The Stock Market Is Partying Like It Is 2008

Reflecting on the stock market bubble of his time, Isaac Newton famously said that he could calculate the movement of the planets but not the madness of men. We have to wonder what he might have said about today’s frothy stock market. The market is partying like it is 2008 even at a time of high interest rates and of growing geopolitical, financial system, and trade risks to the economic recovery.

One indication of the market’s partying is the buying frenzy currently underway in companies that have anything to do with artificial intelligence. Seemingly, the market learned little from the early 2000s dot-com bubble that ended in tears. The general indication of partying markets are stretched equity valuations and the repeated setting of new records by the S&P 500 and Dow Jones. Never mind that, over the past two years, the Federal Reserve has raised interest rates by 5.25 percentage points and is showing no signs of starting interest rate cuts anytime soon.

One thing that seems to have escaped the market’s notice is the heightened geopolitical risks to the world economy. Russia is still engaged in the largest European land war in the post-war period. The Israel-Hamas war is threatening to spill over to the rest of the Middle East as tensions between Israel and Iran rise. The US and the United Kingdom are having to battle the Houthis to keep the vital Red Sea shipping lane open. Meanwhile, China keeps saber rattling over the South China Sea and the status of Taiwan, which happens to supply around 90 percent of the world’s most advanced electronic chips.

The market is also choosing to turn a blind eye to the slow-motion train wreck that is now in progress in the commercial real estate sector. It is doing so in much the same way as in early 2008 it brushed off the start of the sub-prime loan crisis. This is all the more surprising given the warning signs that we should have been receiving from last year’s Silicon Valley Bank failure.

Unfortunately, the risk of another round of the regional bank crisis is all too real. Commercial real estate lending accounts for around 20 percent of those banks’ overall loan portfolio. That leaves these banks all too vulnerable to a big hit from commercial real estate defaults once property developers have difficulty in rolling over the $930 billion in property loans that fall due this year. As a result of changed working habits, office vacancy rates have gone through the roof. And as a result of the Fed, loans will have to be rolled over at very much higher interest rates than those at which they were originally contracted.

A recent National Bureau of Economic Research study painted a gloomy picture of the likely fallout for the banks from the commercial real estate crisis. According to that study, close to 400 small- and medium-sized banks will fail over the next few years.

Another risk that the market seems to be taking in its stride is the risk of heightened world trade tensions. This is surprising considering that in the wake of the recent bursting of its housing and credit market bubble, China looks intent on trying to export its way out of its industrial overcapacity problem. It is also surprising considering the strong likelihood that whoever wins this year’s US presidential election will take a more confrontational stance towards China on trade policy.

In 1914, on the eve of the First World War, the US and United Kingdom stock markets were buoyant only to find that they had to be shut for a few months after the war broke out to avoid a panic. In early 2008, on the eve of the US housing market and sub-prime lending crisis, markets were also buoyant. We have to hope that this time around Mark Twain is not right in saying that history rhymes, even though many clues are pointing to another episode of excessive market optimism.

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Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.