advantages, vast scale, dominant market shares with above-average profit margins, and their products based on ideas rather than metal have low marginal costs with unusually high marginal profitability.
“today's SNP leading companies are in many ways much better than the best companies of the past they enjoy massive technological advantages they have vast scale dominant market shares and thus above average profit margins and since their products are based on ideas more than metal the marginal cost of producing an additional unit is low meaning their marginal profitability is unusually high”
A graph from JP Morgan Asset Management shows 324 monthly observations from 1988 through late 2024 of the forward PE ratio on the S&P 500 and the annualized return over the subsequent 10 years, demonstrating a strong relationship: higher starting valuations consistently lead to lower 10-year returns, with minor variations but no serious exceptions.
“the graph from JP Morgan Asset Management has a square for each month from 1988 through late 2024 meaning there are just short of 324 monthly observations 27 years time 12 each Square shows the forward PE ratio on the S&P 500 at the time and the annualized return over the subsequent 10 years the graph gives rise to some important observations there's a strong relationship between starting valuations and subsequent annualized 10-year returns higher starting valuations consistently lead to lower returns and vice versa there are minor variations in the observ ations but no serious exceptions”
From his early brush with the Nifty50 bubble, Marks formulated guiding principles: (1) it's not what you buy, it's what you pay that counts; (2) good investing doesn't come from buying good things but from buying things well; (3) there's no asset so good that it can't become overpriced and dangerous; and (4) there are few assets so bad that they can't get cheap enough to be a bargain.
“my early brush with a genuine bubble caused me to formulate some guiding principles that carried me through the next 50 odd years it's not what you buy it's what you pay that counts good investing doesn't come from buying good things but from buying things well there's no asset so good that it can't become overpriced and thus dangerous and there are few assets so bad that they can't get cheap enough to be a bargain”
Prior to the emergence of the Magnificent 7, the highest share for the top seven stocks in the S&P 500 during the last 28 years was roughly 22% in 2000 at the height of the TMT bubble.
“prior to the emergence of The Magnificent 7 the highest share for the top seven stocks in the last 28 years was roughly 22% in 2000 at the height of the TMT bubble”
Among the top 20 S&P 500 companies at the beginning of 2000 (Microsoft, GE, Cisco, Walmart, Exxon Mobil, Intel, Citi, IBM, Oracle, Home Depot, Merck, Coca-Cola, P&G, AIG, J&J, Qualcomm, Bristol Myers Squibb, Pfizer, AT&T, Verizon), only six were still in the top 20 by 2024 (Microsoft, Walmart, Exxon Mobil, Johnson & Johnson, Proctor & Gamble, Home Depot), and importantly, of today's Magnificent 7, only Microsoft was in the top 20 in 2000.
“the names of the top 20 S&P 500 companies at the beginning of 2000... these 20 companies were the most heavily represented in the index Microsoft General Electric Cisco Systems Walmart Exxon Mobile Intel City Group IBM Oracle Home Depot Merc cocacola Proctor and Gamble AIG Johnson and Johnson Qualcomm Bristol Meers squib fizer AT&T Verizon at the beginning of 2024 however only six of them were still in the top 20 Microsoft Walmart Exxon Mobile Johnson and Johnson Proctor and Gamble Home Depot importantly of today's magnificent 7 only Microsoft was in the top 20 24 years ago”
The seven largest stocks in the S&P 500 (Apple, Microsoft, Alphabet/Google, Amazon, Nvidia, Meta, and Tesla) represented 32-33% of the index's total capitalization at the end of October 2024, roughly double their share 5 years prior.
“a chart from Michael semolist Chief strategist at JP Morgan Asset Management shows that the market capitalization of the seven largest components of the S&P 500 represented 32 to 33% of the index's total capitalization at the end of October that percentage is roughly double the leader share 5 years ago”
A bubble is not primarily a quantitative calculation but rather a state of mind—characterized by rapid rise in stock prices driven by highly irrational exuberance, outright adoration of subject companies or assets, a belief that they can't miss, and massive fear of missing out (FOMO), resulting in conviction that there is no price too high.
“for me a bubble or crash is more a state of mind than a quantitative calculation in my view a bubble not only reflects a rapid rise in stock prices but it is a temporary Mania characterized by or perhaps better resulting from the following highly irrational exuberance to borrow a term from former Federal Reserve chair Alan Greenspan outright Adoration of the subject companies or assets and a belief that they can't miss massive fear of being left behind if one fails to participate fomo and resulting conviction that for these stocks there's no price too high”
Cautionary signs today include: (1) the optimism that has prevailed since late 2020; (2) above-average valuation on the S&P 500; (3) stocks in most industrial groups sell at higher multiples than stocks in those industries globally; (4) the enthusiasm applied to AI; (5) the implicit presumption that top seven companies will continue succeeding; (6) the possibility that some appreciation stems from automated index buying without regard for intrinsic value; (7) Bitcoin's 465% price rise in 2 years.
“The cautionary signs today include these the optimism that has prevailed in the markets since late 2020 2 the above average valuation on the SNP 500 and the fact that its stocks in most industrial groups sell at higher multiples than stocks in those Industries in the rest of the world the enthusiasm that is being applied to the new thing of AI and perhaps the extension of that positive psychology to other high-tech areas the implicit presumption that the top seven companies will continue to be successful and the possibility that some of of the appreciation of the S&P has stemmed from automated buying of these stocks by index investors without regard for their intrinsic value finally while I'm at it although it's not directly related to stocks I have to mention Bitcoin regardless of its Merit the fact that its price Rose 465 in the last 2 years doesn't suggest an overabundance of caution”
Counter-arguments to the bubble thesis include: (1) the P/E ratio on the S&P 500 is high but not insane; (2) the Magnificent 7 are incredible companies so their high P/E ratios could be warranted; (3) Marks doesn't hear people saying 'there's no price too high' and (4) the markets while expensive and frothy don't seem nutty.
“Here are the counterarguments the PE ratio on the S&P 500 is high but not insane the Magnificent 7 are incredible companies so their high PE ratios could be warranted I don't hear people saying there's no price too high and the markets while high pric and perhaps frothy don't seem nutty to me”
The S&P 500 was up 26% in 2023 and 25% in 2024, marking the best 2-year stretch since 1997-1998, and according to historical pattern analysis, this is the fifth time such back-to-back 20%+ returns have occurred in market history.
“in the last 2 years it's happened for the fifth time the S&P 500 was up 26% in 2023 and 25% in 2024 for the best 2-year stretch since 1997 to '98”
The three stages of a bull market are: first, when few insightful people imagine improvement after a market decline leaves investors dispirited; second, when the economy, companies, and markets are doing well and most people accept that improvement is taking place; and third, when everyone concludes that things can only get better forever after a period of great economic news and soaring earnings.
“the three stages of the bull market the first stage usually comes on the heels of a market decline or crash that has left most most investors licking their wounds and highly dispirited at this point only a few unusually insightful people are capable of imagining that there could be Improvement ahead in the second stage the economy companies and markets are doing well and most people accept that Improvement is actually taking place in the third stage after a period in which the economic news has been great companies have reported soaring earnings and stocks have appreciated Wild L everyone concludes that things can only get better forever”
When something is new and there is no historical pricing precedent, attention to history cannot serve as a tether to keep valuations grounded, but instead investors can justify any price based on the argument that 'it's owned by the brightest people' who are making headlines and fortunes, and few people will throw a wet blanket on that enthusiasm.
“in normal circumstances if an industry's or a country's Securities are attracting unusually high valuations investment historians are able to point out that in the past those stocks had never sold at more than an x% premium over the average or some similar metric in this way attention to history can serve as a tether keeping a favored group grounded on terrafirma but if something's new meaning there is no history then there's nothing to temper enthusiasm after all it's owned by the brightest people the ones who are showing up in the headlines and on TV and they've made a fortune who's willing to throw a wet blanket over that party”
There's usually a grain of truth underlying every mania and bubble—it just gets taken too far; the internet absolutely did change the world and we can't imagine a world without it, but the vast majority of internet and e-commerce companies that soared in the late 1990s bubble ended up worthless.
“There's usually a grain of truth that underlies every Mania and bubble it just gets taken too far it's clear that the internet absolutely did change the world in fact we can't imagine a world without it but the vast majority of internet and e-commerce companies that soared in the late '90s bubble ended up worthless”
The riskiest thing in the world is the belief that there's no risk, and in a similar vein, heated buying spurred by the observation that stocks had never performed poorly for a long period caused stock prices to rise to a point from which they were destined to do just that, illustrating George Soros's investment reflexivity at work.
“I always say the riskiest thing in the world is the belief that there's no risk in a similar vein heated buying spurred by the observation that stocks had never performed poorly for a long period caused stock prices to rise to a point from which they were destined to do just that in my view that's George soros's investment reflexivity at work”
Being too far ahead of your time in market analysis is indistinguishable from being wrong, a critical investment adage learned in the early 1970s.
“one of the first great investment adages I learned in the early 1970s is that being too far ahead of your time is indistinguishable from being wrong”
Corporate profits grow about 7% per year (attributed to Warren Buffett though Buffett said he never said this), meaning if stocks appreciate 20% per year while earnings grow 7%, valuations will eventually become so expensive relative to earnings that stocks will be risky.
“when investors forget that corporate profits grow about 7% per year they tend to get into trouble what this means is that if corporate profits grow at 7% a year and stock stocks which represent a share in corporate profits appreciate at 20% a year for a while eventually stocks will be so highly priced relative to their earnings that they'll be risky I recently asked Warren for a source on the quote and he told me he never said it but I think it's great so I keep using it”
In the aftermath of the TMT bubble, The Wall Street Journal would run a box on the front page listing stocks that were down 90%; many of them had lost 99%, illustrating the magnitude of value destruction when bubbles burst and expectations that 'things can only get better' are violated.
“in my early investing days The Wall Street Journal would run a box on the front page listing stocks that were down by 90% in the aftermath of the TMT bubble they'd lost 99%”
Investors should not be indifferent to current market valuations, as the return on an investment is significantly a function of the price paid for it—this is a fundamental principle that should guide valuation discipline.
“investors clearly shouldn't be indifferent to today's market valuation you might say making plus or minus 2% wouldn't be the worst thing in the world and that's certainly true if stocks were to sit still for the next 10 years as the company earnings Rose bringing the multiples back to Earth but another possibility is that the multiple correction is compressed into a year or two implying a big decline in stock prices”
The combination of falling interest rates, returning investor enthusiasm, technological innovation, earnings growth, and academic research showing stocks always outperform caused the annual return on the S&P 500 to average more than 20% for the 1990s decade, and Marks has never seen another period like it.
“the combination of these positive factors caused the annual return on the index to average more than 20% for the decade I've never seen another period like it”
The stock market as a whole declined about 50% in 1973-74, and it turned out that Nifty50 stocks had been selling at prices that were too high—their price-to-earnings ratios fell from 60-90 to 6-9, and further bad things actually did happen to several companies in fundamental terms.
“The stock market as a whole declined by about half in 1973 to 74 and it turned out these stocks had been selling at prices that actually were too high in many cases their price to earnings ratios fell from the range of 60 to 90 to the range of 6 to9 that's the easy way to lose 90% further bad things actually did happen to several of the companies in fundamental terms”
Investors in the 1990s were sure the internet would change the world, and this assumption prompted tremendous demand for everything internet-related, with e-commerce stocks going public at seemingly high prices and then tripling on the first day, creating a real gold rush.
“at the time investors were sure the internet will change the world it certainly looked that way and that assumption prompted tremendous demand for everything internet related e-commerce stocks went public at seemingly high prices and then tripled the first day there was a real gold rush”
In the last 2 years (2023-2024), the S&P 500 has achieved the fifth instance of 20%+ returns for 2 years in a row—it was up 26% in 2023 and 25% in 2024, making this the best 2-year stretch since 1997-98.
“in the last 2 years it's happened for the fifth time the S&P 500 was up 26% in 2023 and 25% in 2024 for the best 2-year stretch since 1997 to '98”
Being too far ahead of your time in investment timing is indistinguishable from being wrong, but the 1999 tech bubble memo avoided this trap by being right and being right fast.
“one of the first great investment adages I learned in the early 1970s is that being too far ahead of your time is indistinguishable from being wrong in this case however I wasn't too far ahead”
The return on an investment is significantly a function of the price paid for it, so investors shouldn't be indifferent to today's market valuation; while making +2% or -2% over 10 years wouldn't be terrible if stocks sit still, another possibility is that the multiple correction is compressed into a year or two, implying a big decline in stock prices like 1973-74 or 2000-02.
“the return on an investment is significantly a function of the price paid for it for that reason investors clearly shouldn't be indifferent to today's market valuation you might say making plus or minus 2% wouldn't be the worst thing in the world and that's certainly true if stocks were to sit still for the next 10 years as the company earnings Rose bringing the multiples back to Earth but another possibility is that the multiple correction is compressed into a year or two implying a big decline in stock prices such as we saw in 1973 to 74 and 20202 the result in that case wouldn't be benign”
The risk in current markets is not just low annualized returns but the possibility of sharp multiple compression occurring over 1-2 years (like 1973-74) rather than gradually over 10 years, which would produce large capital losses despite earnings growth.
“another possibility is that the multiple correction is compressed into a year or two implying a big decline in stock prices such as we saw in 1973 to 74 and 20202 the result in that case wouldn't be benign these are the things to worry about”
The three stages of a bull market are: first, only a few insightful people see improvement is possible after a crash; second, the economy and markets actually improve and most people accept it; third, after sustained good news and soaring earnings, everyone concludes things can only get better forever—the last stage marks bubble psychology.
“it's the three stages of the bull market the first stage usually comes on the heels of a market decline or crash that has left most most investors licking their wounds and highly dispirited at this point only a few unusually insightful people are capable of imagining that there could be Improvement ahead in the second stage the economy companies and markets are doing well and most people accept that Improvement is actually taking place in the third stage after a period in which the economic news has been great companies have reported soaring earnings and stocks have appreciated Wild L everyone concludes that things can only get better forever”
In normal circumstances, investment historians can use historical precedent to constrain excessive valuations (e.g., 'this industry has never sold above X% premium'), but when something is new with no history, there is no tether to terrafirma, allowing unbounded enthusiasm because it is owned by 'the brightest people' shown in headlines and on TV who have made fortunes.
“in normal circumstances if an industry's or a country's Securities are attracting unusually high valuations investment historians are able to point out that in the past those stocks had never sold at more than an x% premium over the average or some similar metric in this way attention to history can serve as a tether keeping a favored group grounded on terrafirma but if something's new meaning there is no history then there's nothing to temper enthusiasm after all it's owned by the brightest people the ones who are showing up in the headlines and on TV and they've made a fortune who's willing to throw a wet blanket over that party”
The Hans Christian Andersen's 'Emperor's New Clothes' dynamic explains bubble behavior: people are afraid to say they don't see value (the emperor's clothes) because it would mark them as unintelligent, so mass delusions persist unchecked until a naive observer (often later exposed as foolish) points out the truth, but few risk calling it out when a market is blasting off and making adherents rich.
“The explanation often lies in Hans Christian Anderson's story The Emperor's New Clothes Khan men sell the emperor an allegedly gorgeous suit of clothes that only intelligent people can see but in actuality there is no suit when the emperor parades around town naked the citizens are afraid to say they don't see a suit since that would mark them as unintelligent this goes on unchecked until a young boy steps out of the crowd and in his naive Tay points out that the emperor has no clothes most people would rather go along with a shared delusion that's making investors buckets of money then say something to the contrary and appear to be dummy”
Only about half of the Nifty50 companies (as enumerated by Wikipedia) are in the S&P 500 today, and the figure undoubtedly looks worse than reality since mergers and acquisitions caused some names to disappear, not failures, but leading lights of 1969 missing from the S&P 500 today include Xerox, Kodak, Polaroid, Avon, Burrough, Digital Equipment, and Simplicity Pattern.
“it's worth noting for example that only about half the nifty50 as enumerated by Wikipedia there is no agreed on list are in the S&P 500 today that figure undoubtedly looks worse than the reality since mergers and Acquisitions cause caused some of the old names to disappear not failures leading lights of 1969 that are missing from the S&P 500 today include Xerox Kodak Polaroid Avon burrow digital equipment and my favorite Simplicity pattern”
Technology evolution seemed gradual in Marks' early decades (computers, drugs, products improved incrementally) but in the 1990s innovation came in a 'big rush,' with e-commerce stocks going public at seemingly high prices and tripling on the first day.
“in the 1990s Innovation came in a big rush when oak tree was founded in 1995 I insisted that I could get by with just word perfect for word processing and loadest 123 for spreadsheets but when we moved to our current office in 1998 I threw in the towel and let our it team install email and the internet and of course Word Perfect gave way to word and Lotus 123 to excel at the time investors were sure the internet will change the world it certainly looked that way and that assumption prompted tremendous demand for everything internet related e-commerce stocks went public at seemingly high prices and then tripled the first day”
Bubbles historically involve innovations that are either overestimated or not fully understood, with attractions of new products or ways of doing business usually obvious but potholes and pitfalls often hidden and only discovered in trying times.
“the bubbles I've lived through have all involved Innovations as I noted previously and many of those were either overestimated or not fully understood the attractions of a new product or way of doing business are usually obvious but the potholes and pitfalls are often hidden and only discovered in trying times”
A PE multiple in the 30s for Nvidia implies investors think it will remain in business for decades, that profits will grow throughout those decades, and that it won't be supplanted by competitors, meaning investors are assuming Nvidia will demonstrate persistence—a difficult achievement especially in high-tech fields.
“what does a multiple in the 30s imply first that investors think Nvidia will be in business for decades to come second that its profits will grow throughout those decades and third that it won't be supplanted by competitors in other words investors are assuming Nvidia will demonstrate persistence but persistence isn't easily achieved especially in Hightech Fields where new technologies can arise and new competitors can leap frog incumbents”
In bubbles, hot stocks sell for considerably more than 16x earnings; nifty50 investors in 1969 were paying for companies' earnings decades into the future at 60-90x PE, unconsciously rather than analytically. However, today's S&P 500 leading companies don't trade at nifty50-level multiples—they're more fairly valued relative to their superior fundamentals.
“in bubbles hot stocks sell for considerably more than 16 times earnings remember the 60 to 90 times for the nifty50 investors in 1969 were paying for company's earnings even after giving them credit for significant earnings growth many decades into the future did they do so consciously and analytically not that I recall investors thought of a PE ratio as just a number if they thought about it at all today's SNP leading companies are in many ways much better than the best companies of the past they enjoy massive technological advantages they have vast scale dominant market shares and thus above average profit margins and since their products are based on ideas more than metal the marginal cost of producing an additional unit is low meaning their marginal profitability is unusually high”
In November, a couple of leading banks projected 10-year S&P 500 returns in the low to mid single digits, which aligns with the historical relationship between starting valuations and subsequent 10-year returns, validating the empirical pattern.
“in November a couple of leading Banks came out with projected 10-year returns for the S&P 500 in the low to mid single digits the just mentioned relationship is the reason it shouldn't come as a surprise that the return on an investment is significantly a function of the price paid for it”
In a hot new field, investors can adopt a 'lottery ticket mentality'—if a successful startup can return 200x but is only 1% likely to succeed, it's mathematically worth investing in, even though few investments actually have 1% odds of success—leading to few limits on valuations investors will support.
“ultimately the really hot new thing investors can adopt what I call a lottery ticket mentality if a successful startup in a hot field can return 200x it's mathematically worth investing in even if it's only 1% likely to succeed Ed and what doesn't have a 1% likelihood of success when investors think this way there are few limits on what they'll support or the prices they'll pay”
A multiple of 30x on Nvidia implies that investors think: (1) Nvidia will be in business for decades to come; (2) its profits will grow throughout those decades; and (3) it won't be supplanted by competitors, in other words investors are assuming Nvidia will demonstrate persistence, but persistence isn't easily achieved especially in high-tech fields where new technologies can arise and new competitors can leapfrog incumbents.
“what does a multiple in the 30s imply first that investors think Nvidia will be in business for decades to come second that its profits will grow throughout those decades and third that it won't be supplanted by competitors in other words investors are assuming Nvidia will demonstrate persistence but persistence isn't easily achieved especially in Hightech Fields where new technologies can arise and new competitors can leap frog incumbents”
The Nifty50 bubble was enabled by three factors: first, the US economy grew strongly in the post-WWII period; second, these companies benefited from involvement with innovation areas like computers, drugs, and consumer products; and third, they represented the first wave of growth stocks, a new investment style that became a fad in itself.
“three factors contributed to investors fascination with these stocks first the US economy grew strongly in the post World War II period second these companies benefited from their involvement with areas of innovation such as computers drugs and consumer products and third they represented the first wave of growth stocks a new investment style that separately became a fad in itself”
A legendary story illustrates bubble detection: JP Morgan knew there was a problem when the person shining his shoes started giving him stock tips, and similar signs appeared in 2000 when John Frank heard a father at his son's soccer game bragging about tech stocks, and again in 2006 when a Las Vegas cab driver told him he'd purchased three condos.
“Legend has it that JP Morgan knew there was a problem when the person shining his shoes started giving him stock tips my partner John Frank says he saw it in 2000 when he heard the dad at his son's soccer game bragging about the tech stocks they owned and again in 2006 when a Las Vegas cab driver told him about the three condos he'd purchased”
Psychological extremeness marking a bubble can often be inferred from widespread participation in investment fads among non-financial types; legendary examples include JP Morgan learning of a problem when his shoeshine boy offered stock tips, and John Paulson's partner observing bubble conditions when a soccer dad bragged about tech stocks in 2000 and a Vegas cabbie discussed three condo purchases in 2006.
“Legend has it that JP Morgan knew there was a problem when the person shining his shoes started giving him stock tips my partner John Frank says he saw it in 2000 when he heard the dad at his son's soccer game bragging about the tech stocks they owned and again in 2006 when a Las Vegas cab driver told him about the three condos he'd purchased”
When something is on the pedestal of popularity, the risk of a decline is high; when people assume and price in expectations that things can only get better, damage from negative surprises is profound.
“when something is on the pedestal of popularity the risk of a decline is high when people assume and price in an expectation that things can only get better the Damage Done by negative surprises is profound”
A disciplined investor, when hearing 'there's no price too high,' should respond with 'of course there's a price that's too high, but we're not there yet,' and the failure to make this distinction is a sure sign that a bubble is brewing.
“a more disciplined investor might say of course there's a price that's too high but we're not there yet I consider it a sure sign that a bubble is brewing”
In the real world, trees don't grow to the sky, and optimism surrounding new innovations often compounds the error of overestimating fundamental strength by assigning too high a stock price through non-existent historical valuation metrics.
“in the real world trees don't grow to the sky the forgoing discussion centered on the risk of overestimating fundamental strength but optimism surrounding the power and potential of the new thing often causes the error to be compounded through the assignment of too high a stock price”
Bitcoin's price rose 465% in the last 2 years, and regardless of its merit, the fact that the price rose this much doesn't suggest an abundance of caution in the market.
“although it's not directly related to stocks I have to mention Bitcoin regardless of its Merit the fact that its price Rose 465 in the last 2 years doesn't suggest an overabundance of caution”
Nvidia, the leading designer of chips for artificial intelligence, has a current multiple of forward earnings in the low 30s depending on which earnings estimate you believe, which is double the average post-war PE on the S&P 500 but cheap compared to the Nifty50's 60-90x multiple.
“perhaps the sexiest of the seven is NVIDIA the leading designer of chips for artificial intelligence it's current multiple of future earnings is in the low3s depending on which earnings estimate you believe while double the average post-war PE on the S&P 500 that's cheap compared to the nifty50”
Stocks were battered in the bursting of the TMT bubble and the S&P 500 declined in 2000, 2001, and 2002, the first three-year decline since 1939 during the Great Depression, and as a consequence of this poor performance, investors deserted stocks en masse, causing the S&P 500 to have a cumulative return of zero for more than 11 years from the bubble peak in mid-2000 until December 2011.
“stocks were tarred in the bursting of the TMT bubble and the SNP 500 declined in 2000 2001 and 2002 for the first three-year decline since 1939 during the Great Depression as a consequence of this poor performance investors deserted stocks on mass causing the S&P 500 to have a cumulative return of zero for the more than 11 years from the bubble peak in mid 2000 until December 2011”
Counterarguments to concerns about a bubble: (1) the PE ratio on the S&P 500 is high but not insane; (2) the Magnificent 7 are incredible companies so their high PE ratios could be warranted; (3) Marks doesn't hear people saying 'there's no price too high'; and (4) the markets while high price and perhaps frothy don't seem nutty, suggesting we're not yet in a full bubble.
“here are the counterarguments the PE ratio on the S&P 500 is high but not insane the Magnificent 7 are incredible companies so their high PE ratios could be warranted I don't hear people saying there's no price too high and the markets while high pric and perhaps frothy don't seem nutty to me”
When corporate profits grow about 7% per year (a fact Marks attributes to Warren Buffett but Buffett denies saying), if stocks appreciate at 20% per year for a while, eventually stocks will be so highly priced relative to their earnings that they'll be risky, making the rate of stock appreciation vs. earnings growth the key predictor of danger.
“Lately I've been repeating a quote I attribute to Warren Buffett when investors forget that corporate profits grow about 7% per year they tend to get into trouble what this means is that if corporate profits grow at 7% a year and stock stocks which represent a share in corporate profits appreciate at 20% a year for a while eventually stocks will be so highly priced relative to their earnings that they'll be risky I recently asked Warren for a source on the quote and he told me he never said it but I think it's great so I keep using it”
Further bad things actually did happen to several nifty50 companies in fundamental terms, beyond valuation compression—supporting the principle that bubbles based on overestimated innovation can involve real deterioration in business quality as well.
“further bad things actually did happen to several of the companies in fundamental terms”
In the first decade of the 21st century, investors experienced two major bubbles: the TMT bubble (late 1990s, burst mid-2000) and the housing bubble (mid-2000s), the latter characterized by subprime lending, securitization of mortgages, and massive losses for investors and financial institutions.
“in this Century's first decade investors had the opportunity to participate in and lose money due to two spectacular bubbles the first was the tech media Telecom TMT bubble of the late 90s which began to burst in mid 2000 and the second was the housing bubble of the mids which gave rise to a extending mortgages to subprime borrowers who couldn't or wouldn't document income or assets B the structuring of those loans into levered tranched mortgage banked Securities and consequently see massive losses for investors in those Securities especially the financial institutions that had created them and retained some”
The TMT bubble burst in mid-2000, and housing bubble of mid-2000s led to subprime mortgage crisis with subsequent massive losses for investors, especially financial institutions that retained mortgage-backed securities.
“in this Century's first decade investors had the opportunity to participate in and lose money due to two spectacular bubbles the first was the tech media Telecom TMT bubble of the late 90s which began to burst in mid 2000 and the second was the housing bubble of the mids which gave rise to a extending mortgages to subprime borrowers who couldn't or wouldn't document income or assets B the structuring of those loans into levered tranched mortgage banked Securities and consequently see massive losses for investors in those Securities especially the financial institutions that had created them and retained some”
As a credit investor who stopped analyzing stocks nearly five decades ago and has never ventured far into technology, Marks will not comment on specific hot companies or their stocks, only on generalities, and he is certainly no expert on technology, so he cannot speak authoritatively about whether we're in a bubble, just lay out the facts as he sees them and suggest how to think about them.
“as I said at the start of this memo I'm not an equity investor and I'm certainly no expert on technology thus I can't speak authorit ly about whether we're in a bubble I just want to lay out the facts as I see them and suggest how you might think about them”
In the 1990s innovation came in a big rush—when Oaktree was founded in 1995, Marks could get by with Word Perfect and Lotus 123, but when they moved offices in 1998, he adopted email and the internet, and Word Perfect gave way to Word and Lotus 123 to Excel, illustrating how rapidly technology disrupts previous innovations.
“in the 1990s Innovation came in a big rush when oak tree was founded in 1995 I insisted that I could get by with just word perfect for word processing and loadest 123 for spreadsheets but when we moved to our current office in 1998 I threw in the towel and let our it team install email and the internet and of course Word Perfect gave way to word and Lotus 123 to excel”
Marks joined the equity research department at First National City Bank (now Citi) in September 1969 and experienced the Nifty50 bubble, where most Money Center Banks invested mainly in the best and fastest growing companies in America, considered so good that nothing bad could ever happen and there was no price too high for their stocks.
“I joined the equity research department at First National City Bank now City in September 1969 as was the case with most of the so-called Money Center Banks City invested mainly in the nifty50 stocks of the best and fastest growing companies in America these companies were considered to be so good that a nothing bad could ever happen and B there was no price too high for their stocks”
Exactly 25 years ago today I published the first memo that brought a response from readers after having written for almost 10 years without receiving any, called 'bubble.com', addressing irrational behavior in Tech internet and e-commerce stocks.
“this is the memo by Howard marks on Bubble Watch exactly 25 years ago today I published the first memo that brought a response from readers after having written for almost 10 years without receiving any the memo was called bubble.com”
Marks joined First National City Bank's equity research department in September 1969, where the bank invested mainly in nifty50 stocks considered so good that nothing bad could ever happen and there was no price too high—establishing his baptism under fire with a genuine bubble.
“I joined the equity research department at First National City Bank now City in September 1969 as was the case with most of the so-called Money Center Banks City invested mainly in the nifty50 stocks of the best and fastest growing companies in America these companies were considered to be so good that a nothing bad could ever happen and B there was no price too high for their stocks”
Marks is not an equity investor and is not an expert on technology, so he can't speak authoritatively about whether there's a bubble, but he hopes to lay out the facts and suggest how audiences might think about them—using the same approach he employed 25 years ago with bubble.com.
“I'm not an equity investor and I'm certainly no expert on technology thus I can't speak authorit ly about whether we're in a bubble I just want to lay out the facts as I see them and suggest how you might think about them just as I did 25 years ago”
Bubble.com memo published 25 years ago was 'right and right fast,' establishing the pattern that being too far ahead of your time is indistinguishable from being wrong, but in that case timing was correct.
“exactly 25 years ago today I published the first memo that brought a response from readers after having written for almost 10 years without receiving any the memo was called bubble.com and the subject was the irrational Behavior I thought was taking place with respect to Tech internet and e-commerce stocks the memo had two things going for it it was right and it was right fast”