Happy Monday, traders.

Jeff here.

I’ve said it before and I’ll say it again — we’re in a mania-driven market bubble. 

Bubbles occur when asset prices far exceed their intrinsic value, driven by exuberant market behavior. 

Traders simply love to get bullish on speculative sectors. 

Think the dot-com era, the great financial crisis, GameStop Corp. (NYSE: GME) … the list goes on.

2024 has brought a new hot sector dominating the market — artificial intelligence (AI).

And as AI stocks continue to surge, I’m noticing six telltale signs that we’re still in the bubble…

Exponential Price Increases

One of the most obvious signs of a speculative bubble is when the price of an asset class increases rapidly within a short period, without a corresponding increase in its fundamental value.

If you think this hasn’t happened recently, let’s look at some examples…

• Super Micro Computer Inc (NASDAQ: SMCI) is up 220% YTD
• Dell Technologies Inc (NYSE: DELL) is up 64% YTD
• Nvidia Corporation (NASDAQ: NVDA) is up 69% YTD
• Palantir Technologies Inc. (NYSE: PLTR) is up 50% YTD

Keep in mind that we’re only two months into 2024…

There’s an apparent reason why these moves have occurred.

All of these companies have one thing in common — the market thinks their share prices will rise because of AI.

High Trading Volumes

Stocks going up isn’t enough. 

To be confident in the existence of a market bubble, you want to see a significant rise in trading volumes.

High volume indicates that more traders are getting involved in the market, driven by the fear of missing out (FOMO), which can further inflate the bubble.

Increased Leverage

The use of borrowed money to invest in assets — also known as leverage — can amplify returns…

But it can also increase overall risk in the market.

An increase in leverage is a sign that investors are becoming overconfident and taking on more risk, often a feature of asset bubbles.

One way to judge leverage in the market is to track how many people are buying options…

Unsurprisingly, global futures and options volume hit a record 137 billion contracts in 2023.

Market Euphoria

A general sense of irrational exuberance and optimism in the market, where traders believe that prices can only go up, can indicate a bubble.

Reddit posts asking questions like “Will Stocks Go Up Forever?”, or predicting that the SPY would hit $600 by the end of 2023, are perfect examples of this problem. 

It’s hard to know when market euphoria is reaching a peak, and trying to call the top is a fool’s errand.

But be aware that every asset bubble showcases this phenomenon — and we’re seeing it all over the place in this market environment. 

Broad Media Coverage and Public Participation

When an asset class starts receiving widespread media attention, it may indicate that the bubble attracts a broad base of participants, including those who might not fully understand the risks.

This has been supported by recent data showing that a record share of U.S. households now own stocks.

That means when the bubble bursts, the ripple effect following a potential drop in asset prices could be much more painful and widespread than it has been historically. 

Sector Concentration

Asset bubbles are often concentrated in specific sectors.

An excessive focus on one sector, with prices rising much faster than in others, can be a sign of a bubble.

This is exactly what happened during the “dot-com bubble.” Every company on the planet started adding “.com” to its name, causing the share price to surge.

Now, I’m noticing a similar situation with “AI.” Corporations far and wide are scrambling to get in on the AI hype.

But one day — probably not too far off in the future — that hype will face a major correction. 

WARNING: This doesn’t mean you should close every long position and start shorting everything…

While these signs can indicate a bubble, they don’t tell you when the bubble will burst.

Timing is everything…

A Crucial Lesson from Michael Burry

In the movie “The Big Short,” Christian Bale played a guy named Michael Burry.

Burry identified the bubble in real estate as early as 2006, placing hugely bearish bets in 2007.

But he was too early. He held his bearish swaps in the sector for more than a year as real estate prices continued to rise.

His clients were furious with him as their portfolio values plummeted, yet Burry kept his “diamond hands” strong…

And before long, he was vindicated. 

In 2008, when the real estate market crashed and led to the biggest financial crisis since the Great Depression, Burry made a fortune, becoming an overnight celebrity in the process. 

As impressive as Burry’s analysis and predictions were, his timing was less than ideal. 

And while Burry had hundreds of millions of dollars to insulate his position, you don’t. 

I’m telling you this story because I want you to be aware of the signs of a market bubble.

That said, don’t overextend yourself into bearish positions when the overall trend is still bullish.

This is an uncertain moment in the stock market that requires balance, discipline, and adaptability.

Trade accordingly,

Jeff Zananiri

P.S. Are you looking for a way to stay market-neutral in this crazy bubble?

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