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A decade ago, Andrew Ross Sorkin, a journalist, TV anchor and co-creator of the show Billions, started obsessively studying the 1929 stock market crash. Now he has finally published a book about that event — with clever timing. For with tech stocks having gyrated wildly this week, there is intensifying debate about whether we have just witnessed a bubble linked to hype about artificial intelligence, which is now set to burst.
Invoking history is currently all the rage, whether your year of choice is 1929, 2000 or 2008. “I got lucky”, Sorkin told me during a debate this week, with a chuckle.
So what lessons can investors learn? The most significant one here is that manias are never “just” about stock market swings, however eye-catching — they are also about excess leverage, ample liquidity and investor lunacy.
One way to frame current events is to think about those three Ls. To put it bluntly: AI mania is a symptom, not just a cause, of other imbalances in a world of easy money.
Consider liquidity. In some sense, it might seem investors have no reason to worry about excess liquidity given that last week the Federal Reserve decided to stop shrinking its balance sheet because of concerns of poor liquidity in parts of the money markets where banks interact with the Fed.
More specifically, the so-called repurchase rate has recently surged, relative to other Fed benchmarks, which signals potential stress in this obscure corner of finance.
This is unnerving. However, it seems to reflect two things: technicalities around the Fed’s use of quantitative tightening; and huge funding flow distortions arising from how the US government shutdown has affected Treasury operations.
And if you take a longer-term look at the financial system, liquidity seems abundant, if not excessive, in many other areas, due to the past decade of quantitative easing, the low level of US real interest rates, fiscal stimulus and private credit creation. Indeed, the Goldman Sachs financial conditions index has loosened markedly this year — and will probably loosen further given the Fed’s stance.
Matt King, founder of Satori Insights, says: “By ending QT and easing rates — even as financial conditions on some metrics are at their easiest since the extraordinary stimulus of late 2020 — the Fed seems likely to add to what many already consider ‘froth’ across multiple financial markets.” This is noteworthy given that such froth usually sparks follies, by lulling investors into complacency, until such liquidity suddenly evaporates in a crisis.
Or ponder the second L, leverage. In some corners of finance this is not currently too alarming. US household borrowing, for instance, is lower now than in 2007, and overall non-financial corporate borrowing is flat. But leverage in AI-linked ventures is rising and western government debt is exploding. Financial sector leverage has risen, primarily around private equity and credit and the level of stock market margin trading has surged. “Financial sector leveraging is feeding repo and hedge funds,” argues King, who thinks all the liquidity has pushed asset prices higher, particularly since passive funds are now dramatically amplifying market momentum.
Then there is the third L: scattered lunacies, amid the froth. Consider, for example, how Palantir’s stock price has recently traded at nearly 230 times forward earnings; or the fact that 10 lossmaking AI start-ups now command a value of almost $1tn; or the revelation that before First Brands collapsed, more than $2bn of its $12bn debt vanished without creditors noticing. Or note the return of “ratings shopping” — financiers seeking deceptively flattering credit ratings for deals — which creates “a looming systemic risk”, according to Colm Kelleher, chair of UBS.
So does this mean we should expect a replay of 1929? Not necessarily, in Sorkin’s view. Although he expects a financial market correction, he does not think this need be followed by a 1930s-style depression, since central banks have learnt lessons from history and will once again inject liquidity to prevent a slump, as they did after 2008 and in 2020.
I agree. But this also creates political and financial risks. Take the influential rightwing blogger Curtis Yarvin. For him and his ilk, central bank bailouts are just accelerating “monetary dilution”, that is turning dollar-based finance into an even bigger bubble, that will eventually burst. This is why Yarvin et al created crypto and love gold.
This argument will continue to rage. But in the meantime, investors should pay attention to two things. First, the tech mania could still have further to run, given investor assumptions about that Fed “put”, strong non-AI corporate earnings and the fact that, notwithstanding the crazy valuations, AI is a real technology.
Second, in the long run bubbles do always deflate, often when least expected. In public markets this can be a sudden “pop”; in private finance (which matters now), it is more often a long, slow “hiss”. Either way, keep watching leverage and liquidity, and remember that some lunacies often only become clear in hindsight — just as in 1929.
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