Investors Are Forever Blowing Bubbles

"Blowing soap bubbles is child’s (investor's?) play, but surprisingly, physicists (economists?) haven’t worked out the details of the phenomenon."



After all-time closing highs in both the Nasdaq and S&P 500 yesterday, investors drove both indexes higher again today following the release of the latest CPI number and the Fed's decision to leave their target Fed funds rate unchanged for now. The bond market followed suit, with bond prices increasing and the 10-year yield dropping to its lowest level in more than two months.

There were no surprises of any consequence in the CPI and the Fed decision to keep the fed funds target rate range at 5.25-5.50% was widely expected and pretty much a non-event.

Investors are obsessed. They are convinced that a Fed rate cut is in the offing and won't take no for an answer. The seeds of that obsession were sown in the fall of 2022, and the bubbles continue to grow in size and fragility.


Stocks peaked in December 2021, about three months before the Fed announced a change in its interest rate policy from four decades of 'lower for longer' and near-zero interest rates. The intention was to raise interest rates to a level that was more in line with historical averages.

Stocks declined all through 2022, bottoming after losing fully one-third of previous peak valuations.

The Fed has held rates steady at a significantly higher level since then and stocks have continued to rise in anticipation of an eventual cut in rates. Currently, the entire decline of 2022 has been erased and the major indexes are sporting moderate nominal gains over and above their previous peaks. With the strong recovery in stocks and the enthusiastic actions of investors to buy more at higher prices, one might assume all is well. Other things give a different impression.

Bond prices, even though they have recovered marginally from their extreme lows last year, are down approximately fifty percent from their peak prices in 2021. In addition, there are signs of a broadly slowing economy with weakness in retail sales (discretionary consumer spending), durable goods orders, and home sales. In fact, the economy continues to weaken while investors keep buying stocks. That doesn't seem quite right.


The commercial real estate bubble has already burst. Loan defaults and vacancies abound and are likely underreported. The residential real estate market has seen sales drop sharply. Home prices have remained high, but increases have begun to slow and, in some cases, drop, as sellers lower the asking prices. Mortgage rates have quadrupled in the past two years, so any relief is probably some time away. Incremental decreases in rates won't be enough to calm a very troubled real estate market.


Stock investors continually push the envelope based mostly on their obsessive expectation of a cut in interest rates. Expectations of a rate cut have been indicated, implied, and conjured up for nearly two years now. The timing of a cut is continually delayed, and the likelihood is lessened. Nevertheless, investors continue to look for the rose in the dung heap, delusion now, disappointment sooner or later. (also see Economic Growth Or Dead Cat Bounce?)

(Late note regarding the decline in PPI - Wholesale prices fell by .2%. This is good news on the surface, although investors see it primarily as justification for expecting the Fed to announce rate cuts sooner and maybe get multiple cuts before the end of the year. The problem is that investors have bid up stock prices in anticipation of the cuts to a point that likely discounts any actual rate cuts. Stocks might be fully priced, and when an actual cut is announced, there is a possibility that stocks will not go higher and could even decline. Also, the economy is weakening rapidly, and the negative economic environment could easily overcome any expected positive benefits from rate cuts.)

Kelsey Williams

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN'T, AND WHO'S RESPONSIBLE FOR IT and ALL HAIL THE FED!