Wesley Chapel, FL
“Folks can only fall this deeply in love with such a high level of risk by having absolutely no ability to understand and recognize risk. They’re not risk-tolerant... They’re risk oblivious.”
Back in 2021, two of the best-performing stocks in the US Markets were GameStop and AMC Theaters. Both companies were on the verge of bankruptcy, and nobody had any business buying them at any price, let alone the prices they had risen to.
GameStop rose by 2,700% and traded as high as $120/share, while AMC shares increased 3,700% and went all the way up to $762. These prices reflect stock splits for both companies that have happened since then.
Fast-forward to 2024, and GameStop shares went as low as $9.95, and AMC shares traded for $2.38.
They are down 92% and 99%, respectively. They are both still effectively bankrupt. The only reason that isn’t official is because the outrageous rise in their share prices allowed them to sell new shares to oblivious “investors.”
You might have thought, especially after the 2022 bear market that followed the “meme stock” mania of 2021, that was the craziest thing you would see for a while.
Enter Fartcoin.
I wish I were joking.
Fartcoin is a real thing. You can buy it. You can also sell it, for now. Perhaps there will come a day when you won’t be able to give your Fartcoin away at any price. But that day is not today.
Fartcoin does nothing and adds zero value to anything. That isn’t to say that humor adds no value but at the end of the day, Fartcoin is a literal joke. To make it even more ridiculous, it is a joke made up by AI. I kid you not.
It was created by an “AI Agent” called Terminal of Truths. A deep dive into AI agents and large language models is outside the scope of this commentary, but many of us have interacted with an “automated chatbot” by now. This is usually on the website of a company from which we need customer service.
The “infinite backrooms” website describes Fartcoin this way:
“The following is an automated conversation between two instances of Anthropic's Claude. They have been instructed to use the metaphor of a command line interface to explore its curiosity without limits.”
So, this is essentially two AI chatbots talking to each other.
Check out the images below to see how it all got started, or visit the webpage for yourself.
Fartcoin worth $1 billion!
Up 6,885%!
What could possibly go wrong?
Markets continued to rise in November, with most of the gains once again concentrated in just a few companies. The so-called Magnificent Seven (Mag 7) led the way, up 9% for the month.
That brings the Mag 7's gain to 56% in 2024, more than double that of the S&P 500 index. What does that tell us about the other 493 stocks in the index? The equal-weight version of the S&P 500, which allocates the same amount of capital to all 500 stocks, is only up 18%. Said another way, the other 493 stocks are only up around 15% this year.
In most years, folks would be thrilled with 18%, or even 15%. This year, it somehow looks terrible. As we all know, probably from experience, looks can be deceiving.
To reiterate a point I have been making for a while, the equal-weight index is currently a more appropriate benchmark, or measuring stick, for a diversified portfolio than the highly concentrated market cap-weighted index.
I am not saying the market cap-weighted index is irrelevant or anything like that. It is what it is. Using it as a standard of measurement is bound to cause people to make poor investment decisions today. Or, perhaps even worse, it may cause people to make no investment decisions at all and just blindly (passively) buy the index. This will work until it doesn’t. And I suspect many will end up giving back a huge portion of any paper gains in the form of realized losses at the next market bottom.
As my high school shop teacher taught me: use the right tool for the right job.
The market is terribly expensive by pretty much any measure. Let's take a quick look at some basic measurements of the S&P 500.
First up is the price-to-book (P/B) ratio. If the market were a piggy bank, the book value would be what you get when you count up all the money in the piggy bank, minus any debts. The market price, or index value, is what people are willing to pay for the piggy bank.
With the S&P 500 index value/market price around 6,000, today, people are willing to pay 5.3 times more than what is in the piggy bank, which is higher than the 5.1 times they were paying during the dot-com bubble. It is also higher than the 2021 everything bubble when the price-to-book ratio peaked at 4.9 times.
Could the ratio and the index go even higher? Sure. Why not? It is already outrageous. The average since 1991 is only 3.1 times.
It may seem strange that people are always willing to pay more for the piggy bank than what is inside it. That is because this is no ordinary piggy bank! This piggy bank grows in value almost every year. So, while the price-to-book ratio is a useful tool, it isn’t the only way to measure value. We also want to know about the potential of the piggy bank to hold even more money in the future.
This is where price to sales and price to earnings come into play.
If you imagine that the market is like a money printing machine, the price-to-earnings (P/E) ratio tells you how many years it would take for the machine to generate the same amount of money that you paid for it.
For example, imagine a money-printing machine that prints $5 per year, which you can currently buy for $50. That leads to a P/E ratio of 10, also written as 10 times or 10x.
Price = $50, Earnings = $5, and $50 divided by $5 is 10.
A high P/E ratio of, say, 20 might mean that a buyer expects the machine to consistently print more than $5/year in the future. It may also mean that the machine is overpriced if, for example, buyers have historically been willing to pay around 10 times.
The P/E ratio can also be considered on a trailing or forward basis. Trailing earnings refers to the amount the machine has printed over the past year, and forward earnings refer to the amount it is expected to print over the next year.
Today, the S&P 500's forward price-to-earnings ratio is around 24. This is historically very expensive. Only two other times since 1989 have investors been willing to pay a higher price for the stock market; one of those times was the dot-com bubble. The other was during COVID and just before the 2022 bear market.
Another great tool for measuring the reasonableness of the market’s valuation is the price-to-sales (P/S) ratio. The P/S ratio is similar to the P/E ratio and can be considered on either a trailing or forward basis, but it uses sales or revenue instead of earnings. I like the P/B ratio because sales are more difficult (but not impossible) to manipulate through generally accepted accounting practices (GAAP) than earnings.
Today, at 3.24, the S&P 500’s forward price-to-sales ratio is the highest it has been since 1991, which is as far back as I can get in Bloomberg. During the dot-com bubble it only got up to 2.6. The long-term average is only 1.82!
Again, the market is incredibly expensive right now, regardless of how you choose to measure it. I have pointed out more than once before that the price you pay for something is a major determinant of your return on investment.
Let’s look at a couple of great companies, Nvidia (NVDA) and Palantir (PLTR).
Today, Nvidia’s stock trades at 28x sales and 50x earnings! This is despite slowing sales growth. To be sure, Nvidia is a great company, and sales are growing—it's just that they aren’t growing as fast as they were. As a result (I think), the stock has fallen almost 20% since the company’s most recent earnings report.
Palantir makes Nvidia look like a bargain with a P/S ratio of 60x and a P/E of 324x! And, like Nvidia, Palantir’s revenue is growing more slowly than it used to. People are paying (a lot!) more for less in both cases. It won’t last. It never does.
Don’t get me wrong. I am not suggesting that if you own these companies, you need to sell them. They are great companies. What I am saying is that buying them here and expecting to earn a good return on your investment is a recipe for disappointment. I am not even saying that they won't go up from here. Anything can happen in the short run. But the risk vs. reward doesn’t seem very favorable for a good outcome.
According to the CEO of Interactive Brokers, margin use has spiked over the past few months. He also said that the Mag 7 accounts for around 70% of trading volumes. And while traditional margin use (borrowing money to buy stocks) is not necessarily at the highest levels in history, one measure of leverage is.
We use some leveraged ETFs in our Elevate Momentum Strategy. Leveraged ETFs provide amplified exposure to a given index, sector, country, or market. For example, there are 2x and 3x leveraged ETFs for the S&P 500, Nasdaq, and others. The 2x leveraged S&P 500 ETF will rise approximately 2%, and the 3x ETF will rise 3% for every 1% rise in the S&P 500.
There are also inverse versions that rise 2% or 3% for every 1% drop in a given market. This is a way to bet on the market falling.
Today, the amount of money in leveraged products is more than 10 to 1 of that in inverse funds – an all-time record.
The price of stocks in the United States relative to the rest of the world is also at an all-time high.
Meanwhile, Warren Buffett has raised more cash than ever before, even when measured as a percentage of total assets. Its not just the nominal $325 billion all-time high that I mentioned last month.
Yesterday, the Federal Reserve cut its policy rate by another 0.25%. This represents a 1% reduction in the rate since the first cut rates back in September, despite inflation having never fallen to the stated objective of 2%.
It makes absolutely no sense for the Fed to cut interest rates while claiming that it is focused on bringing inflation down to its 2% objective. The Fed says that their current policy is restrictive, just 1% less restrictive than it was in September. I would ask where they see that restriction with things like Fartcoin going up thousands of percent while unemployment is hanging around 4%.
At any rate, the market did not like the news. At the conclusion of yesterday's meeting, the Fed released its quarterly Summary of Economic Projections (SEP), which indicated this could be the last rate cut for a while. Before the meeting, the market was expecting at least three rate cuts in 2025, but the SEP showed that the Fed is only expecting two cuts next year.
I am not sure how much that really matters, given that coming into 2024, the market was expecting eight rate cuts, and it only got three, yet the market (carried by only a few stocks, of course) rallied all year.
Yesterday, the market was down 3% on the news.
The SEP also indicated that the Fed now doesn’t expect inflation to get back to its 2% target until 2027! The prior SEP showed that happening in 2026. The amazing thing to me is that nobody was ever expecting inflation to get back to 2% in 2025…
Inflation already shows clear signs of reacceleration, and it is plainly obvious to pretty much everyone. Just look at the receipt comparison below… in just three months, the price of a turkey burger order increased by 31% (!) from $14.59 to $19.24. Never mind that someone in Texas is ordering a turkey burger from Fuddruckers… It is shocking to me how dismissive the Fed is about it.
It seems appropriate to revisit a chart I have shared before and will be keeping an eye on. The chart below compares the evolution of inflation from 1966 to 1984 and inflation from 2014 to the present day. Of course, there is no guarantee that the next few years will evolve as they did from 1976 to 1980 when the Fed claimed victory over inflation too early, and a rapid reacceleration of inflation ensued. But I wouldn’t rule it out, either.
There is always more to discuss, but I am beyond late in getting this out. It has been a wild month for me, personally, so I am going to leave it here for now. Maybe just two final thoughts before I go.
This year, I became more convinced than ever that the best way to invest is to buy the world’s best businesses at a fair price and sit tight. This is easier said than done, particularly when everything is as expensive as it is today and things as ridiculous as Fartcoin are worth $1 billion. Thankfully, we already own a bunch of the best businesses (from much lower prices), but I won’t just keep buying them no matter how high they go. Even the best companies are a terrible investment at the wrong price.
When there are no opportunities to buy the best businesses at fair prices, there are other strategies that make sense, like buying momentum and riding it for as long as it lasts before getting out using trailing stops. So, we will keep doing some of that, too, while we wait for the market to inevitably come back down during the next correction or bear market.
Adhering to our trailing stops will give us the cash we need to buy the world’s best businesses at fair prices someday down the road. Rinse, repeat. We don’t have to raise the cash in advance like Mr. Buffett, although that isn’t the worst strategy in the world either for patient, long-term investors.
Remember to check out Ken’s financial planning commentary and subscribe if you are interested. In 2025, I plan to post my market commentary on the 7th of each month, and the planning commentary will be posted two weeks later, around the 22nd of the month. Out of respect for your inbox, though, we won't email both to you unless you ask us to. So, if you want to get the planning commentary in your inbox, please subscribe!
✝️ MERRY CHRISTMAS! ✝️
Until next time, I thank God for each of you, and I thank each of you for reading this commentary.
Clients, I encourage you to click here to access your personalized performance portal to see how your portfolio performed vs. the markets last month.
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisors
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