Balance. When everything is in balance, you achieve stability. Put two people of exactly equal weights on opposite ends of a seesaw and both will hover over the ground. In the economy, balance happens when supply equals demand. In our labor market, enough new jobs have been created to roughly match the growth in the workforce. A supply/demand balance results in wage rates increasing in lockstep with the pace of inflation. As for the economy itself, excluding the impacts of trade and inventory adjustments, final sales are growing at or slightly above 2%, again achieving balance with a combination of slow growth in the labor force and moderate increases in productivity, thus keeping inflation moderate.
All this is reflected in the bond market where 1-year Treasury yields have remained in a rather tight range of 4.0-4.5% for more than a year.
But while the economy, inflation and the investment grade bond markets have stayed pretty much in balance through 2025, the same cannot be said for the stock market. A strong first quarter was upended by Liberation Day announcements of tariffs much greater than investors were expected. Stock prices tanked immediately. But as the fears subsided and many initially announced tariffs were either rescinded or reduced, markets staged a recovery. In fact, the speed and slope of the recovery defied all expectations. AI enthusiasm and simple momentum created a spike of enthusiasm that bordered on euphoria. The NASDAQ rose for 7 straight months. All leading averages reached new highs in October. After two consecutive years of 25%+ increases, by late October, the S&P 500 was on pace to make it 3 years in a row. Meanwhile corporate profits grew at a single digit pace over the same period. The imbalance created by enthusiasm driven demand for risk assets simply wasn’t sustainable. The only questions were when and how was some semblance of balance going to be restored.
We got a hint of this volatility three years ago. After the SPAC craze and heightened exuberance of 2021, the S&P 500 fell over 18% in 2022. The decline was all about restoring balance. There was no recession. Yes, inflation accelerated. But inflation alone doesn’t kill stock markets. Using the word balance yet again, asset prices should rise at a similar pace to offset the impact of inflation plus a real return to pay for the additional risk versus a bank deposit.
So, what happened the past two weeks? The government shutdown ended and elections gave some signals that Americans were not happy with the economic status quo, but even before the election results came in and the shutdown ended, there were storm clouds forming. Several key earnings reports in September triggered much larger than expected downside reactions. At the same time, good news from some of the hottest stocks of 2025 couldn’t push stocks higher. Stock prices rise because there are more buyers than sellers. Duh! An old saw on Wall Street says that when stocks fail to rise on better than expected news that’s a clear warning sign that buyer momentum has been exhausted. Look at the Mag 7. Meta Platforms# clearly had the worst earnings report of the group. The news wasn’t all bad. Its signature networks, Facebook, Instagram and WhatsApp, all did just fine. In fact, better than fine as AI features incorporated into those products expanded usage and helped to target ads better. But Meta’s race to build the large language model of choice clearly fell short. The company spent billions to hire top flight talent. Will that let the company move toward the leader of the pack? Who knows? But investors spoke with their feet; they will wait for evidence of a return to prominence before getting too enthusiastic once again. Other Mag 7 names, like Microsoft# for instance, met expectations that pushed analysts to raise price targets. But investors sensing exhaustion reacted by selling, not buying. Ditto Nividia# last week. A brief post-earnings pop gave way to profit taking. Nvidia didn’t do anything wrong; profit taking overwhelmed new buyers.
While investors focused on the Mag 7 names because of their size and impact on markets, the cracks at the top led to fissures down below. This past summer there were several IPOs of tech companies that shot immediately to two or three times their offering price. One could argue the offering prices themselves were at inflated valuations. On such name, Figma, was originally an acquisition target of Adobe. But government anti-trust actions forced Adobe to cancel the deal. Yet just months later, Figma came public itself at $33 per share, above the price Adobe had offered. In the euphoric mood of last summer, the stock opened at $85 and immediately shot to over $125. After the market purge of the past two weeks, the stock closed Friday at a shade over $34. Anyone who bought the stock since the IPO now has a significant loss. Figma hasn’t done anything wrong. But the stock’s exuberance-fed balloon got pricked. There are no signs yet that the downturn is over.
Figma is small potatoes compared to bitcoin. Just last month bitcoin’s price set a new record high of more than $126,000. As it turned out the legislation that created a structure to regulate cryptocurrency, while a boom to the use of stablecoins, actually amplified the point that bitcoin, because of its inherent volatility, would not be used as a currency despite the second syllable “coin” in its name. As for its being a store of value, gold has outperformed bitcoin materially this year. If it isn’t a currency and not always the best store of value, what is it? The obvious answer is that it is a speculative instrument. Seeing opportunities born from bitcoin euphoria, creative financial minds created bitcoin ETFs, bitcoin options (including perpetual options) and derivatives that magnified the price changes in bitcoin by 2-3x. Corporations, notably a company named Strategy, whose stock price at one point was twice the value of its bitcoin holdings, sold a combination of equity, preferred and debt to buy yet more bitcoin. That gambit ended last week when market forces eradicated the premium of its stock price over the NAV of its bitcoin holdings. Last week also witnessed record outflows from bitcoin ETFs forcing them to sell into a weak market. Where does bitcoin go from here? It’s a speculative instrument with no cash flow. It could go to $25,000 or $250,000 depending on the enthusiasm of buyers versus to concerns of sellers. Last week, sellers won big time. If you are a bull on bitcoin, ask yourself where are the future buyers? Every owner is a future seller. For the price to keep going up, buyer support will be needed on an ongoing basis.
There is one other factor in play which we have touched upon in recent weeks. Debt. Two of the hottest creators of large language models to be used for AI applications are OpenAI and Anthropic who have built ChatGPT and Claude respectively. To build these models and maintain leadership costs lots of money. Hundreds of billions of dollars. Neither has the equity backbone to support anywhere near that kind of investment. So, they either have to borrow a lot, sell more equity or find partners willing to give them funding in exchange for future business. Nvidia# and Microsoft# have been investing in both with the promise, some might say hope, that the large language model builders will buy lots of chips and spend lots of dollars on Azure, Microsoft’s cloud platform. Remember “Fields of Dreams” tag line, “Build it and they will come”? A month ago, investors bought that message. Last week they questioned what happens if you build it and they don’t come? At the moment everyone is capacity constrained. Stocks of both Nvidia and Microsoft have wavered as investors heard the risks. But the real concerns have shown up in the stock reaction of Oracle# and CoreWeave, among others. Nvidia and Microsoft have fortress balance sheets that can withstand short-term imbalances. Demand will clearly arrive over time but the real question is will it arrive on time for companies that need sufficient cash flow to service a huge pile of debt or not? Last week pessimism dominated optimism. That doesn’t mean the pessimists are right. But it does point out markedly that excessive debt creates a layer of risk not shared by companies with fortress balance sheets. In a market starting to purge itself of excessive risk, debt ridden companies are avoided.
Let me try and pull this all together. The overall economy is solid. Growth is moderate. Inflation is still above target but most of the tariff impact will probably be fully reflected soon. To be sure, there are pockets of economic weakness like housing although existing home sales have started to perk up. Wage growth continues to moderate. Improved productivity will further depress inflation. Slowly moderating Fed Funds rates seems appropriate. Thus, broadly speaking, the economy is doing OK, not great, but clearly growing. That suggests the correction we are witnessing in the stock market is just that, an old-fashioned valuation correction. I have no idea where the bottom is. It could be ending now or it could become a 10-20% correction as in 2022. While the last two weeks are concerning, there has been no sign of panic. I think the “buy the dip” mentality is still there. In a real purge that could reach 20% or more, the buy the dip mentality would end with capitulation. That’s how all bear markets end. So far, we are nowhere near that point. But remember another Wall Street truism. Stocks take the escalator up and the elevator down.
A healthy purge in the stock market is long overdue. It’s never any fun to watch, just as living through a storm can be nerve wracking. But when skies clear, and the long-term damage is modest, markets can rebalance. Long-term stocks rise 7-9% per year, close to 6% excluding inflation. Even after the November correction, the Dow is up 9% for the year, while the S&P 500 and NASDAQ are up 12% and 15% respectively. And that’s after two years when gains were well over 20% each. The correction in the stock market will echo elsewhere. Private credit demand has soared, suggesting the incremental demand may be for lesser quality debt. Private equity funds still can’t exit positions suggesting many of their holdings on their books are overvalued. The boom in AI has created thousands of aspirants to the thrones of leadership. Most will end in the graveyard. A purge in the stock market won’t occur in a vacuum. We see the impact in crypto where markets are fairly liquid and transparent. Before all is done, the less transparent markets may have to face a reckoning of sorts. Maybe a buy the dip moment is coming but I don’t think it is here yet. Sharp downside movements of more than a percentage point or two have to end with some sort of capitulation. With that said make a list of the companies you might want to own over the next 10 years. Don’t worry about price now. A real correction always offers the best buy points. A 10% or greater correction would likely be a 20%+ correction for the market’s momentum leaders. The economy is solid. AI is for real. Demand for electricity is a real growth opportunity. Building a modern defense arsenal is a necessity. New drugs and medical devices will enhance lives. There are great companies all over the map. Most can be identified. A correction is a buying opportunity not a time to capitulate with one caveat. One of Warren Buffett’s favorite expressions is that you never know who’s swimming naked until the tide goes out. If you own one of those naked swimmers, sell now, otherwise be patient.
Today, Peter Best is 84. An obscure name to many, he was the Beatles drummer replaced by Ringo Starr just before they had their breakout success. Basketball legend Oscar Robertson turns 87.
James M. Meyer, CFA 610-260-2220