The Everything Bubble is back and bigger than ever

LONDON - Five years ago, financial speculation was running amok. This was the heyday of meme stocks, special purpose acquisition companies (SPACs), non-fungible tokens and dubious cryptocurrencies such as Dogecoin. In the summer of 2021 Richard Bernstein, the former Merrill Lynch quantitative strategist turned portfolio manager, put out a note listing five factors which pointed to the existence of a stock market bubble. Within months US equities had peaked and over the following year entered bear market territory. Now the so-called “Everything Bubble” has returned with a vengeance. This time the downside risks appear much greater.

Bernstein, who is now global head of macro at the investment firm Janus Henderson, listed increased liquidity as the first bubble factor. Back in 2021, the US money supply was surging after the Federal Reserve’s massive pandemic-induced bond-buying schemes. That excess cash spilled over into the stock market. The US central bank’s balance sheet is no longer exploding. Still, says Bernstein, financial conditions today remain remarkably easy. The Chicago Fed’s index which tracks the metric has trended downwards since late 2022 but remains slightly above its 2021 trough.

Increased leverage was a second factor. In 2021 Bernstein pointed out that many retail investors (including 80% of investors who are members of Gen Z) were borrowing to buy stocks. Speculators were also using single stock options to boost returns. There’s even more leverage around today. Margin debt has been growing faster than mortgage and credit card debt, says Bernstein, and now stands at record levels both in dollar terms and relative to GDP.

Zero-day to expiry options account for around half of the total turnover of US stock options. Hedge fund leverage is also at an all-time high. In early 2021, the over-leveraged Archegos Capital Management blew up. This summer, Situational Awareness, which had borrowed heavily to buy AI-related stocks, ran into trouble. The hedge fund, run by the former OpenAI employee Leopold Aschenbrenner, managed to avoid Archegos’ fate after Citadel Securities stepped in to acquire the bulk of its publicly listed securities.

Other popular sources of speculative borrowing include leveraged single-stock exchange traded funds (ETFs). Defiance ETF, an asset management firm, is even planning to launch ETFs for popular stocks such as software firm Palantir Technologies and chip giant Nvidia that re-leverage every hour. The Chicago Mercantile Exchange this summer launched single-stock perpetual futures, or “perps”.

Great investment bubbles often involve a rapid increase in the number of speculators, enticed into the market by opportunistic financial operators. Bernstein listed the democratization of the market as a third bubble factor. Back in 2021 Robinhood Markets HOOD.O, the app-based broker, was the preferred platform for the crowd which rushed headlong into meme stocks and SPACs they discussed on Reddit’s WallStreetBets message board. Robinhood, whose app bore a passing resemblance to an electronic fruit machine, provided commission-free trading and cheap margin loans.

Prior to its July 2021 IPO, Robinhood reported 18 million “funded accounts.” Since then it has added a further 10 million customers. Robinhood CEO Vlad Tenev still extols his firm’s democratizing mission: “Our product velocity is focused on one goal: making everyone an owner,” he said in July. In this case, “product velocity” refers to the extension of Robinhood’s services from trading in shares, fractional shares and cryptocurrencies to making markets in tokenized equities (securities linked both to unlisted private companies such as OpenAI and publicly traded meme stocks like AMC Entertainment AMC.N), and prediction markets.

Prediction markets, which allow users to trade coin-flip contracts for a broad array of events, have taken off. Robinhood’s revenue from “event contracts” now exceeds its crypto business. The time-honored distinction between investment, speculation and outright gambling is collapsing. Kalshi, which partners with Robinhood, recently applied for permission to issue “perps”. As Bernstein observes, “when people confuse the financial markets with the prediction markets, something has gone really wrong.”

The fourth factor signaling a market bubble is increased new issues. Five years ago, the amount raised by new companies listing on US exchanges reached an all-time high. Tech SPACs - among them Virgin Galactic, which offered space tourism, electric truck maker Nikola and battery developer QuantumScape - were all the rage. Nikola has since filed for bankruptcy while the share prices of Virgin Galactic and QuantumScape are down more than 95% from their peak.

Today, the IPO market is even hotter. In June, Elon Musk’s SpaceX – arguably the greatest meme stock in history – raised a record USD 75 billion. AI leader Anthropic is preparing a listing at a mooted USD 2 trillion valuation. Even SPACs are making a comeback.

Bernstein’s fifth and final bubble factor was increased turnover. At the time, US stock market trading volume was running around 25% above its long-term average. This year, equities trading is even more frenetic. In January, the average daily US stock turnover exceeded USD 1 trillion for the first time. This summer, retail equities turnover was close to twice its average level since the turn of the decade, according to Citadel Securities. Volume on the Nasdaq market is also at record levels.

The Everything Bubble proved vulnerable to the end of the zero-interest rate era that arrived in 2022. Today, interest rates and bond yields have returned to more normal levels. In other respects, though, the current bubble looks much more dangerous.

The US stock market today is even more concentrated in a handful of giant companies and increasingly exposed to a single theme: AI. Even as OpenAI and Anthropic continue to burn cash, AI investment is driving corporate earnings. Much of the investment is financed with debt. Former Morgan Stanley strategist David Roche points out that total on- and off-balance sheet debt for US tech giants and AI labs exceeds USD 3 trillion.

Circular financing among the leading AI players depends critically on expectations of continuously accelerating revenue growth, so that that even the slightest slowdown risks undermining the whole edifice. Prudent investors should be preparing not for a rerun of the short-lived 2022 bear market but something far more dramatic. 

(By Edward Chancellor; Editing by Peter Thal Larsen; Production by Streisand Neto)