It's True That the Market is in a Bubble - but You Shouldn't Bet Against It

Jeffrey Bierman, chief market technician at TheoTrade and finance adjunct professor at Loyola University Chicago, warns that the U.S. stock market is in a massive bubble. However, he advises that betting against it would be unwise. He attributes the bubble primarily to machine-run algorithms that are driving technology stocks to unsustainable heights, even as overall market breadth weakens.

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Bierman highlights that “any technology stock with an AI story is rising too far and too fast.” He stresses that individual investors are not behind this bubble; instead, it’s the algorithms pushing the market higher, disregarding fundamental valuations.

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In a recent interview, Bierman elaborated on his perspective. Here are the key points from that discussion:

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Market Valuations
Bierman describes the current stock valuations as indicative of a bubble, particularly in high-profile stocks. He believes this bubble might not burst immediately because the S&P 500 Index has become very one-sided with minimal volatility. He points to the Relative Strength Index (RSI), noting that anything above 70 is in the danger zone, and the S&P 500 has surpassed that, with RSI levels reaching as high as 88 and potentially going to 90, indicating an overbought market.

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Market Breadth and Risks
Market breadth, according to Bierman, is the worst it has been in years. He cautions that combining an overbought market with poor market breadth is highly risky. When algorithms decide to stop buying and start selling, it could lead to a rapid market reversal, similar to what was briefly seen during the COVID-19 pandemic.

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Sector Performance
Despite various warning signs, the market continues to climb, largely driven by the technology sector. Bierman notes that most traders and investors are selling off other sectors and focusing on technology stocks like NVIDIA, Apple, Microsoft, Meta Platforms, Netflix, Walmart, and Costco. Algorithms are a significant factor in this trend, as they are programmed to buy into strength and sell into weakness, leading to the current emphasis on 52-week highs.

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The AI Narrative
Bierman asserts that the market is heavily driven by the artificial intelligence (AI) narrative. Companies involved in AI production or services are seeing their stocks rise, regardless of potential risks or valuations. This phenomenon, he explains, has led to a market bubble where fundamentals are ignored in favor of the prevailing narrative. The rapid pace of this trend is further fueled by options trading and a “positive feedback loop,” where rising momentum perpetuates further increases.

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Potential Shifts in Market Sentiment
While the market’s overbought status doesn’t necessarily mean it’s time to sell, Bierman believes that sentiment could shift if the algorithms reverse their buying behavior. Currently, the market often rises for extended periods without significant corrections, detaching itself from news and traditional market influences. When a reversal does occur, it could lead to a swift and significant downturn as the machines maintain selling pressure.

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Investor Behavior and Market Risks
Bierman warns that this situation can’t last indefinitely. Investors are unlikely to sell until the algorithms guide the market lower. In typical market conditions, stocks experience ups and downs over shorter cycles, but the current market defies this pattern. This detachment from the news and reliance on algorithms makes the market more unpredictable.

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Betting Against the Market
Despite his concerns, Bierman advises against shorting the market. He notes that those who have attempted to short the market recently have suffered losses. The market seems determined to go higher, regardless of negative news, interest rates, or macroeconomic data. This is driven by “confirmation bias,” where investors and algorithms focus on the prevailing upward trend.

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Bierman’s Strategy
Bierman himself is cautious, choosing to lighten his long positions and take gains when peak valuations are reached. For money managers, the primary concern is not missing out on rallies, leading to performance-chasing and a disregard for traditional valuation metrics like inflation, the U.S. dollar, and interest rates. He humorously refers to the current market as a “Seinfeld market,” where the narrative or meme of the moment takes precedence over fundamental factors. This, he believes, is the final stage of the bull market, characterized by a lack of fear and a focus on the fear of missing out (FOMO), with risk becoming an afterthought.

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In summary, Bierman’s analysis suggests a precarious market situation driven by technology stocks and AI narratives, sustained by algorithms, with potential for a sharp downturn once sentiment shifts. Despite the risks, he advises caution against betting on a market decline until clearer signs of a reversal emerge.

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