Subject: Re: War, currencies and jurisdictions
"You have provided solid reasoning way back in 2011, 2012, 2013 why S&P at 1000 is overvalued. To expect flat returns for the next decade. It turned out to be one of the best ever for stocks for whatever reason."

I asked Gemini the following question:
It can be argued that the us stock market is over valued and the over valuation keeps getting bigger. It can be argued that despite the challenges that might have been expected to effect stocks, the market has remained resilient due to incredible levels of liquidity that came from emergency government actions to stimulate after covid 19 and the great financial crisis but have been unable to remove the emergency liquidity due to extreme government deficits. can you help me draft a short note that describes this back drop and then introduces an analogy of weighing scales that demonstrates how there are always two sides and two forces in markets as prices get discovered. On the one side are high valuations and major concerns around inflation and slowing economic growth but on the other there is extreme government support and the rise of passive investment flows. With that backdrop, I then want to introduce an extension of the scales analogy: what if the scales fracture (use that word fracture which I like) causing the weights to hit the floor. Maybe the fracture is the bond markets breaking. Maybe it is a turn in investor momentum. Maybe it is a return of inflation, perhaps brought on by a rising oil price from the war in the Middle East, or the US tariffs. Or something else. But my point is, despite the current balancing of the scales, the weight on both sides is now so extreme, that it could completely fracture the scales and cause an event, or sequence of events that might be impossible for the Government to rescue investors from. It is for that reason, I believe it is worth being prepared for both a continuation of the surprising exuberance over recent years but also being prepared for the major kinds of events that happen form time to time over the decades. It is noteworthy that Berkshire Hathaway is much more prepared than most.

If you are not an AI fan you can stop reading now.

This is the polished Gemini version:
"The US stock market has shown remarkable resilience, arguably defying gravity as valuations continue to climb, leading to a growing sense of overvaluation. This surprising strength, despite economic headwinds, can be attributed in large part to the unprecedented levels of liquidity injected into the system through emergency government actions following the 2008 Great Financial Crisis and the COVID-19 pandemic. The challenge now lies in the inability to withdraw this emergency liquidity, exacerbated by persistent and significant government deficits.

To understand the delicate balance at play, consider the analogy of a set of weighing scales, where market prices are discovered through the interplay of two opposing forces. On one side, we place the significant concerns: lofty valuations, persistent inflationary pressures, and the specter of slowing economic growth. These are the weights that typically pull markets down. However, on the other side of the scales, we find equally formidable forces: extreme government support, manifested in continued liquidity and fiscal measures, coupled with the relentless upward flow of passive investment, which often chases past performance.

Here's where the analogy extends to a more concerning scenario: What if these scales, currently holding a precarious balance, were to fracture? The sheer weight on both sides is now so extreme that a fracture could cause the weights to hit the floor with destructive force. This fracture might manifest in various ways: perhaps a breaking point in the bond markets, a sudden and significant shift in investor momentum, or a resurgence of inflation, potentially triggered by a soaring oil price due to geopolitical tensions in the Middle East or the impact of US tariffs. It could, of course, be something entirely unforeseen.

The critical point is this: despite the current, seemingly stable, balancing act of the scales, the extraordinary weight on both sides has created a situation where a complete fracture is a distinct possibility. Such an event, or sequence of events, could unleash consequences that might be impossible for governments to mitigate or rescue investors from.

It is for this very reason that I believe it is prudent to be prepared for both eventualities: a continuation of the surprising market exuberance we've witnessed in recent years, but also, crucially, to be prepared for the major, cyclical events that periodically reshape markets over the decades. As a notable example, it's worth observing how Berkshire Hathaway appears to be significantly more prepared for such eventualities than many other market participants."

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

"The Extreme Backdrop: Government Liquidity, Fiscal Stimulus, and Passive Investment Surges
The US stock market has shown remarkable resilience, arguably defying gravity as valuations continue to climb, leading to a growing sense of overvaluation. This surprising strength, despite economic headwinds, can be attributed in large part to the unprecedented levels of liquidity injected into the system through emergency government actions following the 2008 Great Financial Crisis (GFC) and the COVID-19 pandemic. The challenge now lies in the inability to withdraw this emergency liquidity, exacerbated by persistent and significant government deficits, all while a powerful structural shift towards passive investing continues to gain momentum.

To understand the delicate balance at play, consider the analogy of a set of weighing scales, where market prices are discovered through the interplay of two opposing forces. On one side, we place the significant concerns: lofty valuations, persistent inflationary pressures, and the specter of slowing economic growth. These are the weights that typically pull markets down. However, on the other side of the scales, we find equally formidable forces: extreme government support, manifested in continued liquidity and fiscal measures, coupled with the relentless upward flow of passive investment, which often chases past performance.

Here's the statistical backdrop illustrating this extreme environment:

1. Federal Reserve's Balance Sheet (Quantitative Easing - QE)
The Federal Reserve's balance sheet is a direct measure of its asset purchases, primarily through quantitative easing (QE), which injects liquidity into the financial system.

Pre-GFC (around 2007): The Fed's balance sheet was typically under $1 trillion.
Post-GFC (QE1, QE2, QE3): In response to the GFC, the Fed embarked on multiple rounds of QE. By October 2014, the balance sheet peaked at around $4.5 trillion, a roughly 4-5 fold increase from pre-crisis levels.
COVID-19 (QE4): The response to COVID-19 saw an even more dramatic expansion. From roughly $4.2 trillion in February 2020 (pre-pandemic) to a peak of nearly $8.9 trillion by May 2022. This was an increase of approximately $4.7 trillion in just over two years, effectively doubling its size from pre-pandemic levels, and reaching nearly 10 times its size before the 2008 financial crisis.
Current (as of early June 2025): While the Fed has been engaged in "quantitative tightening" (QT) since June 2022 to reduce its balance sheet, it still remains elevated at around $6.68 trillion.
2. Government Fiscal Stimulus Packages
Beyond monetary policy, the US government enacted massive fiscal stimulus measures to directly support individuals and businesses.

Great Financial Crisis (2008-2009): The American Recovery and Reinvestment Act of 2009, while significant at the time, totaled around $840 billion.
COVID-19 Pandemic (2020-2021): This period saw an unprecedented level of fiscal intervention:
The federal government provided approximately $4.6 trillion in total funding for pandemic response and recovery.
Key bills included the CARES Act (March 2020) at approximately $2.2 trillion, the Consolidated Appropriations Act, 2021 (December 2020) at around $900 billion, and the American Rescue Plan Act of 2021 (March 2021) at approximately $1.9 trillion.
These packages included direct payments to individuals (totaling over $800 billion across three rounds), enhanced unemployment benefits, and significant aid to businesses and states.
3. Budget Deficits and National Debt
These massive stimulus efforts have naturally led to ballooning budget deficits and a dramatic increase in national debt.

Budget Deficits (as a percentage of GDP):
During the GFC: The deficit peaked at 9.8% of GDP in 2009, the highest proportion since World War II at that time.
During COVID-19: The deficit surged even higher, reaching 14.9% of GDP in 2020 and 12.4% in 2021, surpassing the GFC peak and setting new post-WWII records.
National Debt (total and as a percentage of GDP):
Pre-GFC (2007): US national debt was around $9 trillion.
Post-GFC (2014): By the time QE3 ended, it was around $17.8 trillion.
Pre-COVID (2019): Debt held by the public was around 79% of GDP.
Post-COVID (as of March 6, 2025): The total federal government debt has surged to over $36.56 trillion. Debt held by the public was roughly $29 trillion.
Debt-to-GDP Ratio: This ratio climbed from 79% of GDP in 2019 to 97% of GDP in 2022. The Congressional Budget Office (CBO) projects it to rise to 116% by 2034 and potentially 172% by 2054 if current policies remain unchanged.
4. The Rise of Passive Investment Flows
A structural shift in how investors allocate capital has also provided a persistent tailwind to markets, particularly large-cap stocks.

Dramatic Growth: Passive funds (like index funds and ETFs) have grown from less than 5% of the U.S. equity and bond mutual fund and ETF markets 30 years ago to more than 50% by the end of 2023.
Assets Under Management (AUM): In 1993, passive funds invested in US stocks managed $23 billion. By 2021, passive assets had risen to $8.4 trillion, representing 53% of combined active and passive funds and 16% of the US stock market.
Continued Inflows: In 2024 alone, passive investments recorded a global net inflow of around $1.1 trillion. For US equities specifically, passive US equity funds took in a large sum ($244 billion) in 2023, while active funds suffered widespread net outflows.
ETF Growth: The global ETF market reached $11.1 trillion in AUM as of December 31, 2023, demonstrating a cumulative annualized growth rate (CAGR) of 19.8% since 2008. As of May 2024, global ETF AUM was around $13 trillion, with the U.S. accounting for approximately $9 trillion of that.
Here's where the analogy extends to a more concerning scenario: What if these scales, currently holding a precarious balance, were to fracture? The sheer weight on both sides is now so extreme that a fracture could cause the weights to hit the floor with destructive force. This fracture might manifest in various ways: perhaps a breaking point in the bond markets, a sudden and significant shift in investor momentum, or a resurgence of inflation, potentially triggered by a soaring oil price due to geopolitical tensions in the Middle East or the impact of US tariffs. It could, of course, be something entirely unforeseen.

The critical point is this: despite the current, seemingly stable, balancing act of the scales, the extraordinary weight on both sides has created a situation where a complete fracture is a distinct possibility. Such an event, or sequence of events, could unleash consequences that might be impossible for governments to mitigate or rescue investors from.

It is for this very reason that I believe it is prudent to be prepared for both eventualities: a continuation of the surprising market exuberance we've witnessed in recent years, but also, crucially, to be prepared for the major, cyclical events that periodically reshape markets over the decades. As a notable example, it's worth observing how Berkshire Hathaway appears to be significantly more prepared for such eventualities than many other market participants."

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

"While the market has shown incredible resilience, a look at several widely accepted valuation metrics suggests that the U.S. stock market, particularly the S&P 500, is indeed wildly overvalued by historical norms.

Here are some key statistics:

1. Shiller Cyclically Adjusted Price-to-Earnings (CAPE) Ratio
This is one of the most respected valuation metrics, developed by Nobel laureate Robert Shiller. It divides the S&P 500's price by the average of 10 years of inflation-adjusted earnings. This smoothing helps account for business cycle fluctuations.


Current Shiller CAPE Ratio (as of June 2025): Approximately 36.06.
Historical Average (since 1870s): The long-term average is around 17.1.
Implication: The current CAPE is more than double its historical average, indicating extreme overvaluation. It has only been higher during the dot-com bubble (peaking around 44 in 1999/2000) and briefly during the COVID-19 stimulus frenzy (reaching over 38 in late 2021). Historically, high CAPE ratios have been followed by lower long-term returns.
2. Market Capitalization to GDP (The "Buffett Indicator")
Warren Buffett famously called this "probably the best single measure of where valuations stand at any given moment." It compares the total market value of all publicly traded U.S. companies (often using the Wilshire 5000 index) to the country's Gross Domestic Product (GDP).


Current Ratio (as of March 2025): Approximately 200%.
Historical Average: Warren Buffett suggested a range of 75% to 90% as reasonable, with 120% signaling overvaluation. The long-term average is generally considered to be in the 100-110% range.
Implication: At 200%, the market cap to GDP ratio is at historically elevated levels, similar to or even exceeding the dot-com bubble peak. It indicates that the size of the stock market is far outpacing the underlying economic activity.
3. Price-to-Sales (P/S) Ratio for the S&P 500
The P/S ratio measures a company's market capitalization relative to its total sales or revenue. For the S&P 500, it's the aggregate market cap divided by aggregate sales.

Current S&P 500 P/S Ratio (as of December 2024): Approximately 2.985.
Historical Average: The historical average for the S&P 500 P/S ratio is typically much lower, often cited in the range of 1.0 to 1.5. Even during the dot-com bubble, the P/S ratio peaked around 2.2-2.3.
Implication: The current P/S ratio is significantly above its historical average, suggesting that investors are paying a much higher price for each dollar of company sales than they have in the past. This points to extreme overvaluation, as sales are generally less volatile and less susceptible to accounting tricks than earnings.
4. S&P 500 Earnings Yield (Inverse of P/E Ratio)
The earnings yield is the inverse of the Price-to-Earnings (P/E) ratio (Earnings per Share / Price per Share). It represents the earnings generated for every dollar invested in the index. A lower earnings yield means you're getting less earnings for your investment, implying higher valuation.


Current S&P 500 Earnings Yield (as of December 2024): Approximately 3.57%.
Historical Long-Term Average: The long-term average earnings yield for the S&P 500 is around 4.68%.
Implication: A current earnings yield of 3.57% is considerably lower than the historical average, translating to a higher P/E ratio and indicating that investors are willing to accept a much lower "return on earnings" compared to historical norms. When compared to bond yields (like the 10-year Treasury, which is currently around 4.25% as of mid-2025), the equity risk premium (the extra return expected from stocks over bonds) also looks historically compressed, making bonds appear more attractive on a relative basis.
Summary of Valuation Extremes:
These metrics collectively paint a picture of a market that is exceptionally expensive by historical standards.

Shiller CAPE: More than double its historical average.
Buffett Indicator: Roughly double its historical "fair value" range.
Price-to-Sales: Nearly double its long-term average, even exceeding dot-com bubble levels.
Earnings Yield: Significantly lower than average, suggesting higher prices relative to earnings.
While proponents argue that low interest rates, technological innovation, and strong corporate profits (driven in part by government stimulus) justify these elevated valuations, history suggests that such extreme valuations often precede periods of lower long-term returns, or even significant market corrections."

And then for entertainment I asked: so where will the S&P 500 and Berkshire Hathaway stock be in 5 years. I have not read the response yet but will guess, Gemini is as much in the dark as we are.

"Predicting stock market movements, especially 5 years out, is notoriously difficult and no one can do it with certainty. The analogy of fracturing scales is particularly apt here because the current environment presents such extreme and conflicting forces.

Given the knowledge of extreme overvaluation by historical norms, unprecedented liquidity, high government deficits, and the rise of passive investment, here's a qualitative assessment of where the S&P 500 and Berkshire Hathaway stock might be in 5 years, along with the rationale:

S&P 500 in 5 Years
The Highly Probable Scenario (Based on Historical Valuation Reversion):

Given the current extreme valuations (Shiller CAPE, Market Cap to GDP, P/S ratios all well above historical averages), the most historically consistent outcome for the S&P 500 over a 5-year horizon would be significantly lower real (inflation-adjusted) returns, possibly even negative returns or a period of prolonged stagnation/decline.

Rationale: Markets tend to revert to their historical means. When valuations are this stretched, future returns are typically suppressed. This doesn't necessarily mean a straight line down, but rather that the compound annual growth rate (CAGR) over the next five years is likely to be much lower than the historical average (around 10% annually) and could easily be negative after accounting for inflation.
The "Fracture" Scenario: If the "scales fracture" (e.g., a bond market crisis, a severe inflation shock, or an abrupt shift in investor sentiment leading to significant outflows from passive funds), the S&P 500 could experience a substantial correction or even a bear market. In this scenario, it could be significantly lower than its current levels. The more extreme the current overvaluation, the deeper the potential fall in a severe downturn.
The "Muddle Through" Scenario: The current liquidity and passive flows could continue to prop up the market for longer than historical models suggest. However, even in this scenario, returns would likely be muted as earnings growth struggles to catch up with inflated valuations. The market might drift sideways or experience smaller, more frequent corrections. This would likely result in an S&P 500 that is modestly higher, but with much lower annualized returns than the last 5-10 years, and still susceptible to a significant drop.
Key Factors that will influence the S&P 500's trajectory:

Inflation and Interest Rates: The Fed's ability to tame inflation without triggering a severe recession will be paramount. Persistent high inflation or further aggressive rate hikes would likely depress equity valuations.
Corporate Earnings Growth: Can companies continue to grow earnings to justify current valuations? Economic slowdowns or recessions would severely impact this.
Government Policy & Deficits: The ongoing need to finance large deficits could crowd out private investment or lead to more inflationary pressures, further complicating the Fed's job.
Geopolitical Events: Conflicts (Middle East, Russia-Ukraine), trade wars, and other global instabilities could trigger market downturns.
Investor Sentiment and Passive Flows: A reversal in the strong inflow into passive funds, perhaps due to sustained underperformance or a loss of confidence, could remove a significant prop from the market.
Berkshire Hathaway Stock (BRK.A / BRK.B) in 5 Years
Berkshire Hathaway is a different beast due to its unique structure and management.

Possible Scenarios:

Outperformance in a Bear Market/Correction: This is the most likely scenario where Berkshire Hathaway shines. Warren Buffett and Charlie Munger (until his passing) have historically excelled in acquiring assets at distressed prices during market downturns. Berkshire's massive cash hoard (over $180 billion as of early 2025) positions it uniquely to make significant acquisitions or invest in undervalued public companies if the S&P 500 experiences a major "fracture." In such a scenario, Berkshire's stock could hold up significantly better than the broader market, and potentially even rise as it deploys its capital shrewdly.
Underperformance in a Continued Bull Market: If the S&P 500 continues its upward trajectory driven by speculative fervor and growth stocks, Berkshire, with its value-oriented approach and large cash position (which acts as a drag when assets are overvalued), might lag the broader market. Buffett has consistently stated he won't pay exorbitant prices, even for great businesses.
Leadership Transition Impact: Warren Buffett is expected to step down as CEO by the end of 2025, with Greg Abel taking the helm. While Buffett has been preparing Abel for years and will remain Chairman, the psychological impact of his departure should not be underestimated. This transition could lead to short-term volatility but is unlikely to derail the long-term prospects given Berkshire's strong culture and decentralized structure. The investment philosophy is deeply ingrained.
Steady but Slower Growth: Even if there isn't a massive market downturn to exploit, Berkshire's underlying operating businesses (insurance, railroads, utilities, etc.) are generally stable cash generators. This provides a resilient foundation. So, even in a less dramatic environment, Berkshire could see modest, steady appreciation driven by these businesses, though perhaps not the kind of outsized returns it delivered in its earlier decades.
Key Factors that will influence Berkshire Hathaway's trajectory:

Opportunity to Deploy Cash: This is arguably the biggest driver. If market dislocations or attractive private acquisition opportunities arise, Berkshire's cash pile becomes a huge asset.
Performance of Operating Businesses: The continued health and profitability of its diverse portfolio of wholly-owned businesses.
Success of Management Transition: How smoothly Greg Abel takes the reins and continues the disciplined capital allocation.
Interest Rates: As a major insurer with significant float, Berkshire benefits from higher interest rates on its fixed-income investments.
Conclusion:

While specific price targets are impossible and irresponsible to give, the current valuation landscape strongly suggests that the S&P 500 faces headwinds for substantial returns over the next 5 years, with a significant risk of a correction.

Berkshire Hathaway, on the other hand, appears uniquely positioned to weather potential market storms better than the S&P 500, and potentially even thrive if market valuations revert to more reasonable levels, allowing it to deploy its massive cash reserves. Its preparedness, as you noted, is indeed a key differentiator in this extreme and potentially fracturing market environment."