Whatever the outcome of the November 5th Presidential election is, market volatility will likely increase while the anticipated policies of the next administration are debated. After the Presidential Inauguration on January 20th, 2025, the process of implementing those policies will begin and the markets will continue to gyrate as polarized electorates comes to terms with the new administration’s policy plans and life begins to normalize.
Within this backdrop of volatile cross currents, we view the markets being at an inflection point where we are entering a post-bubble market environment where new leadership will emerge — much as it did in the post-tech bubble periods from 2000 to 2011 and during the 1970s. Based on our study of these historical analogues, we believe that small capitalization stocks, value stocks, commodities, precious metals, and emerging markets are where new leadership will most likely emerge. We already have seen strength in Argentina, China, gold, silver, and Bitcoin. By rotating into new emerging value opportunities, investors will likely find new sources of superior performance and wealth generation while mega cap US growth stocks lose their position as the dominant driver of wealth generation that they have held for the last four decades and last decade, in particular.
Interest rates are integral to stock, bond, and real estate valuations and, since 1981, interest rates have been declining. This backdrop of declining interest rates has helped to drive stock, bond and real estate prices and performance higher in an accelerating feedback loop. Since August 2020, when 10 year US Treasury yields bottomed at 0.55%, this important valuation driver has ended. The chart below shows that 10-year US Treasury yields declined from 15.85% to 0.55% and that this four decade trend of declining rates ended and reversed in 2020. With the rise in inflation, we see little chance of interest rates returning to their August 2020 lows, and the disappearance of this value driver will help drive a rotation to new investment leaders in the years ahead.
The current US equity market resembles the 2000 technology bubble. The critical takeaway from the 2000 bubble is the remarkable outperformance of out-of-favor value investments in small cap stocks and value stocks, commodities, energy, and precious metals, as well as emerging and international markets in the decade which followed the 2000 peak. We refer to this leadership change as the Great Rotation.
Below is a chart by Crescat Capital which compares the price action of the top ten Megacap Tech stocks in 2000 with today’s top ten Megacap stocks. We believe that cap weighted index construction combined with the great innovation and growth in technology over the last decade or two, leads us to believe that today’s Megacap performance is unsustainable and a reversion to the mean is a risk worth mitigating.
The sum of the market caps of Apple ($3.369 T), Alphabet ($2.104 T), Tesla ($0.799 T), Nvidia ($3.92 T), Mastercard ($O.466 T), Microsoft ($3.051 T), Amazon ($2.081 T), Meta ($1.432 T), Visa ($0.564 T), and Broadcom ($0.789 T) is $18.575 trillion. In a $29.35 trillion US GDP economy, today’s $18.575 T equity capitalization of the top ten US Megacaps is a whopping 63.2% — a stunning market capitalization to GDP ratio that is emblematic of a bubble valuation in our opinion.
Veteran market observers know that certain sectors come to dominate a share of the S&P 500 and that later that sector is replaced with another leading sector. These rotations are often accentuated with behavior manifestations of extreme fear and greed that behavioral economics Nobel Laureate Robert Shiller popularize with the term “irrational exuberance” and his epic book Irrational Exuberance first published in March 2000. Today’s obsession with the massive transformative potential of Artificial Intelligence, that is manifested in Nvidia stock, the Magnificent Seven stocks, and today’s top ten Megacap tech stocks appears to be this cycle’s moment of “irrational exuberance”.
Post Bubble Leadership:
Another talented strategist, Julian Brigden, of Macro Intelligence 2 has analyzed geographic and sector outperformance in the post-tech bubble environment. The chart below shows the outperformance of the emerging markets (MSCI EM) index and other foreign indices relative to the US market in the post bubble period. This analogue and recent strength in Argentina and China support our enthusiasm for emerging market opportunities for the next several years.
Argentina’s stock market has tripled since 2022, based on the Global X MSCI Argentina ETF (ARGT). Argentina is a country that has suffered from hyper-inflation, collapsing currency, and crippling government bureaucracy. Firebrand Javier Milei has led a conservative libertarian revolution in Argentina since 2022 and is credited for its improving fortunes. One Argentinian stock we bought for our clients was YPF Sociedad Anonima (YPF), the Argentinian National Oil Company, which owns much of the Vaco Muerte shale in Argentina, a shale on the scale of the Permian Basin.
In recent months we have been attracted to several Chinese stocks following several years of disappointing performance.
The chart below of the FXI shows the early 2000 six-fold bull market in the post US bubble period. We believe that recent strength in the Chinese market may signal a positive turn for its economy and its relations with the US, following years of increased belligerence and potential war footing.
Five stocks we have identified as companies that are large, abjectly dominant, and terribly cheap compared to comparable US equities are: BYD Company Limited (BYDDY), Daqo New Energy Corp. (DQ), Weibo Corporation (WB), PDD Holdings Inc. (PDD) and BIDU, Inc. (BIDU).
Bridgen’s work also illustrates sector outperformance relative to technology in the 2002 to 2008 post bubble environment. In the chart below, several non-technology sectors, led by energy, materials, and mining outperformed technology. We are particularly keen on mining and materials in the years ahead.
Gold and Silver
We have been buying Silvercorp Metals (SVM), a proven silver miner with significant mineral properties in China and Ecuador and a $1 billion market capitalization that is demonstrating accelerating earnings momentum. Due to its viable mineral properties, attractive valuation, and profitability, we anticipate meaningful upside as the company ramps up its best mining prospects in China and Ecuador.
What intrigues us about gold and silver mining is the recent rise in the underlying precious metal does not appear to be priced into miners’ share prices. The rise in precious metal prices since 2019, implies an attractive and expanding gross profit potential that has not yet been reflected in the miner’s share prices, especially when compared to the price of the underlying.
The chart below shows that gold has doubled in price since 2019 when it traded for $1200 per ounce compared to today’s $2736 per ounce price.
Furthermore, miners’ share prices lag the metal price as shown in the chart below comparing the SPDR Gold Shares ETF (GLD) with the VanEck Gold Miners ETF (GDX).
Silver lags gold prices and, like gold shares, silver miners lag the price of silver. This is displayed in the chart below of the Global X Silver Miners ETF (SIL) compared to the iShares Silver Trust (SLV). In light of gold prices doubling in the last five years, gold leading silver prices, and silver miner’s share lagging the silver’s price appreciation, we foresee a meaningful rise in silver miner shares in the years ahead. SVM looks poised to benefit from this favorable backdrop.
Positive Feedback Loops and Unsustainable Parabolic Charts:
There are several feedback loops which have helped drive the parabolic bull markets in the S&P 500 and NASDAQ 100. Dollar strength, momentum investing, and market capitalization structures have driven today’s unsustainable parabolic charts in the S&P 500 and NASDAQ 100.
The development and proliferation of capitalization weighted indices over the last four decades has led to a positive feedback loop where the largest capitalization stocks get the most capital until their momentum peaks. In the decade which followed the 2000 technology bubble, the fate of five of the ten largest companies in the world – General Electric, Cisco, Exxon, Intel, NTT, Lucent and Nokia — illustrate how precarious market capitalization leadership can be and how recency bias likely trapped many investors in the wake of the 2000 market peak. Following the “Go-Go Sixties” a similar Megacap reversion occurred for the “Nifty Fifty” in the 1970s and led to flat returns for the S&P 500 for nearly a decade. These analogues from the 1970s and 2000s make us cautious on the S&P 500, QQQ, Megacap Tech, and the 60% equity 40% bond portfolio allocation.
An accommodating Federal Reserve could, counter intuitively, be another factor which could burst today’s Megacap bubble. The diagram below from Macro Intelligence 2 suggests that the Federal Reserve’s cutting of Fed Fund rates could weaken the US dollar and make US assets less attractive. As the Fed eases interest rates and foreign investment exits US markets, and US equities will be sold by foreigners. Furthermore, the sale of US technology stocks will lead companies to enhance earning and fire US workers, which, in turn, could lead to a recession.
Conclusion
Increased volatility should slow the momentum in Megacap technology shares in the coming months. Simultaneously, the market is at an inflection point where Megacap stocks’ rise is beginning to reverse and structural cap weighted fund flows which have driven the QQQ and S&P 500, as well as innumerable thematic and momentum ETFs, reverse momentum. As frenzied momentum investing slows, markets will increasingly allocate to new areas of investment that are attractive value propositions as has been illustrated in Argentina, China, gold, silver, and we expect that this rotation will drive new leadership in small cap and value stocks, emerging markets, and commodities.
When the S&P 500 and NASDAQ 100 finished their decline, two and a half years after the 2000 tech bubble peak, these indices were down 52% and 83% respectively. The exceptional returns generated in energy, precious metals, and emerging markets during 2000 to 2011 period, created great wealth for those with the flexibility and perspicacity to rotate away from their recency bias toward technology mania and invest in new markets where great value and growth prevailed for nearly a decade.