Overbought and Out of Breath

That was a good line from Morgan Stanley’s strategist this week, which said all dreams in the stock market may not come true. It’s a sign that strategists are beginning to think the market is overpriced, overvalued, and vulnerable to some sort of correction.

It certainly seems that way.

The market’s been very easy this year so far. Everybody’s a hero. Almost any strategy has worked. There’s a lot of sentiment built up in the market – and what could kill that sentiment is what we’ve got to worry about.

The first thing that could kill sentiment is simply a change in herd mood.

There’s an almost universal acceptance at the moment that the market’s expensive, overbought, vulnerable, and risky – and that’s starting to appear more and more in articles. We’re seeing news services count the number of pieces talking about a bubble or questioning whether the return on investment in AI is really there. The number of negative articles has shot up.

The herd is becoming very aware that the market is looking a little vulnerable.

Take the Nasdaq, for instance. If you look at the chart – and don’t worry too much about charts; you’ll go bust in the long term using charts in the short term – the weekly chart of the Nasdaq is overbought for the first time since the middle of 2024. Back then, the Nasdaq dropped 15% in five weeks for almost no reason.

So, we can get overbought and have a correction without a clear catalyst, just because the herd decides to change mood. The herd is very aware that it’s doing 200 miles an hour with its hair on fire. We’re up at altitude – and it’s much easier to pass out at altitude. It won’t take much for the herd to change its mind.

There’s a universal awareness now that the market’s risky. So, we have to worry about the herd.

The other thing that could kill us off is that we’re being driven by headlines at the moment. It’s rather like the tech boom. I lived through the tech boom, as I’m sure many of our members did.

Back then, the internet was just starting. Imagine you had an idea that you could shop using a mouse and a screen. For us, shopping was a weekly family affair – we’d go to Southland, walk around for three hours, and buy stuff.

These days, you can shop online. But in those days, people were just imagining it – shopping online and having things delivered to you. It was a fantastic idea. And it did happen. But what happened at the time was that share prices shot through the roof, anticipating something that didn’t actually materialise for two decades.

That’s happening again, I think.

The market is running on headlines.

There’s also a thing called circularity, where all the big players are doing deals with each other, and share prices respond to every deal – even though no real value is being created. Nvidia’s done deals with Oracle and Intel. OpenAI just did a deal with AMD, and the AMD share price shot up 23%.

But as with shopping online – great idea – it took 20 years to appear. I think there will be bottlenecks in this AI earnings profile.

Everything can’t happen instantly, even though it feels that way these days. Building a data centre, which is the core of the whole AI cloud growth theme, is no small feat. It takes years. AMD just went up 23% in one night on the idea they’re going to build six gigabytes of data centres, with the first gigabyte starting in the second half of next year.

Where are all the earnings coming from?

Prices are getting ahead of reality. We’re very vulnerable now to any comment from the hyperscalers suggesting they’re not getting the expected return on investment within the expected timeframe.

We’ve got Big Tech results season coming up around the 20th–23rd of October. If there’s even one comment – about backing off capital expenditure, about earnings being further out than expected, about bottlenecks in data centres – any disappointment, and the whole lot could come tumbling down.

It’s still a fantastic theme, just like shopping online. It’ll come back. But the herd’s aware share prices are up there. We’re very vulnerable to any sort of disappointment. The risk now is that results are a hurdle to get over, rather than something to look forward to.

So, there are risks just because of price. Do you sell before it happens?

There’s a well-quoted line from Chuck Prince at Citibank: “While the music is playing, you have to dance.”

The music’s still playing today. Tomorrow could be different.

We’re dancing still. When the music stops – when the lights come on – everyone’s going to find out. And by then, it’ll be too late.

So, we’re trying to assess when the moment is to get out before the lights come on. That’s the conundrum everybody has at the moment – and it’s real.

You’ll have to subscribe to the newsletter to find out what we think about it. But we’re thinking about it every day at the moment.