Climbing the Wall of Worry – Are We in a Bubble Q1 2024

In this video, Bernhard Koepp gives a detailed review of the reasons behind the strong Q1 2024 performance of the US equity markets and reviews some of the investment themes followed by CJL’s investment management team. 

Hi, there. This is Bernhard Koepp from C.J. Lawrence in Midtown Manhattan. It’s March 28th, and we are right at the end of the first quarter, and it’s a spectacular quarter. This is the best first quarter that we’ve seen since 2019. We’ve had back-to-back quarters now of 10% performance for the market for the S&P 500.

Why the Bullish Trend?

We are in this period, which is historically a bullish phase for the market, from the point when the Fed pivoted in October to the first-rate cut, which we expect sometime in June. That typically is a time for the market where almost everything works. We’ve had a very concentrated market in the last year in certain names. There was this phenomenon of the Mag-Seven. Well, we’ve seen the market broaden out now already. If you looked at the difference, or the spread between equal-weighted and cap-weighted companies in the S&P 500, the maximum spread was about 14%. Well, we’re down to about 5% at this point.

We’ve certainly seen a broadening out from the typical tech stocks or communication stocks or semiconductor stocks that we’ve seen that have been driving the market. But this is also the period where investors and clients climbed what we call the wall of worry. We are at this point now where the markets have broken out.  We are above the previous peak that was before the market went into the bear market in 2022. There’s a lot of head scratching. How could we be at an all-time high here given all the doom and gloom that we saw in the past year or so from strategists and economists? Well, I’ll try to explain that a little bit in this video and give you some kind of a road map into what’s to come. Let’s look at consumer net worth. We got some data today on consumer sentiment, and it was off the chart. We are not surprised by that, because typically when consumer net worth makes a new high, strong consumer sentiment is a byproduct.

Consumer Strength

There is a six-month lag between consumer spending and consumer net worth. Given how strong the market has been in terms of equity returns and asset prices, there is this six-month lag between consumer spending and consumer sentiment and net worth.  That bodes well for GDP going forward. The bears on the economic front have been pointing in the past to the leading economic indicator actually going down, but we’re seeing now an uptick in the leading economic indicator for the U.S. economy, which is quite nice. In that sense, we have seen a floor under GDP with all of the negative scenarios regarding recessions and things like that.  At this point, most economists and strategists no longer believe we are looking at a recession anytime soon, or even that we avoid a recession altogether. Let’s look at inflation for a moment and the debate on inflation on the supply side and also on the demand side. When we talk about supply side, we’re really talking about supply chains.

Supply Chain

We woke up the other day seeing this enormous freighter plow into a bridge in Baltimore. Of course, the first thing is, oh my gosh, obviously lives were lost, which was tragic.  But also, how does this affect supply chains? We’ve been focusing on shipping in the last couple of months, given what’s happening out in the Middle East with the Houthis basically making it very difficult for ships coming from the Arabian Gulf and from Asia to go through the Suez Canal. You’ve had ships now going the longer route, which is actually the bumpier route in the ocean around the Horn of Africa. There was a worry that supply chains would be disrupted and that would be further exacerbating these supply side problems about inflation. If you remember with the pandemic, we had supply chains completely disrupted, and the largest cause of our inflation was probably due to those factors. We’ve come from 9.1% inflation now to about 3%, and a lot of that has to do with the normalization of supply chains.  There is a great chart that I can send you from the New York Fed that shows a normalization of supply chain pressures.

What is interesting is that pre-pandemic supply chain pressures were more related to things like trade wars. In the last few days, we saw many CEOs being invited to China.  Where we are going is a big question mark, especially with the two candidates for president who want to be tough on China when it comes to tariffs. Trade wars tend to be inflationary. Further, we have seen many companies move, not just from a trade war point of view or a tariff point of view, but from a geopolitical strategic point of view to reshoring manufacturing to their home economies. That is something that in the near term certainly adds to the inflationary supply pressures that we’re seeing.

Demand Driving Inflation

Now let’s turn from the supply to the demand part that’s driving inflation.  This is the part of the equation that the Fed can actually control.  We’ll see if the Fed can engineer CPI inflation to go from where we are now, 3%, to their 2% target. Let’s turn to money supply.  As a trained economist, in school I learned from greats like Milton Friedman, that inflation tends to be a money supply issue. If we look at the traditional measure of money supply, which is M2, and put that chart on top of CPI, it’s a perfect fit. We can see how, with money supply coming down, it coincides quite perfectly with CPI, but there’s an 18-month lag. If the Fed is talking about, or being a bit more confident about, future inflation coming down, and we saw this in the Q&A with Powell just the other week, the two factors, supply chains, which is the supply-driven factors and the demand-driven factors that we’re seeing in the economy and money supply, they’re all pointing to a moderating inflation rate down the road.

We got the revised reading on GDP for the fourth quarter. It was 3.4%. That’s down from 4.8% in the third quarter of last year.  We’re seeing a deceleration of GDP. But in terms of consumer net worth and the consumer sentiment, it looks like the sweet spot for the GDP for 2024 is between 2 and 3%, which creates a very interesting investment environment, especially for growth investors. Let’s take a look at a few commodities that are in the news all the time, oil and gas. We are in the midst of an all-time low natural gas price.  It is extraordinary to think that we could be at all-time low natural gas price given the war in Ukraine. When Russia invaded the Ukraine, it disrupted the distribution of natural gas into Europe. The most dependent country on that natural gas was Germany. They had to retool their entire imports for natural gas from being almost 100% dependent on Russia to now importing LNG from the United States. It took them about 200 days to retool their import capacity for LNG, and now they are doing that.

Once the Russians invaded the Ukraine, natural gas prices went from about $4 up to about $10 of – an incredible increase in price. We’re back down to around $2 for natural gas at this point, which is really extraordinary and shows that supply chains have adjusted to geopolitical issues. This was also driven by the fact that the United States is the biggest producer of natural gas and oil. On the oil side, things are a little bit more complicated. The fact is that the United States is the biggest producer of oil. Production is at an all-time high. We have an ample supply of oil. It’s no longer OPEC. These are the factors that are not adding to inflation. EVs, or electric vehicles, need lithium batteries to function. Though lithium prices initially spiked, they have now declined 80% from the top, which is also adding to this more deflationary environment.

More cyclical factors that are driving commodities like gasoline futures are rising, and that has to do with a stronger economy ahead. Lumber prices are also climbing.  That has to do with a stronger housing market. Because of high interest rates, there was a lot of doom and gloom in 2023 about the housing economy here in the U.S. Well, the thing that’s really driving the stronger housing industry is low inventory. If I showed you a chart of inventories by companies like Redfin, it would show you that the inventories for new homes and new listings is really low. We had lots of activity during the pandemic when everybody went out to buy a home. Now the supply of listings is really quite low, and that’s driving a lot of investment into home builder activity and so forth. It is a really strong environment if you’re in that housing market. Quick turn to China , where the economy is in trouble. The economy is decelerating there, but what’s more important for us here from the inflation front is that they’re exporting deflation.

If you think about when you walk into a Walmart about 80% or 70% of the things that you buy are produced in China. The lower year-over-year prices on these products also contributes to our lower inflation outlook. This gives you an idea of why the market is doing so well here.  This is why the Fed is less worried about the last piece, going from 3.1% inflation to 2%.  Why are they not worried about that when it comes to lowering rates? It has to do with productivity, and I think we don’t talk about productivity growth enough. I’m old enough to have been a money manager, a stock picker in the 1990s when we had this massive surge in productivity. If you remember in the 1990s we built the internet, but I remember very, very clearly the period in 1994 and 1995, it was doom and gloom. We were coming out of the savings and loans crisis.


There were 1,400 savings and loans banks and thrifts that went bust. It was doom and gloom; however, this was the beginning of the World Wide Web. We were talking about massive new technologies and their implementation which created a massive surge in productivity. During those days, you may remember, Greenspan called it, “The new era of growth.” That really was this period.  It was a very special period from 1995 probably to 2000, when you had massive returns in the market coming off of a very bearish kind of environment, and it created amazing returns. It feels a little bit like that today because productivity growth was negative coming out of the pandemic. The notion that sitting at home made you more productive was clearly debunked. Now we have this new technology called generative AI, which is really very similar to the period in the 1990s, but we would argue even stronger.  This technology has driven tremendous productivity growth in the last year.

If you look at the 2.6% productivity growth in the reading for the fourth quarter, we expect productivity growth to rise even more. If we take 2.6% productivity growth and add 1% population growth, you get 3.6% GDP growth.  Basically, that is free of inflation.  With nominal GDP growth, we can go up to 3.6% and not overheat the economy. This is very, very important. Productivity growth plus population growth gives you cover and gives the Federal Reserve and Powell the cover to lower rates in the second half of the year because it won’t overheat the economy. There are a lot of economists and strategists out there that are talking about, “Oh, my gosh, no, the Fed shouldn’t lower rates and shouldn’t normalize rates because it will overheat the economy because we have a pretty strong economy already.”

Is this a Bubble?

Well, no.  The reason Powell and the Fed can lower rates and normalize the yield curve the way it should — shorter rates on the short end and longer rates on the long end — is because of productivity growth.  That is very important. When you have productivity growth in an economy like this, rates going down and a stable GDP, that is a great environment to invest in.  Thus, we are quite optimistic. One last comment on bubbles. We get this question all the time, “Are we in a bubble?”  I’ve been a portfolio manager doing this for 30 years and if I showed you a chart, and we’re happy to send it to you, on using price-to-earnings ratio using trailing earnings estimates from the ’80s until today, there were several bubbles.

The average of the P ratio of the S&P 500 since 1988 is about 18 times. We hit 31 times in 2001, and that certainly was a bubble. It felt like a bubble at the time. I remember doing research on companies that had no earnings and no revenues, and we had to value companies based on clicks, and that certainly came apart in 2001. Then the next bubble that we saw was the subprime mortgage bubble. That was the 2008 -2009 period, which became known as the Great Recession. You had price-to-earnings ratios for the S&P 500 going to almost 30x and then collapsing. The last bubble that we had was actually in around 2020. We went to about 26, 27 times for the S&P 500, and that was what we call the e-commerce bubble. Remember when we shut the economy down, valuations on anything that was e-commerce went up like crazy. That had to do with the fact that everything was going to the cloud. We were purchasing everything through Amazon.  Valuations gapped up during that period, which was the e-commerce bubble.

If we look at price-to-earnings ratios today, we’re about at 21X. It’s not a cheap market, for sure, but this is not a bubble type economy or a bubble type valuation for the equity markets. There are pockets we can talk about, for instance, one of our favorite stocks like Nvidia. Certainly, Nvidia has had an amazing run in terms of performance. It was up about 200% last year, and it’s up about 80 or 90% already in this year in the first quarter. But the price-to-earnings ratio for an Nvidia is about 38 times. But if we look into the future, if you look at the runway of the generative AI theme and how entrenched or the competitive mode that Nvidia has in that area, it’s quite extraordinary to say that this is a bubble at this point. So we are quite optimistic about where we are in the cycle in terms of where we are in the market.

Look for Opportunity

Certainly, for new money, wait for a dip. The markets are quite overbought at this point, but there will be data coming out on the economy in terms of inflation that will probably look higher than what people are willing to stomach at this point. The inflation data that are coming out just in the next couple of months, from a seasonal perspective, tend to be higher. We cannot lose sight of the bigger picture and pull back on terms of the trajectory of core inflation and things like that. That will give you a chance on the next pullback so if you have new money, put it to work then. That’s it. That was a lot. If you have any questions, give me a call or shoot me an email at  Have a good holiday.


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