Stock Market Warning Signs That I’m Trying to Ignore, From AI Polyamory to a Meme Fund Rebirth

The Roundhill Meme Stock ETF is back, now with non-memey names such as Rigetti Computing. Here, its Ankaa-3 quantum computer system. (Drew Bird Photography)

Stocks, gold, and crypto are hitting record highs, and portfolio balances are fat. What could go wrong? Don’t answer that. Let’s just agree to ignore the following warning signs for investors, because bull markets are fun, and calling the top is hard.

Of course, the S&P 500 index looks expensive at 25 times earnings, but there is little historical correlation between current valuations and short-term returns, which is another way of saying that high prices don’t mean that prices won’t go much higher. Raising some extra cash now can reduce the risk of a sudden downturn, but increase the risk that your fully invested neighbor does better than you because you sold too soon. The statistical term for that is Stanley deviation, if you happen to live next door to the Stanleys. I’m pretty sure it’s a driving force of late-stage upswings.

So let’s quickly run through some cherry-picked warning signs before ignoring them and sticking with our carefully planned allocations.

AI’s Open Relationships

If there’s a Wall Street award for the chart that most evokes a game of naked Twister but for artificial-intelligence companies, Morgan Stanley is a lock this year. In a recent report, it attempted to map the industry’s circular financial relationships. The result is jarring and off-putting to look at, even if the participants seem to be having fun.

In March in this space, I highlighted the strange case of CoreWeave, which turned from crypto mining to deploying Nvidia AI chips in data centers, while counting Nvidia as a key investor. Last month, Nvidia agreed to make a massive investment in ChatGPT creator OpenAI to help it build out its computing infrastructure. This past week, OpenAI signed a partnership with Nvidia rival Advanced Micro Devices. Oracle provides services to OpenAI and buys from Nvidia using vendor financing, like CoreWeave.

Morgan Stanley argues that more disclosure would be helpfu l to investors, and points to a measure of future contracted revenue called remaining performance obligations, or RPOs. OpenAI accounts for about two-thirds of RPOs at Oracle and 40% at CoreWeave, meaning both depend on OpenAI’s success. It also says that, across the industry, “new innovative finance structures and off-balance-sheet partnerships” are making it “challenging to evaluate the risks.” AI companies recently accounted for pretty much all of the S&P 500’s rise since the public launch of ChatGPT in late 2022, meaning that ordinary index fund investors have plenty of exposure to the group’s polyamory.

Refried Memes

Remember the GameStop hoopla? Heavily shorted shares of a company in the fading business of selling videogames on disc suddenly soared, largely because stock flippers that look for ideas in a Reddit chat room called WallStreetBets decided that would be funny. Other unlikely stocks jumped around the same time—a struggling movie theater chain; a company with Zoom in the name, but not the one you’re thinking of; a holding company for assets of the old Blockbuster Video; and so on. In December 2021, there was an exchange-traded fund that launched called Roundhill Meme Stock. In a turn of events that no one saw coming, except for everyone, who definitely saw it coming, the fund turned sharply lower starting pretty much immediately. It closed after less than two years. Now it’s back.

If this is a harbinger, it’s a tricky one. The original fund used short-selling activity and online chatter as gauges of meme status. The new one uses an active stockpicker. Its top holdings include companies in quantum computing, fuel cells, crypto, artificial intelligence, and rare-earth metals. Many of these are recent highfliers with distant visions of profits. For example, the top holding, Rigetti Computing, develops semiconductors for quantum computing, does less in revenue than a well-located liquor store, isn’t expected to turn a profit this decade, and is up more than 6,000% in a year.

These would be excellent candidates for a momentum fund, or a venture fund trying to sort spicy growers from pipe dreams. But they lack the only characteristic that is essential for a meme stock: a punchline. If you knowingly buy the wrong Zoom stock and convince others to do likewise, maybe you’re not exactly being funny, but on some level, you’re trying. If you run up quantum computing stocks years ahead of the profits, you’re being sincere about either the business prospects or the trading momentum. If a once-fallen meme fund returns without meme stocks, is it still a warning sign? Then again, if a company that relaunches a meme fund doesn’t seem to understand what a meme is, is that a meme of its own? I’m not sure where that leaves us.

Racing Convertibles

The S&P 500 is up a frisky 15% so far this year. That’s nothing compared with Bitcoin, up 30%, and gold, more than 50%. There is rising talk of a debasement trade, where investors, worried that the mounting federal debt is reaching escape velocity, or that the Federal Reserve will lower interest rates to a point that spurs more inflation, are looking to park funds in assets that are disassociated with the dollar. What is unusual is that convertible bonds are beating the stock market, too. The iShares Convertible Bond ETF has returned around 23% year to date.

Stocks and corporate bonds are born when companies wish to raise funds, and are willing to give up either part ownership or interest to do so. Convertible bonds pay interest and offer stock upside, although usually not as much as common stocks. Issuers are often risky, but today look more out-there than usual. The top holding in the iShares fund is Strategy, whose business model is to raise funds to hoard Bitcoin. Crypto, fuel cells, and AI cash burners are well-represented.

The fact that convertible bonds are paying off doesn’t mean that a neglected pocket of the fixed-income market is getting its due from value buyers. It means that risky stocks are going nuts. A warning sign? Don’t ask me. I’ve already started ignoring it.

Write to Jack Hough at jack.hough@barrons.com. Follow him on X and subscribe to his Barron’s Streetwise podcast.