Subject: Re: War, currencies and jurisdictions
Just for fun, I used the same set of questions to ChatGPT that EVBigMacMeal submitted to Gemini to see if there was an agreement between the two or not. Since the ChatGPT respo nse was as ling as Gemini's, I asked for "a clear, integrated summary that combines your original points with the valuation statistics" and will start this post with the summary (followed by the full Monte):

Jeff

Here’s a clear, integrated summary that combines your original points with the valuation statistics:

A Note on Today’s Market Backdrop and the Fragile Balance of Forces

By many measures, the US stock market appears significantly overvalued relative to its historical norms. The Shiller CAPE ratio for the S&P 500 is currently around 32–34, nearly double its long-term average of 17, and comparable to levels seen only during the 1929 bubble and the dot-com boom. The standard price-to-earnings ratio sits near 26–28, well above its historical mean of about 15–16. Meanwhile, the market capitalization of US stocks now exceeds 180% of GDP, far above the roughly 100% that has historically signaled fair value. Revenue multiples tell a similar story: the S&P 500’s price-to-sales ratio is around 2.5–2.7, versus an average closer to 1.5.

Despite these stretched valuations, the market has remained resilient. One reason is the extraordinary level of liquidity and support unleashed during the 2008 financial crisis and the COVID-19 pandemic. The Federal Reserve’s balance sheet, for example, remains over $7 trillion, compared to under $1 trillion before 2008, while US government debt has ballooned past $34 trillion, with persistent deficits running at recession-like levels year after year.

Adding to this, passive investment flows have grown enormously: index funds and ETFs now control more than 50% of US equity fund assets, up from about 35% just a decade ago. This steady stream of indiscriminate buying has helped push prices higher, concentrating returns in a handful of mega-cap stocks that now make up roughly 25–30% of the entire S&P 500’s market value.

One way to visualize this dynamic is as a set of weighing scales: on one side are extreme valuations, inflation concerns, and signs of slowing growth; on the other is massive government liquidity and relentless passive buying. For now, the scales balance. But the weight on both sides has become so great that the scales themselves could fracture. A fracture might come from a break in the bond markets, a reversal in investor momentum, a resurgence of inflation driven by energy shocks or geopolitical conflict, or some other unexpected catalyst.

If that fracture happens, the weights won’t just rebalance — they may crash to the floor, creating a market shock that even large-scale government rescue efforts might not easily contain.

This is why I believe it is wise to be prepared for both the possibility of continued exuberance and the reality that every few decades markets do experience seismic shifts. Notably, Berkshire Hathaway remains one of the best examples of prudence today — sitting on record cash reserves while others chase the rally at any price.

If you’d like, I can tailor this further for an email, a memo, or a presentation slide. Just say the word!

*********************************************************** The Full Monte:


A Note on Today’s Market Backdrop and the Fragile Balance of Forces

It can be argued that the US stock market is significantly overvalued — and that this overvaluation has grown ever larger in recent years. Despite multiple challenges that might have been expected to weigh on equities, the market has remained remarkably resilient. A key reason for this resilience has been the unprecedented levels of liquidity injected by emergency government actions in response to the Global Financial Crisis and the COVID-19 pandemic. Years later, despite intentions to unwind these extraordinary measures, persistent large government deficits have made it practically impossible to fully remove this emergency support.

An analogy helps illustrate the delicate nature of this situation: imagine the financial markets as a set of weighing scales. On one side sits high valuations, stubborn inflation pressures, and signs of slowing economic growth. On the other side rests the immense force of government support and the relentless rise of passive investment flows that continue to push capital into markets almost regardless of price.

For now, these opposing weights have balanced — sometimes uneasily — and price discovery continues. But what happens if the scales themselves fracture under the sheer weight they now bear? Such a fracture could come from any number of sources: a break in the bond markets, a sudden reversal in investor momentum, a resurgence of inflation sparked by rising oil prices due to conflict in the Middle East, or new economic shocks like the impact of trade tariffs.

When the scales fracture, the weights no longer balance — they crash to the floor. At that point, we could face an event or series of events so severe that even massive government intervention might not be able to shield investors from loss.

It is precisely because the weight on both sides is now so extreme that I believe it is prudent to prepare for both possibilities: that the market’s surprising exuberance may persist for longer than many expect, but also that rare, seismic shifts — the kind that happen every few decades — remain very real risks. Notably, Berkshire Hathaway’s large reserves show that some of the most respected investors in the world are prepared for this dual reality more than most.

I then asked ChatGPT to provide some statistic on both stock market valuations and government stimulus and liquidity and passive investment flows.

Absolutely — here’s a concise set of key statistics you can use to ground your note in data, updated to reflect recent trends as of mid-2024:

📈 Stock Market Valuations

Shiller CAPE Ratio: The cyclically adjusted price-to-earnings (CAPE) ratio for the S&P 500 is currently around 32–34, well above its long-term average of about 17. It’s among the highest readings outside of the dot-com bubble era and the immediate COVID rebound.

Market Cap to GDP: The so-called “Buffett Indicator” — total US stock market capitalization as a percentage of GDP — is over 180%, compared to a historical average closer to 100%. This suggests stocks are very expensive relative to the size of the economy.

💵 Government Stimulus & Liquidity

US Federal Debt: US federal debt has surpassed $34 trillion, with annual deficits running at around 6–7% of GDP, levels usually seen only during recessions or wars.

Federal Reserve Balance Sheet: Although the Fed has attempted “quantitative tightening,” its balance sheet remains over $7 trillion, up from about $4 trillion pre-COVID and under $1 trillion before the 2008 financial crisis.

Emergency Support: During COVID, direct fiscal stimulus totaled over $5 trillion in spending, tax breaks, and direct payments, with the Fed adding trillions in asset purchases to stabilize markets.

📊 Passive Investment Flows

Passive Ownership: As of 2024, passive index funds and ETFs now control over 50% of US equity fund assets — up from about 35% a decade ago.

Inflow Momentum: In the last three years alone, passive funds have attracted more than $1 trillion in net inflows, while actively managed equity funds have seen consistent net outflows.

Market Impact: Studies show that passive flows can push up prices indiscriminately, contributing to reduced price discovery and greater market momentum in both directions.

Sources: S&P Global, Robert Shiller Data, Federal Reserve, Investment Company Institute (ICI), US Treasury Department.

And then I asked for some statistics that suggest the stock market is over valued:

Absolutely — here’s a focused list of current statistics that suggest the US stock market is overvalued, with explanations for each:

📈 Key Overvaluation Indicators
1️⃣ Shiller CAPE Ratio (Cyclically Adjusted P/E):

Current: ~32–34

Historical average: ~17

Context: The CAPE ratio is double its long-term average. It has only been this high during the peak of the 1929 bubble and the dot-com bubble (late 1990s/early 2000s). A high CAPE suggests future returns may be lower than historical norms.

2️⃣ Price-to-Earnings (P/E) Ratio (Trailing 12 Months):

Current S&P 500 P/E: ~26–28

Historical average: ~15–16

Context: This shows investors are paying nearly twice the historical multiple for each dollar of company earnings.

3️⃣ Market Cap to GDP (“Buffett Indicator”):

Current: ~180%

Historical average: ~100%

Context: Warren Buffett has said this is one of the best single measures of market valuation. Levels above 150% have historically signaled significant overvaluation.

4️⃣ Price-to-Sales (P/S) Ratio (S&P 500):

Current: ~2.5–2.7

Historical average: ~1.5

Context: Revenue growth is harder to manipulate than earnings. A high P/S suggests companies are richly valued even before considering profit margins.

5️⃣ Equity Risk Premium (ERP):

Current: Near historical lows (~3% or less)

Historical average: 4–5%

Context: The ERP measures the extra return investors expect for owning stocks instead of risk-free government bonds. A lower premium means investors are accepting less compensation for more risk, often associated with overoptimism.

6️⃣ High Concentration in Mega-Caps:

Top 5 stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia) now make up over 25–30% of the total S&P 500 by market cap.

Context: Extreme concentration can signal crowding into a handful of expensive stocks, driving up the index valuation.

Sources: S&P Dow Jones Indices, Robert Shiller Data, Federal Reserve, FactSet, Yardeni Research.