Amid Algorithmic Tech-Market Euphoria, Fear Takes a Holiday

We live in interesting times, which is not always a good thing, as a well-known Chinese proverb says. Nonetheless, the ambiguities and paradoxes of the era in which we live, as well as its careening pace of change, present excellent opportunities for analytical minds to observe and appreciate the delicious complexity and convolution of it all. 

I was amused and intrigued last night when reading a MarketWatch interview with Jeffrey Bierman, chief market technician at TheoTrade and adjunct professor of finance at Loyola University Chicago. Bierman paradoxically cautions that the U.S. stock market has been enveloped by a huge bubble but argues that it would be insane to bet against it. 

Bubbles burst, right? Yes, they do, and even this one will meet its demise, but Bierman posits that it might still tug on a lot of rope before it hangs itself. 

According to Bierman, the deux ex machina keeping the markets buzzing assumes the form – appropriately enough – of machine-run algorithms. These algorithms particularly favor the largest technology stocks – known to some as the Magnificent Seven – driving them to dizzying  but fundamentally unsustainable heights, especially considering that the market’s breadth, represented by the range of stocks experiencing appreciation, is disproportionately thin. 

You might have guessed that AI is a factor in this unnatural market psychodrama. We’re all getting fatigued – a word I use advisedly, perhaps euphemistically – with AI, and some of us are even growing aggressively hostile to the hype it receives. But the markets haven’t tired of AI yet. As Bierman explains, “any technology stock with an AI story is rising too far and too fast.” 

If you think that individual investors are the culprits pumping the bubble to the monstrous dimensions of the Stay-Puft Marshmallow Man, Bierman has confounding news for you. Algorithms, in service primarily to institutional shareholders, are the primary drivers, often ensnared in their own hermetic positive feedback loops and deluded by confirmation bias. 

 In a recent post about Tesla, I presented data showing that most major technology stocks remain overwhelmingly the preserve of institutional investors; Tesla, which has a relatively high proportion of retail investors, is an outlier, attracting the enthusiasm and investment capital of members of Elon Musk’s fervent cult of personality. 

It’s trite but undeniably true to say that nothing lasts forever and all things come to end. So it will be with the AI-driven tech-stock bubble, but not quite yet, according to Bierman. In fact, he says the bubble might not burst for a while because we’ve entered a market fantasyland where technical indicators like the Relative Strength Index (RSI) have been disregarded amid all the self-perpetuating exuberance. Yes, fundamentals suggest restraint, the market breadth is tenuously thin, but neither factor, nor both factors taken collectively, can break up this party. 

When the algorithms eventually reverse course – and nobody seems to have a handle on exactly when that will happen – keening, lamentation, and gruesome carnage are likely to follow. As Bierman puts it: “Combining an extremely overbought market with terrible market breadth is very dangerous. When the algos decide to stop buying and start selling, it could reverse polarity rather rapidly. If that happens, the algos can obliterate the market. We haven’t seen that happen since COVID-19, and then it only lasted a couple of weeks.” 

Maybe it last only a couple weeks this time, too, before reverting to growth mode. Maybe the market remains supine, out for the count, for much longer. We can discern only a general outline on the distant horizon; the details will come into focus later. 

The Fearlessness of the “Seinfeld Market” 

The current market is all tech, all the time. AI is the fuel, and algorithms are the engine. The algorithms, as Bierman notes, are programmed to buy into strength and sell into weakness. (Only humans – ah, those silly humans, not yet put out to pasture by artificial general intelligence – buy weakness.) The algorithms see 52-week highs, and they read them as signals to buy more; they see 52-week lows, mostly in non-tech realms, and they keep selling. 

The overarching narrative, however, is AI, which is why the market ascent is technology laden, and why the algorithms keep responding to new tech-stock highs. The result? Well, Bierman puts it cogently:

When people stop doing research, ignore fundamentals and only buy the narrative, you know you’re in a market bubble. Inside of a bubble, fundamentals don’t matter. 

The only difference this time is it’s happening at a much faster pace. A lot of this is options-driven. The momentum feeds on itself on what’s called a “positive feedback loop,” going higher and higher. The market is at all-time highs, and continually walking itself higher with little slippage. On the way down, however, it could turn into a negative feedback loop that perpetuates itself beyond investor imagination or risk tolerance. 

Sounds scary, doesn’t it? Well, it doesn’t have to be. Bierman believes the selling and downward spiral won’t begin until “the machines (the algorithms) walk the market lower,” effectively triggering the herd’s stampede for the hills, and, not coincidentally, prompting a belated rediscovery of research and fundamentals among the chastened. 

Despite the furtive approach of inevitable doom, Bierman offers another bit of paradoxical advice: Don’t short the market before it begins its reverse. For now, the market is set on going higher because that’s what the algorithms are telling it to do. 

For his part, Bierman says he’s taking gains where he perceives peak valuations on his long positions. This seems sage advice. It’s better to take gains, even if you might think in retrospect that you took some of them too soon, than to hold on until the water flume is in full-fledged, blood-curdling descent. 

Bierman says the current market mentality is that of a “Seinfeld market,” where nothing matters except the current narrative or meme. 

Greed has got the whip hand, and fear is on vacation. At some point, though, fear will be back. As in a well-crafted suspense film, we know fear is out there somewhere; we just don’t know when it will strike from the shadows.