Dear Reader,
This is Dylan Jovine with Behind the Markets.
Happy Friday. Today is Friday, May 29th.
With all the irrational exuberance we've been seeing in the market lately, I feel the need to do a reality check.
I'm not a Debbie Downer. I'm generally optimistic by nature — I know people who are always saying the sky is falling, and I am not one of those humans. Right now the market sentiment is about 65% bullish, 35% bearish.
Bull markets lower IQ points. That is not a joke — what's actually happening is your brain is releasing dopamine every time you check your portfolio and see it up. Everybody's talking about it, everybody's excited, the whole thing feels electric. And that is exactly when you need to be most careful.
It's midnight at the party. Everybody's a little drunk. Don't be the one making drunk decisions.
So here are the five risks I'm watching right now — quickly, so you can enjoy your weekend with your eyes open.
Risk #1: Consumers Are Under Real Strain
Stocks are up, great. But searches for help paying your mortgage have never been higher.
Plato said it a long time ago — in every city there are really two cities. One for the haves, one for the have-nots, and they are always at war.
Consumer spending drives roughly 70% of economic growth.
If the consumer breaks, everything else eventually follows.
Risk #2: The Market Is Narrow
85% of the gains this year have come from 10% of the companies.
Now, that's partly because the indexes have been engineered to be tech-heavy — they're true indexes, but they're also marketing tools at this point.
But a narrow boom is a fragile boom.
You want to see the bull market broaden out — more companies, more sectors, more of the country participating. That's what tells you growth is sustainable. When it stays narrow, it's a warning sign.
Risk #3: Pricing Is Driving Profitability — Not Capacity
Companies like Micron are going gangbusters right now, but a lot of them are raising prices instead of building new capacity.
Think about what that signals.
When a company decides not to build another factory, they're saying: we think this cycle lasts one or two years, not a decade. We don't want the hangover of extra capacity when this ends.
When they start building extra factories — that's when I'll believe this is a long-term structural shift rather than a demand-pull situation where seven years of future demand is being pulled into today.
Demand-pull booms are exciting on the way up. The hangovers are brutal. Think dot-com.
Risk #4: The Cost of Capital Is Rising
Data centers are enormously expensive. You need to borrow billions to build them.
When the cost of that borrowing goes from 4% or 5% to 6% or 7%, the math on these projects changes. Some of them stop making sense. Some get smaller. Some get cancelled.
Private equity is actually doing something healthy here by raising the bar — forcing people to prove their return on investment before handing over billions. But it's a headwind nonetheless.
Risk #5: The Bond Market
By far the biggest risk to equities right now.
Here is a simple exercise for you: check the 10-year bond yield before you check the stock market every morning. It will tell you more about where stocks are heading that day than any other single indicator.
Yields go up, stock prices go down.
Yields go down, stock prices go up.
If the 10-year yield hits 5%, this market is going to hit a ceiling it cannot push through.
That is the gravity keeping everything in check right now.
None of this means the bull market is over. It doesn't. But it does mean there are a lot of drunk drivers on the road right now.
Drive carefully this weekend.
Have a wonderful one.
I'll see you on Monday.
“The Buck Stops Here,”
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Written by Dylan Jovine