Bubbles, Crashes & Fiscal Dominance - Should You Be Worried?
To investors,
Sam Callahan worked with Lyn Alden to publish a piece yesterday titled Full Steam Ahead: All Aboard Fiscal Dominance. They dug into the data to show a number of future scenarios for the United States economy. I recommend reading the full report, but here are the main takeaways:
• Structural fiscal deficits have surpassed private sector lending and monetary policy as the primary drivers of economic activity and inflation, marking a fundamental shift in the economy’s liquidity dynamics.
• Debt-to-GDP projections reveal the impact interest rate policy could have on fiscal sustainability. At a fixed 5% rate, debt-to-GDP would steadily increase over the next decade, while a 2% fixed rate would lead to a decline. However, this measure can be misleading, as nominal GDP growth driven by fiscal deficits increases, masking the extent of nominal debt accumulation and inflation in various forms.
• The Department of Government Efficiency is unlikely to make meaningful cuts to federal spending as only 14% of the budget is non-defense discretionary, while 87% of nominal spending growth over the next decade is projected to come from mandatory programs and interest expense.
• Stabilizing factors such as the global demand for U.S. dollars and debt denominated in its own currency suggest an era of fiscal dominance in the U.S. that’s less dramatic than alarmists predict but more persistent and intractable than optimists hope. The deficit problem is unlikely to be resolved this decade, running structurally hot with steady nominal growth and ongoing currency debasement.
One of the conclusions from Sam’s analysis is “in this environment, holding hard, scarce assets such as real estate, equities, gold, and bitcoin offers a pragmatic way to preserve purchasing power and navigate the pressures of fiscal dominance.”
This aligns with my thought that citizens, regardless of their investment experience, are being pushed away from dollars and into investable assets. You can overlay the rise in investment exposure with the explosion of risk-taking opportunities, including crypto altcoins, sports gambling, and much more.
As more capital enters the market, many asset prices will be driven higher. As prices go higher, people begin to get wealthier. As they get wealthier, this new capital is convinced they are smart, rather than at the right place in the right time.
You can see where this is going — capital appreciation begets more capital entering the market. People begin to chase returns. The “get rich quick” mindset is undefeated throughout history. And at some point investors start to allocate capital to financial assets indiscriminately.
This is when the market becomes susceptible for bubbles and the ensuing asset price crashes. Almost as if it was planned, famed investor Howard Marks published a memo earlier this week titled On Bubble Watch.
Marks lays out an interesting argument for what constitutes a bubble:
“But 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.”
“No price too high” stands out to me in particular. When you can’t imagine any flaws in the argument and are terrified that your officemate/golf partner/brother-in-law/competitor will own the asset in question and you won’t, it’s hard to conclude there’s a price at which you shouldn’t buy. So, to discern a bubble, you can look at valuation parameters, but I’ve long believed a psychological diagnosis is more effective.”
This is a fascinating way to think about bubbles and it coincides with what I have experienced in the various euphoric manias I have lived through already. Think back to 2021. It felt like every person with a brokerage account was getting rich. Asset prices would grow to the sky. And you would be excommunicated from the investment world if you spoke of risk, bubbles, or crashes.
That should have been our sign that things were too good to be true. I don’t think we are at the same level of euphoria today, but it is definitely something to continue to watch as we enter 2025. There is a potential path forward that takes us right back to the excitement and chaos of that market over the coming months.
Howard Marks is clear in his memo that he is not an equity investor. However, he takes the time to outline his current view of the market, including the potential risks.
The cautionary signs today include these:
the optimism that has prevailed in the markets since late 2022,
the above average valuation on the S&P 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 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 two years doesn’t suggest an overabundance of caution.
I am not here to predict a market crash. I actually believe we are headed in the opposite direction. The fiscal dominance that Sam Callahan wrote about, combined with the need for more risk-taking by citizens, will likely drive us higher across numerous asset prices. But at some point there will have to be a correction.
Will stocks crash like they did during COVID? I don’t know. Will bitcoin crash 80% again to repeat the 4-year cycle? I don’t know.
There will be a separation between long-term investors and short-term speculators though. The difference lies in whether you can hold through a market correction or you are forced to panic sell as prices are crashing. The former will outperform the latter almost every day.
So the story for the next two decades really boils down to one thing challenge in my mind — can you find resilient assets that will persist through the increasing volatility we are headed towards?
If you can do that, your portfolio will do quite well. If you jump from fad-to-fad, I am worried that financial ruin awaits you. Keep your head on a swivel out there. The world is accelerating and uncertainty is our date to the dance.
Hope you all have a great day. I’ll talk to everyone tomorrow.
- Anthony Pompliano
Founder & CEO, Professional Capital Management
🚨 READER NOTE: I am hosting Bitcoin Investor Week in NYC from February 24-28th. This will be the largest finance conference of the year focused on bitcoin. Speakers include Mike Novogratz, Cathie Wood, Jan van Eck, Anthony Scaramucci, Jack Mallers, and many others.
You can purchase tickets here: Get ticket for Bitcoin Investor Week
Coinbase’s Chief Legal Officer Explains How Regulators Have Been Abrasive to Bitcoin & Crypto Industry
Paul Grewal is an American attorney working as Chief Legal Officer at Coinbase.
In this conversation we talk about it all, why regulations have been so abrasive toward the crypto industry, what is going on with de-banking, Operation Chokepoint 2.0, what happened with Tornado Cash, why Trump administration is so bullish for crypto regulation, and what milestones Paul looks forward to in 2025.
Enjoy!
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Love this long format
Uncertainty is heavy right now!