This edition of Market Factors starts with a handy index measuring asset bubbles and moves on to trouble in software stocks. The diversion is a reminder that the Americans are heading to the moon again and we have quick hits, as usual.
Illustration by juliannafunk
Indexes
Quantifying an asset bubble
BofA Securities’ equity derivatives and strategy team have developed a Bubble Risk Indicator (BRI) and I wish I’d found it a week earlier because its warning about gold and silver prices was perfectly timed.
The BRI is predicated on the tendency of asset bubbles to become more volatile and unstable as they reach a peak. Investors race in on the back of FOMO while others panic at the first indication of weakness to realize their gains. Price swings in the bubbly asset get wilder and wilder in both directions but overall, volatility rises as the asset bubble climbs to its implosion.
Four segments make up the BRI – returns, volatility, price momentum and a fragility score that compares realized volatility to the average price action in the past. Stocks from popular investment themes are measured by these factors, with a resulting score on a scale of 0 to 1.0. A result of 0.8 or higher implies impending market doom for the relevant investing theme.
The team also pay close attention to peripheral factors like leverage – borrowing to buy bubble stocks – and the performance of newly issued stocks. Both rise sharply just before the party ends.
Last Wednesday the BRI flagged gold and silver as being in the danger zone, with a score approaching maximum bubbly-ness of 1.0. The gold price is down 13.8 per cent since then and silver is lower by 33.0 per cent, as of midday Monday.
Rare earth metals and Korean equities are the other two areas with BRI scores above 0.8, suggesting caution (or hedging) for those with exposure to those themes. The Bloomberg Commodity Index is just below the 0.8 threshold.
The Magnificent Seven stocks are nowhere near problematic levels of the BRI with a score last week below 0.5. The S&P 500 is hovering right near the 0.5 level.
Enough of the client-friendly Merrill Lynch DNA remains in BofA Securities that they are generally good at allowing me access to research but they are a bit cagey about distributing the work of the derivatives strategy team. Either that or I keep missing it.
In either case it will be difficult to keep readers up to date on BRI changes even though I will give it a shot. In the meantime, investors should keep a close eye on volatility indices like the VIX or the MOVE (Merrill Lynch Option Volatility Estimate) index that gauges bond market volatility. Sharp jumps in volatility while markets spike higher will be a warning sign as will news of new stock issues doubling on the first day of trading, or an increase in investor leverage.
AI
Tough time for software
AI compute access provider Anthropic unveiled Claude Cowork on Jan. 12 and software stocks have been weak since. Claude Cowork can write code, analyze data, send emails, and build presentations and websites without prompts or handholding from users. (Here is an example where it collected data and built a dashboard online as the first of five tasks). It can be given a task and then execute it while employees get coffee.
It’s not difficult to see how these AI agents threaten revenues for major software companies. Employees can assign Claude Cowork or subsequent agents to write code for them, specific to their needs, and dispense with expensive software packages that were previously required.
I’m not sure I want to own software stocks until there’s more clarity. AI is definitely poised to cut into their growth, it’s just a matter of how much.
This illustration provided by NASA depicts the MAVEN (Mars Atmosphere and Volatile EvolutioN) spacecraft orbiting the planet Mars.The Associated Press
Diversions
Back to the moon
There is a very funny woman on X who said she wouldn’t visit Mars if it was located on Long Island and a lot of time I feel the same way. There are no doubt scientific discoveries made to address the challenges of space travel but all I can think about as an example is Tang, the disgusting orange drink.
Other times, like now when humans might be orbiting the moon while you’re reading this, I’m not that cynical. The physics, chemistry and metallurgical knowledge necessary to go to the moon is remarkable, as is the courage to sit in problematic space suits with an ocean of flammable gas under your butt.
Any cynicism might arise from an unfair comparison between current reality and Star Trek. It’s a long way between here and there, if we as a species ever progress anywhere near that far. (I have a pet theory that when the holodeck gets invented, no one will leave the house, never mind the galaxy). Current efforts in space just seem stuck at a rudimentary stage - like comparing The Flintstone versus The Jetsons - as impressive as they are.
The Americans plan to walk on the moon again in 2028, hopefully disbanding the “Kubrick shot the moon landing!” conspiracy theorists for good. That will generate some amazing pictures and video that I look forward to and I still hope we can do the same on Mars before my body assumes room temperature. In the meantime I will make more of an effort to find scientific advancements born of the U.S. space program and celebrate the efforts to explore beyond the planet more often than I have.
The essentials
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Globe Investor highlights
CIBC’s chief market technician Sid Mokhtari reveals his Top 10 stock picks for February
Norman Rothery updates the Screaming Value portfolio
Food prices are still soaring. So why aren’t grocery stocks going along for the ride? David Berman has some answers
South Korea’s stock market has doubled in a year, sparking a generational change in how equities are viewed in a country also suffering from housing affordability
It may not be long until Donald Trump starts calling his new Fed chief ‘clueless’, says Mike Dolan
How much of the recent mania for gold and silver was fuelled by U.S. dollar “debasement” fears? Quite a lot, judging by the crash in precious metals on Friday, says Jamie McGeever
Quick Hits
My soon-to-be nephew is employed by a company that does cleaning for equipment that goes into data centres. Data centres require a degree of air quality similar to semiconductor manufacturers to maximize the life span of expensive processing chips. Companies selling servers, connecting cables, cooling, racks or any other equipment just drop it off and my nephew’s company basically sanitizes it before installation. I found this to be an interesting example of the huge number of companies necessary to run a data centre.
Citi analyst Pierre Lau reported that Korean exports of transformers are up 17 per cent year over year in case you were wondering how the electrification investment theme was going.
Predictions for the loonie are all over the place. Citi is very bearish in the short term and Scotiabank strategists are very bullish. The spread between the yield on the domestic two-year government bond and two-year U.S. Treasuries is seemingly driving the bus here.
On Feb. 20, the U.S. Supreme Court will announce a series of rulings. Which cases they will rule on is not known but it’s possible that one of them might end president’s Trump’s power to slap tariffs on imports. This would, to say the least, move markets.
See our full earnings and economic calendar here