Investor Euphoria

&
The Anatomy of a Market Crash

September 9, 2025

Produced by:
Santiago Capital

Authored by:
Brent Johnson
Michael Peregrine
Table of Contents

Executive Summary ____________________________________________________________________ page 2

Background ___________________________________________________________________________ page 4

Case Studies in Euphoria _______________________________________________________________ page 9

Lessons for Investors: A Deeper Examination ____________________________________________ page 16

A New Factor: Passive Management ____________________________________________________ page 21

Parallels in Today’s AI Boom ___________________________________________________________ page 26

Why it Matters NOW _________________________________________________________________ page 31

Conclusion __________________________________________________________________________ page 38

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Executive Summary

Markets move in cycles of innovation and speculation, and the present surge in artificial intelligence
is no exception.

Today’s AI boom displays nearly all the features that have defined past bubbles—soaring valuations,
concentrated flows of capital, euphoric investor sentiment, and media narratives that reinforce
expectations of unstoppable growth. By most measures, the parallels extend beyond resemblance: the
speculative fervor around AI rivals and in many ways exceeds the South Sea Bubble, the 1840s railway
mania, the 1920s boom, the dot-com era, and the subprime mortgage frenzy.

At the center of the storm lies a combustible mix of genuine technological promise, abundant liquidity,
and human psychology. Investors see the potential for world-changing transformation, credit remains
accessible enough to fuel risk-taking, and fear of missing out drives behavior to extremes.

The result is an environment where both startups and established firms are valued as though flawless
execution, relentless hypergrowth, and immediate mass adoption were inevitable.

Such assumptions are unsustainable.

Every historical bubble has revealed the danger of expectations drifting too far from reality. In the late
1990s, the mantra was that profits no longer mattered; today, many AI firms are projecting revenues
and margins based on unproven scenarios.

When the gap between projections and actual results grows wide, the risks compound. Financial
losses are the most visible outcome, but history shows that misconduct often follows. From the
railway booms of the 19th century to Enron, WorldCom, and the more recent mortgage excesses,
periods of extreme optimism have created fertile ground for creative accounting, misrepresentation,
and fraud.

The warning signs are well known.

Extreme valuations relative to tangible earnings, heavy concentration of capital in a handful of

celebrated winners, and the easy availability of venture funding or leverage all raise systemic risk. The
proliferation of complex financial products magnifies fragility, turning small disruptions into cascading
stress events.

And as always, the insistence that “this time is different” echoes loudly in the background,
emboldening herd behavior while discouraging sober analysis.

When both retail and institutional investors chase momentum trades rather than fundamentals, the
system edges closer to its breaking point.

History also offers a guide to navigating these environments.

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Investors who wish to participate in innovation without being consumed by its excesses must apply a
disciplined, historically informed framework. This means challenging assumptions behind valuations,
scrutinizing profit projections, monitoring leverage and liquidity conditions, and examining whether
business models are robust enough to withstand shocks.

It also means cultivating behavioral awareness—recognizing that FOMO, herd instincts, and narrative
intoxication can overwhelm even the most seasoned decision-makers.

Perhaps most critically, vigilance against aggressive accounting or unrealistic guidance is essential,
since the incentives for embellishment grow strongest in speculative peaks.

This study is not written from a position of permanent pessimism. It is a general exploration of the
anatomy of market crashes, designed to provide a framework for understanding why speculative
cycles form and how they unwind.

At the same time, it is timely. The conditions we observe today suggest that a sharp correction is not
a distant possibility but a near-term risk.

And our goal is not to preach fear.

Rather, it is to help prepare readers for the rogue waves that history tells us appear just when the
waters seem calmest. We believe extraordinary opportunities will emerge once excesses are flushed
from the system, but to capture them, investors must first survive the volatility that lies ahead.

The sections that follow build upon this foundation, beginning with the AI boom itself. As the most
vivid present-day example of innovation colliding with speculation, it provides a live case study of
how opportunity and risk entwine, setting the stage for both painful collapse and enduring renewal.

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Background

Financial markets have always swung between fear & greed, moments of stability & episodes of mania.

Crashes are rarely a product of truly unforeseen shocks; more often, they are the inevitable outcome
of long stretches of investor euphoria. These euphoric phases are characterized by an intoxicating
mix of extreme optimism, soaring valuations, the easy availability of credit, and the conviction that
some new technological or economic paradigm justifies abandoning the lessons of history.

In hindsight, signals of excess usually appear glaring. But in the moment, investors, institutions, and
even regulators are lulled by persuasive narratives and the apparent reliability of ever-rising prices.

This paper examines the anatomy of such euphoric cycles. It explores the conditions that allow
optimism to grow unchecked, the signals that can be seen in real time, the distortions that only reveal
themselves after collapse, and the enduring lessons investors can carry forward.

Historical examples ranging from tulip mania to the dot-com boom to the SPAC frenzy of 2021, paired
with data on valuations, leverage, IPOs, and liquidity, provide the lens through which we analyze how
manias build, why they unravel, and how disciplined investors can prepare for their aftermath.

Conditions That Breed Euphoria

Euphoria tends to be powered by three main elements:

1. Inflated valuations.

2. Abundant credit.

3. And a compelling narrative of progress.

Valuation is the most immediate signal. Robert Shiller’s CAPE ratio offers a century-long view of how
earnings multiples expand during speculative eras.

In 1929, CAPE rose above 32 before collapsing to 5 in the depths of the Depression. In 2000, at the
height of the dot-com bubble, it touched 44—a record that stood until today’s era, when CAPE once
again surged into the high-30s.

Each peak was followed by years, even decades, of muted returns.

Elevated valuations may not trigger an instant collapse, but they reliably compress long-run forward
returns, leaving markets vulnerable to sudden shifts in sentiment.

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Credit availability provides the second engine.

Liquidity supplied by banks, shadow lenders, or central banks amplifies speculation. Margin debt offers
a stark illustration: it reached $278 billion in March 2000, $381 billion in July 2007, and $935 billion in
October 2021, before topping $1 trillion in the current cycle. Each surge coincided with a wave of risk-
taking; each retracement magnified losses as forced selling cascaded through the system.

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The third element is narrative.

Bubbles are rarely built on nothing; they are anchored in genuine shifts. Railroads in the nineteenth
century, electrification and automobiles in the early twentieth, the internet in the 1990s, and AI and
cryptocurrencies in the 2020s all provided credible visions of boundless growth. Yet markets
consistently priced these innovations with unrealistic speed and scale.

The phrase “this time is different” echoes across every euphoric episode, deployed to rationalize
valuations and leverage levels that in calmer times would be dismissed as reckless.

Signals Visible in Real Time

Even at the height of mania, warning signs are visible to those willing to look.

Retail investor surges are a common marker. The 1920s saw households speculating in bucket shops
with leveraged stock bets. The 1990s featured day traders armed with online brokerages and chat-
room tips. In the 2020s, commission-free apps fueled meme-stock frenzies as millions piled into
GameStop, AMC, and other speculative trades.

When investing turns into cultural entertainment, markets are already deep in the euphoric phase.

Issuance is another signal.

Nearly 500 IPOs flooded markets in 1999, many from unprofitable firms. In 2021, more than 1,000
listings, dominated by SPACs, eclipsed even that surge. Such waves demonstrate not only investor
appetite but also opportunism by issuers exploiting inflated valuations.

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Price patterns often provide confirmation. Parabolic moves—where prices accelerate beyond
sustainability—are the classic tell. The NASDAQ between 1998 and 2000, Bitcoin in 2017 and 2021,
and certain AI stocks in 2023–2025 all displayed this behavior. Media coverage follows suit, shifting
to unrelenting positivity, with stories of overnight millionaires and celebrity endorsements reinforcing
the frenzy.

Speculative mania reaches full bloom once it enters the mainstream cultural consciousness.

Liquidity measures add further evidence.

In 2020, U.S. M2 money supply expanded nearly 25% year-on-year—the fastest pace since World War
II—fueled by stimulus checks, ultra-low rates, and massive asset purchases. That surge powered
booms in equities, crypto, and collectibles. When M2 contracted in 2022, risk assets fell sharply,
revealing how dependent euphoria is on the tide of liquidity.

Signals Clearer Only in Hindsight

Other distortions only emerge after collapse.

Cheap capital enables malinvestment: dot-com firms burning through cash on marketing in the late
1990s, SPAC startups of 2020–2021 collapsing once easy funding evaporated. Hidden leverage is

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another revelation. In 2008, mortgage-backed securities and CDOs concealed systemic exposures; in
2022, crypto lenders failed for similar reasons.

Narratives, too, undergo a dramatic pivot.

During booms, the focus is boundless growth. After crashes, scrutiny shifts to governance, unit
economics, and sustainability. The shift from “how big can this get?” to “can this survive?” is the
hallmark of reversal.

Accounting misrepresentation is another thread.

Enron remains the archetype: vendor financing, premature revenue recognition, and other tricks
prolonged the illusion, until collapse became unavoidable. When Enron fell, it dragged down Arthur
Andersen, one of the world’s most prestigious accounting firms, underscoring how far the damage
can spread.

Behavioral Dynamics

Beneath these financial patterns lie recurring psychological forces.

Herding compels investors to follow the crowd, reinforcing momentum. Overconfidence convinces
traders they will exit before the downturn, even as exposure builds. Narrative bias gives stories of
transformation primacy over sober analysis. Risk perception erodes as practices once considered
reckless become normalized.

This cycle of behavior repeats with uncanny consistency.

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Case Studies in Euphoria

Speculative manias arise when optimism, innovation, and sudden wealth converge to fire the
collective imagination — and when easy credit provides the means for everyone to participate.

Each instance has its own cultural markers: tulips in 17th-century Holland, the South Sea schemes in
Enlightenment England, radio and automobiles in 1920s America, internet startups at the turn of the
millennium, securitized mortgages in the 2000s, and meme stocks during the pandemic era.

Beneath these surface differences lies a common emotional cycle: excitement, enthusiasm, greed,
and, eventually, panic.

Tulip Mania (1637)

The Tulip Mania of 1637 is often remembered as the first great financial bubble.

It was never simply about a flower. In the Dutch Golden Age, Amsterdam had become the center of
world trade, and merchants, craftsmen, and artisans were enriched by global commerce. Tulips, newly
imported from the Ottoman Empire, were prized as luxury goods, their vivid colors and striking
patterns caused by mosaic viruses.

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To own rare bulbs was to signal both taste and social standing.

Demand soon transformed tulips from status symbols into speculative assets. What made the episode
remarkable was how deeply it penetrated Dutch society. Farmers, artisans, and small merchants
speculated, often through futures contracts that allowed wagers on bulbs never actually exchanged.

At the peak, a single bulb could trade for more than ten times the annual wage of a skilled worker,
with anecdotes of prices rivaling canal-side mansions.

When an ordinary auction failed to draw expected bids, confidence evaporated almost instantly. Prices
collapsed, contracts went worthless, and while the Dutch economy absorbed the shock, the episode
left an enduring lesson: when prestige and speculation merge, markets can detach from reality.

South Sea Bubble (1720)

The South Sea Bubble of 1720 followed a similar trajectory but with greater institutional weight.

Early-eighteenth-century England was encumbered with war debts, and the South Sea Company
proposed an elegant solution: it would assume the national debt in exchange for shares and monopoly
rights to trade with Spanish South America. Promoted by politicians and endorsed as virtually risk-
free, the scheme sent shares soaring.

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Investors ranged from the aristocracy to common citizens, with even the royal family participating.
The age of Enlightenment optimism encouraged faith in boundless opportunities, and opportunists
launched dozens of copycat ventures — some laughably vague, such as “a company for carrying out
an undertaking of great advantage, but nobody to know what it is.”

When it became clear that South Sea’s trading prospects were illusory and its debt-conversion model
untenable, the bubble collapsed.

Families lost fortunes, public fury mounted, and Parliament was forced to investigate.

The lesson was broader than speculation: it underscored the dangerous interplay between state
endorsement, finance, and public trust, a formative moment in British financial history.

1929 Crash

The Wall Street Crash of 1929 captured the euphoric mix of technological innovation, cultural
exuberance, and financial leverage.

The 1920s were transformative: automobiles expanded mobility, radios connected homes, and electric
appliances revolutionized daily life. Jazz, cinema, and the cultural energy of the decade reinforced the
sense that a new era of prosperity was permanent. Corporate profits rose, stock ownership
broadened, and margin loans enabled investors to buy shares with borrowed funds.

Newspapers and radio personalities celebrated the market as a one-way ticket to riches.

By 1929, valuations were stretched to extremes, but the cultural conviction in progress drowned out
skepticism. When the downturn came, margin calls cascaded into panic selling. The crash marked the
abrupt end of the Roaring Twenties, shattering faith in markets and ushering in the hardship of the
Great Depression.

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Dot-com Bubble (1999–2000)

The dot-com bubble of the late 1990s and early 2000s provides one of the clearest modern parallels.

The internet represented a genuine technological revolution, but as in earlier eras, it was
mythologized as the foundation of a “new economy” where old valuation rules no longer applied.
Startups became cultural icons, showered with venture capital and ushered to market through a flood
of IPOs.

Retail investors, empowered by online brokerages, joined the rush. Cultural artifacts of the time
included Super Bowl ads from unprofitable firms and magazine covers proclaiming the death of brick-
and-mortar business. Analysts argued that “eyeballs” and “clicks” mattered more than profits.

The Shiller CAPE ratio surged to 44, a historic extreme. When the bubble burst, the NASDAQ lost
nearly 80% of its value over two years, erasing fortunes and careers. Yet, as in 1929, the underlying
innovations endured: Amazon, Google, and eBay eventually thrived, just as autos and radios had
before them.

The lesson was not that innovation lacked value but that speculation accelerates expectations far
beyond what reality can deliver.

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Global Financial Crisis (2008)

The Global Financial Crisis of 2008 extended the pattern of euphoria into credit markets.

Unlike the dot-com boom, this was not a mania of households buying internet stocks but of
institutions building towers of leverage on the foundation of housing. The cultural backdrop was belief
in homeownership as the cornerstone of the American dream, coupled with faith that housing prices
never declined nationwide.

Banks extended credit to increasingly unqualified borrowers.

Wall Street packaged mortgages into securities and collateralized debt obligations, which rating
agencies blessed with investment-grade status. Yield-hungry institutional investors bought them
eagerly.

When home prices began to slip in 2006 and 2007, the illusion collapsed.

Bear Stearns, Lehman Brothers, and other giants fell, credit markets froze, and the crisis cascaded into
the worst global recession since the 1930s. The central narrative of stability and safety gave way to
systemic fragility and mistrust.

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SPAC and Meme-Stock Boom (2020–2021)

The SPAC and meme-stock boom of 2020–2021 showed how quickly euphoria adapts to new
environments.

The COVID-19 pandemic initially sparked panic, but unprecedented monetary and fiscal stimulus soon
reversed the collapse. With near-zero rates, trillions in government transfers, and record household
savings, retail investors found themselves with capital to deploy.

Platforms such as Robinhood made trading free and gamified, while online communities on Reddit
and Twitter forged a culture of collective speculation. Meme stocks like GameStop and AMC became
cultural symbols, celebrated less for fundamentals than as vehicles of rebellion against Wall Street. At
the same time, SPACs multiplied, providing fast-track listings for untested firms.

In 2021 alone, more than 600 SPACs raised capital, reflecting both investor enthusiasm and a cultural
belief in disruption. By 2022, tightening monetary policy and inflation punctured the boom.

Meme stocks, SPACs, and even cryptocurrencies collapsed, leaving behind another lesson: liquidity,
psychology, and culture can generate illusions of permanence that dissolve almost overnight.

Taken together, these various episodes show how societies repeatedly convince themselves they
stand on the edge of transformation — whether through flowers, global trade, industry, technology,
or digital platforms.

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Credit expansion, cultural narrative, and mass participation provide the fuel.

Collapse brings destruction, reform, and reflection, but also resilience.

In nearly every case, the innovation at the core of the bubble — tulips aside — survived the washout.

What is left behind is both a cautionary tale and a foundation for the future.

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Lessons for Investors: A Deeper Examination

The long history of euphoric manias delivers a consistent set of lessons for investors willing to look
past short-term gains and focus on capital preservation across cycles.

These lessons are not abstract principles; they are grounded in centuries of repeated patterns, from
tulip speculation in the seventeenth century to cryptocurrencies and meme stocks in the twenty-first.

By studying these recurring dynamics, investors can assemble a practical framework that functions
both as a warning system and as a guide to disciplined decision-making.

Valuation Discipline Matters

The clearest signal of speculative excess is valuation. When price-to-earnings multiples, Shiller’s
CAPE, or household allocations to equities reach historic extremes, investors are paying extraordinary
premiums for the promise of future returns. History consistently shows that such moments rarely end
well.

In the late 1920s, industrial stock valuations climbed far beyond historical norms. In the late 1990s, the
CAPE ratio hit 44 — the highest level in U.S. history. At such points, forward returns shrink dramatically,
while the probability of painful drawdowns rises.

Valuations cannot pinpoint exact timing — markets can defy gravity for years — but they do set the
boundaries for what is possible. Trees do not grow to the sky, and markets cannot sustain ever-rising
multiples indefinitely. Sensitivity to valuation signals allows investors to temper expectations and
avoid the illusion of permanence in exponential price gains.

Leverage Amplifies Fragility

If valuation highlights when conditions are stretched, leverage determines the violence of the
outcome. Borrowed money magnifies both profits and losses, turning what could have been orderly
corrections into cascading crises.

In the 1920s, widespread use of margin loans allowed investors to control vast positions with minimal
equity. Once prices declined, margin calls forced liquidations, accelerating the collapse into 1929. In
2008, the fuel came from mortgage credit. Households, banks, and institutions layered debt on weak
foundations, while mortgage-backed securities and collateralized debt obligations spread exposure
throughout the system. When housing prices slipped, leverage detonated across balance sheets,
threatening the global banking system itself.

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Even more recently, Archegos Capital’s 2021 implosion demonstrated how hidden leverage can
destabilize markets. By using total return swaps, Archegos built opaque, highly concentrated positions,
invisible to regulators and counterparties until the collapse.

The lesson is clear: margin debt, credit growth, and leverage ratios must be monitored at both micro
and systemic levels. Leverage acts as a force multiplier — accelerating gains in good times but
ensuring that downturns are sharper and more destructive.

Innovation and Speculation Must Be Separated

Bubbles often coincide with genuine innovation.

The South Sea Bubble was linked to the promise of global trade. The 1920s boom unfolded as radios,
automobiles, and electrification reshaped life. The internet in the 1990s, railways in the 1840s, fiber
optics in the 1990s, cryptocurrencies and artificial intelligence more recently — all represented
transformative technologies.

But markets repeatedly confuse innovation with guaranteed investment success.

In the late 1990s, internet startups with no profit path commanded multibillion-dollar valuations. In
the 1840s, railway shares soared, only for overcapacity and deception to ruin investors. In both cases,
the infrastructure built in the frenzy — rail lines and digital networks — survived and ultimately
powered decades of growth.

The paradox is clear: innovation endures, but speculation distorts.

The winners of tomorrow often emerge only after the mania subsides, while those who bought at
euphoric peaks are left with losses.

The lesson is patience.

Investors must disentangle hype from durability, recognizing that the real societal benefits of
innovation take longer to materialize than markets are willing to wait. Recency bias and envy push
people to chase returns, but disciplined separation of promise from price is vital.

Behavioral Awareness Is Crucial

Charlie Munger often stressed that investors must rewire their instincts, moving from emotion-driven
reactions toward patience and rationality. Valuation and leverage matter, but without awareness of
psychology, investors remain vulnerable.

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Biases such as fear of missing out, herd mentality, and overconfidence repeatedly drive markets away
from fundamentals. The dot-com boom popularized the phrase “profits don’t matter.” The U.S. housing
bubble rested on the belief that home prices could not fall nationwide. The meme-stock phenomenon
of 2020–21 was built on the conviction that retail investors could consistently outsmart Wall Street.

In each case, narratives overrode analysis until collapse exposed the weakness.

Effective investors counter this with humility and structure. They develop contrarian discipline —
resisting mania when optimism is extreme and preparing to act when despair dominates. They set
predefined limits, diversify, and create systems to prevent emotional decisions.

Behavioral awareness is not only defensive; it is an offensive advantage. By ignoring the top and
bottom 20% of market extremes, as J.P. Morgan once suggested, investors can focus on the middle
60% where rational opportunity lies.

Recognizing and countering bias provides a durable edge in markets that thrive on psychological
distortion.

Liquidity Regimes Drive Cycles

Liquidity is the invisible hand behind market booms and busts.

Easy money, low rates, abundant credit and quantitative easing inflates asset prices by encouraging
risk-taking. Tight money reverses the process, triggering forced liquidations and sudden corrections.

In the late 1920s, loose credit fueled stock speculation until the Federal Reserve tightened in 1928–
29, drying liquidity and triggering collapse. In the 2000s, lax lending and low rates powered housing
and credit bubbles until rising defaults and tighter policy exposed systemic fragility.

Warren Buffett’s comparison is apt: liquidity is like oxygen — unnoticed when abundant, but the only
thing that matters when it disappears.

The “Greenspan Put” introduced in 1987 added a new dimension: the perception that central banks
would always intervene to cushion declines. This moral hazard encouraged risk-taking, contributing
to the dot-com bubble and the housing surge. Pandemic-era liquidity showed the same dynamic:
extraordinary injections in 2020–21 inflated assets across technology, crypto, and more.

When inflation rose, aggressive tightening in 2022 punctured the boom.

For investors, monitoring liquidity is indispensable. Money supply growth, credit spreads, real rates,
and central bank communication provide leading indicators of risk. Liquidity regimes dictate when
optimism thrives and when corrections become unavoidable.

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Signs of Accounting Malfeasance

Every mania breeds fraud. When capital is abundant and skepticism fades, deception becomes
systemic.

Fraud is not an accident of booms. It is a feature.

• The South Sea Company exaggerated privileges to keep enthusiasm alive, while opportunists
launched meaningless ventures.

• The railway mania of the 1840s was riddled with inflated projections and false accounts.

• In the 1920s, investment trusts pyramided assets to give the illusion of growth.

• Enron and WorldCom in the late 1990s epitomized how innovation hype and accounting abuse
intertwine. Enron booked imaginary profits as current income and hid debt in special entities.

• WorldCom capitalized billions in routine expenses to fake earnings.

• The Global Financial Crisis repeated the cycle at scale: falsified income data, misrated
securities, off-balance-sheet structures, and hidden risks flourished until housing cracked.

• More recently, Wirecard fabricated €1.9 billion in cash.

• FTX siphoned customer funds behind a façade of transparency.

• Nikola rolled a truck down a hill to feign functionality.

• Theranos deceived patients and investors alike with false promises.

The forms repeat: balance-sheet manipulation, fabricated revenues, hidden liabilities, exaggerated
projections, outright lies, and enabling failures by auditors, regulators, and rating agencies.

Each time, fraud magnifies losses and undermines trust in markets themselves.

Investors must assume fraud is present during manias and protect themselves through skepticism,
forensic scrutiny, and resistance to narratives that discourage doubt.

Synthesis: A Framework for Discipline

Individually, the lessons of valuation, leverage, innovation, psychology, liquidity, and fraud each matter.

Taken together, they form a durable framework for disciplined investing.

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Valuations provide the compass, signaling stretched expectations. Leverage shows where fragility is
greatest. Innovation highlights promise but warns against conflation with price. Psychology explains
why markets swing too far in both directions. Liquidity defines the fuel for cycles, while fraud
represents the inevitable shadow of exuberance.

Integrating these insights allows investors to build an internal early-warning system.

This framework does not call for completely avoiding risk — bubbles are unpredictable, and
participating in innovation is necessary for growth.

Instead, it advocates discipline: scaling back when valuations and leverage run hot, questioning
optimistic narratives, monitoring liquidity, and remaining alert for fraud.

History confirms the need for this.

From the South Sea scheme to dot-com excess, from the housing crash to today’s AI and digital assets,
the same drivers repeat. Technology and markets evolve, but fear, greed, and herd instinct remain
constant. By internalizing these lessons, investors gain the ability to avoid the traps of euphoria while
positioning themselves for opportunity in the aftermath.

Patience, adaptability, and contrarian thinking are the final ingredients. Markets are cyclical, often
irrational, and punctuated by excess.

A framework rooted in history and reinforced by discipline provides not only protection in turbulence
but also the resilience to exploit recovery. Investors who embrace this mindset transform the volatility
of cycles from a threat into a platform for long-term wealth.

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A New Factor: Passive Management

While history teaches that valuations, leverage, liquidity, innovation, psychology, and fraud have
consistently driven euphoric cycles, the modern era has introduced a structural force with no true
historical precedent: the explosive rise of passive investment strategies.

Unlike the dynamics of tulips, railways, dot-coms, or subprime mortgages, the dominance of index
funds and exchange-traded funds (ETFs) has the potential to fundamentally reshape the anatomy of
future market crashes.

Passive management, by design, does not discriminate.

Capital flows into broad indices are allocated according to market capitalization weightings rather than
judgments about valuation, quality, or sustainability. As trillions of dollars have shifted from active
stock picking into index funds, a new feedback loop has emerged: the largest companies in the index
receive the largest inflows, pushing their prices higher, which further increases their index weightings,
attracting still more inflows.

This reflexive mechanism has created a structural bias toward concentration in a handful of mega-cap
firms.

And the sheer scale of passive flows is unprecedented.

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In the 1980s, passive strategies represented a negligible share of market activity.

By the mid-1990s, they had gained modest traction. Today, however, more than 50% of U.S. equity
fund assets are managed passively, with ETFs alone holding trillions of dollars. Some estimates
suggest that in key index-linked sectors, daily trading is dominated by passive vehicles. This structural
shift raises critical questions about how markets will behave in times of stress.

One consequence is reduced price discovery.

Historically, active managers competed to evaluate earnings, balance sheets, and cash flows,
rewarding efficient companies and punishing weak ones. In a market dominated by passive flows,
however, this process is muted.

Capital allocation is driven not by analysis of fundamentals but by inclusion in an index. Weak
companies can be buoyed simply by being part of a benchmark, while strong companies can become
disproportionately inflated as passive flows chase size rather than value.

This distortion may exacerbate the build-up of fragility during euphoric phases.

The real danger emerges during periods of reversal. Our friend Mike Green has highlighted this
repeatedly.

Passive funds are structured to provide liquidity on demand — investors can redeem ETF shares at
any moment — but the underlying assets may not be nearly as liquid. In calm markets, this mismatch
is hidden.

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In stressed markets, however, redemptions from passive vehicles could trigger indiscriminate selling
across entire sectors or asset classes. Unlike active managers, who might at least stagger sales or
attempt selective liquidations, passive structures can unload large baskets of securities all at once,
amplifying downward momentum.

And consider the implications of concentration.

The largest stocks in the S&P 500 — the so-called “Magnificent Seven” in the 2020s — dominate index
weightings. If investors exit broad passive funds during a correction, these companies could face
massive simultaneous selling pressure, not because of their fundamentals, but simply because of their
size within benchmarks.

In effect, passive flows could transform market leaders into accelerants of broader downturns. The
very stocks that stabilized portfolios in the past could become engines of volatility in the future.

Passive strategies may also reinforce herd behavior.

When investors pile into index funds during booms, they all own the same set of securities. When
sentiment turns, they also exit together.

This synchronized behavior risks turning what might have been localized corrections into systemic
events. In earlier eras, diversity of investor strategies and time horizons provided some stabilizing
forces. Today, homogeneity of flows could strip that resilience away.

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Another layer of risk lies in the rise of leveraged and thematic ETFs.

These vehicles provide investors with exposure to narrow slices of the market — from clean energy
to artificial intelligence — often using derivatives to amplify returns. While marketed as efficient tools
for gaining targeted exposure, they also represent points of structural fragility. In a selloff, derivative
unwinds and concentrated exposures could compound volatility, creating feedback loops that extend
far beyond the niche sectors they track.

Skeptics argue that passive funds are simply a wrapper — that they hold the same underlying securities
as active managers, and therefore cannot fundamentally change market dynamics.

Yet this view underestimates how flows and incentives matter. Active managers can choose to
withhold capital, avoid overpriced assets, or shift exposure to safer securities. Passive vehicles cannot.
Their rigidity is their defining characteristic, and in moments of stress, rigidity can be dangerous.

The rise of passive management does not invalidate the timeless drivers of bubbles. Valuations will
still stretch, leverage will still accumulate, liquidity will still dictate cycles, and fraud will still emerge.

What has changed is the market plumbing.

With passive funds holding such a dominant share of assets, the mechanics of how capital enters and
exits markets could exacerbate both the ascent of bubbles and the violence of their collapse.

SEPTEMBER ‘25 SANTIAGO CAPITAL 24

For investors, the lesson is not to shun passive strategies altogether. They offer low-cost exposure,
broad diversification, and long-term benefits.

Rather, it is to understand the systemic risks embedded in their scale. Monitoring flows into and out
of passive vehicles, recognizing the concentration risks in index-heavy names, and accounting for the
liquidity mismatch between ETFs and their underlying assets will be critical in anticipating how future
selloffs might unfold.

In sum, passive investing introduces a structural factor that did not exist in the bubbles of the past.

And this has changed the very architecture of markets.

While history teaches that every mania ends the same way — optimism undone by leverage, liquidity,
and psychology — the next crash may be distinguished by the role of passive flows. The scale of their
impact remains untested in a full-blown crisis.

What is clear is that passive management, for all its efficiency, has created new vulnerabilities that
could make future downturns sharper, faster, and more synchronized than those of the past.

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Parallels in Today’s AI Boom

The rapid ascent of artificial intelligence has ignited investor enthusiasm at levels not seen since the
dot-com boom of the late 1990s.

Capital is pouring into AI and technology companies, many of which are commanding valuations
untethered from traditional measures of profitability or cash flow.

The story of transformative potential has overshadowed financial scrutiny, while enormous sums
chase the belief that AI will reshape entire industries overnight. The fingerprints of past bubbles are
visible once more: stretched valuations, abundant credit, seductive narratives, questionable
accounting practices, and now, the added force of passive market structures.

Valuations and Credit Conditions

Valuations across AI-linked companies reflect near-perfect assumptions of adoption, profitability, and
execution.

Just as internet companies in the late 1990s were priced on “eyeballs” and “clicks” rather than profits,
today’s AI stocks are often valued on projections of total industry domination. Private market

SEPTEMBER ‘25 SANTIAGO CAPITAL 26

valuations echo the same exuberance, with billions of dollars raised at multiples detached from
fundamentals.

These prices are being sustained not only by optimism but by abundant liquidity. Venture capital,
corporate debt markets, and global pools of capital have made financing extraordinarily easy, allowing
both startups and incumbents to extend themselves aggressively.

The role of credit in amplifying fragility remains as central as it was in 1929, 2000, or 2008.

Narratives as Accelerants

Every historical mania has been accompanied by a grand story of transformation.

Railroads promised to knit entire nations together; the South Sea Company promised riches from
trade; dot-coms promised to rewrite the rules of business. AI now wears the crown of inevitability: a
technology so powerful it will change commerce, logistics, healthcare, finance, and even national
security.

This narrative has been amplified by media coverage, corporate leaders, and investors eager not to be
left behind. Skepticism is cast as blindness to the future, while the phrase “this time is different” is
implied even when unsaid.

SEPTEMBER ‘25 27
Questionable Accounting Practices in AI and Technology

History warns that when valuations detach from reality, accounting practices often follow.

To sustain growth stories, companies adopt aggressive financial strategies that stretch standards and
erode transparency. Today’s AI and technology firms are no exception. Several patterns stand out:

1. Aggressive Revenue Recognition – Booking revenues on long-term or contingent contracts

that may never materialize.

2. Capitalization of Expenses – Shifting vast R&D and infrastructure costs to the balance sheet,
inflating short-term profitability.

3. Stock-Based Compensation Distortions – Treating equity grants as immaterial while

excluding them from adjusted earnings.

4. Non-GAAP Metrics Abuse – Stripping out recurring costs under the guise of “one-time”
adjustments.

5. Channel Stuffing and Partnership Inflation – Recording revenues from related-party deals or
unsustainable arrangements.

These tactics may not always amount to outright fraud, but they create a distorted picture of financial
health. They also generate pressure on competitors to adopt similar practices, spreading fragility
across the sector.

The historical parallels are unmistakable: dot-com “pro forma” earnings, Enron’s off-balance-sheet
entities, WorldCom’s capitalization of expenses, and WeWork’s notorious “community-adjusted
EBITDA.” In every case, questionable accounting both reflected and fueled the mania, until reality
forced a reckoning.

The Role of Passive Market Structures

As noted above, what makes the current cycle unique is the dominance of passive investing.

Index funds and ETFs now direct trillions of dollars into the largest companies simply because of their
weight in benchmarks, not because of fundamental strength.

This creates a reflexive loop: AI leaders receive outsized inflows, which boost their market caps, which
in turn attracts even more passive capital. The result is concentration risk and an automatic
reinforcement of the very valuations already stretched by optimism.

This rigidity becomes dangerous in reverse.

SEPTEMBER ‘25 SANTIAGO CAPITAL 28

When sentiment turns, redemptions from passive vehicles trigger indiscriminate selling across entire
indices. The largest firms, which benefited most from passive flows, can become engines of volatility
in downturns.

The mechanics of passive investing, absent in prior bubbles, may accelerate and synchronize future
selloffs in ways history has not yet tested.

Why These Dynamics Portend Crashes

The recurring pattern is clear.

Elevated valuations create fragility. Abundant credit amplifies risk. Narratives suspend disbelief.
Questionable accounting sustains illusions of profitability. Passive flows reinforce concentration.

And as long as optimism dominates, these conditions persist.

But when liquidity tightens, interest rates rise, or a high-profile scandal surfaces, the shift in sentiment
is sudden and unforgiving. Confidence erodes not just in one company but in an entire sector,
spreading contagion across markets.

History shows that unwinding these illusions is never gradual.

The collapse of Enron cast suspicion across the energy sector. Dot-com failures discredited
technology more broadly. The bursting of the housing bubble shook confidence in the entire financial
system. AI, now embedded at the core of market indices, could trigger a similar systemic shock if
accounting revelations, liquidity shifts, or valuation resets converge.

SEPTEMBER ‘25 29
Implications for Investors and Regulators

For investors, the lesson is vigilance.

Reported numbers must be interrogated, with close attention to cash flow, balance sheet integrity,
and reliance on non-GAAP adjustments. Narratives should be weighed against fundamentals, and
passive flows should be recognized as both a source of stability in booms and fragility in busts.

For regulators, the challenge is enforcing accounting discipline before markets force it.

Transparency in reporting and scrutiny of aggressive practices are essential to preserving confidence.

Summary

The AI boom is not unique in its psychology.

It follows the well-worn path of speculative manias: valuations stretched beyond reason, credit
flowing freely, narratives of limitless growth, and accounting practices that blur reality.

What is new is the structure of today’s markets, where passive investment magnifies concentration
and accelerates reversals. Together, these forces set the stage for fragility on a scale not yet tested.
History suggests that ignoring these signals does not end quietly.

The crash, when it comes, will follow the familiar anatomy.

Only this time with a new accelerant embedded in the system itself.

SEPTEMBER ‘25 SANTIAGO CAPITAL 30

Why it Matters NOW

Momentum has been Lost

Momentum across the major indices and leading technology stocks has begun to break down, even
as prices appear resilient. This loss of internal strength in both the benchmarks and their largest
components is an early warning sign that the rally’s foundation is weakening.

This matters because the equity rally over the past year has rested on increasingly narrow leadership.

The Dow Jones, S&P 500, and Nasdaq all sit near cycle highs in price terms, but beneath the surface
the story is less reassuring. Relative strength indicators (RSI) for each index peaked more than a month
ago and have rolled over, while stochastic momentum has already begun to signal exhaustion.

This divergence, with momentum weakening while price grinds higher, is one of the classic markers
of a market running on fumes.

The fragility of the indices is further compounded by the visible deterioration in the market’s largest
components, the so-called “Magnificent Seven.”

Nvidia (NVDA) has already broken lower from its highs, with RSI plunging toward oversold territory.

Microsoft (MSFT), another cornerstone of both the S&P 500 and Nasdaq, shows a decisive loss of
momentum, with price slipping under its 50-day moving average and relative strength sliding.

SEPTEMBER ‘25 31
Tesla (TSLA) has been unable to reclaim its late-2024 highs, instead moving sideways with fading
momentum. Even Apple (AAPL), long a barometer for broader sentiment, is displaying signs of fatigue
despite its recent bounce. The RSI is elevated but rolling over, suggesting that price strength is not
being confirmed by internal conviction.

SEPTEMBER ‘25 SANTIAGO CAPITAL 32

Semiconductors, key beneficiaries of the AI boom, show a similar pattern: prices remain elevated, but
momentum has broken down.

When taken together, these patterns suggest that the broader indices are hanging on by a thread.

Prices remain at or near highs, but the leadership stocks that drove the gains are showing visible
cracks. Historically, when the generals fall, the army follows.

With indices heavily concentrated in these few names, the breakdown of momentum in MAG7 stocks
is not just a technical curiosity. It is a warning signal of potential systemic weakness across the market.

Passive Structures as an Amplifier of Risk

The vulnerability is magnified by today’s market structure. Passive strategies — index funds and ETFs
— dominate equity ownership to a degree unprecedented in history. By their construction, these
vehicles allocate capital according to market capitalization.

That means the largest names, particularly the MAG7, have received a disproportionate share of
inflows on the way up. Nvidia, Microsoft, Apple, and Tesla are not just individual companies; they are
the pillars upon which trillions in passive savings rest.

This structure works reflexively.

SEPTEMBER ‘25 33
As prices rose, passive inflows chased them higher, boosting valuations further and reinforcing their
dominance in benchmarks.

But the same mechanism operates in reverse. When momentum breaks down and investors redeem
from passive vehicles, those vehicles are forced to sell in proportion to index weight. Selling pressure
on Nvidia or Apple does not remain confined to those stocks; it cascades into the entire index,
dragging down every fund and portfolio tied to the benchmark.

What makes the present moment critical is the convergence of technical and structural fragility.

Momentum in the indices has already peaked, suggesting internal exhaustion. The MAG7 leaders are
breaking down one by one, with NVDA and MSFT showing sharp momentum deterioration.

Passive allocation means that weakness in these names will not be isolated. It will propagate through
the entire system. In effect, the market has built a reflexive loop in which selling begets more selling,
not because fundamentals have changed, but because the structure of the market now demands it.

The risk is that what begins as a technical correction in a handful of stocks could metastasize into a
broader market decline. With valuations stretched, liquidity tightening, and questionable accounting
narratives already under scrutiny, the passive flows that once stabilized markets now threaten to
accelerate volatility.

SEPTEMBER ‘25 SANTIAGO CAPITAL 34

This gives us additional pause when we look at current valuations in an historical context.

Not to mention positioning. After all, if trend following strategies are all in, what does that say about
those they are following?

SEPTEMBER ‘25 35
For investors, the implication is clear: the market’s apparent stability is more fragile than it appears,
and the breakdown in leadership stocks could be the catalyst that turns passive strength into a
systemic vulnerability now.

Summary

None of this analysis guarantees that a crash is imminent. Markets can remain stretched longer than
logic suggests, and periods of divergence between price and momentum can last for weeks.

What the evidence does show is that the table is perfectly set for it.

And we are entering a season when markets typically grow more unstable, and this year’s backdrop
includes a series of potential catalysts dead ahead: inflation data that could surprise, central bank
meetings that may sharpen policy divides, and geopolitical tensions that can flare without warning.

Divergent monetary policies across major economies add another layer of uncertainty. Or perhaps no
external shock is needed at all. Sometimes markets stumble simply because new buyers fail to appear.

Meanwhile, the volatility index sits at unusually low levels, a sign that investors have grown
complacent. Low volatility also means the cost of insurance is cheap.

In an environment where leadership is faltering, internals are weakening, and potential catalysts loom
large, the ability to secure protection at bargain prices is an opportunity few cycles have offered.

SEPTEMBER ‘25 SANTIAGO CAPITAL 36

The current setup suggests that these hedges are unlikely to stay cheap for long, and when they pay
off, they could do so in dramatic fashion.

Regardless, the lessons of the past are very straightforward. And right now, they are screaming.

Rember, the best time to prepare is before the rain. Before the rain…

SEPTEMBER ‘25 37
Conclusion

The AI-driven boom illustrates why the lessons of financial history remain indispensable.

The forces that fuel bubbles — optimism, credit, liquidity, and psychology — are timeless. What
changes are the forms they take. Just as tulips, railways, dot-com startups, and subprime mortgages
once carried the mantle of progress, AI now combines transformative potential with extraordinary
inflows of capital, speculative fervor, and narrative momentum.

The outcome of this cocktail is rarely stability. And AI’s scope sets it apart.

Unlike earlier bubbles confined to a sector, artificial intelligence promises to transform industries
simultaneously: software and cloud computing, manufacturing and logistics, healthcare and finance.
This broad applicability attracts both institutional capital seeking exposure to “the next general-
purpose technology” and retail investors drawn by stories of exponential adoption.

The speed of technological advancement, paired with unprecedented levels of investment,

compresses time horizons, increasing the likelihood that valuations detach quickly from reality and
correct with violent force.

The historical parallels are stark.

In the late 1990s, digital networks were heralded as instant revolution, justifying extreme valuations
for firms with no profits. In the 2000s, housing was seen as permanently safe, enabling massive
leverage across the financial system. Today, AI firms are priced on projections of flawless execution,
immediate scale, and rapid profitability. When those assumptions inevitably falter, the gap between
expectation and reality can set off sharp reversals, magnified by leverage and momentum unwinds.

Psychology amplifies these risks. Human behavior — FOMO, herd instincts, overconfidence, and the
evergreen belief that “this time is different” — remains as powerful as ever. Investors are wired to
chase stories of limitless growth, even when discipline warns otherwise.

The danger is not only misplaced optimism, but also deception. History shows that periods of euphoria
invite embellishment, misrepresentation, and fraud, as management teams and promoters strain to
meet impossible expectations. AI’s hype-driven environment, with its promises of disruption across
every sector, is fertile ground for similar temptations.

Yet beyond these familiar forces lies something new: the structural dominance of passive investment
strategies. In earlier bubbles, capital was allocated largely by active investors who made judgments,
however flawed, about valuation, risk, and potential.

Today, trillions of dollars flow into index funds and ETFs that allocate automatically, rewarding size
rather than fundamentals. This reflexive loop, where the biggest companies attract the most inflows
simply because they are big, has concentrated risk in a handful of mega-cap firms.

SEPTEMBER ‘25 SANTIAGO CAPITAL 38

These passive flows now create unique vulnerabilities in downturns.

When investors redeem ETF shares in stress events, selling occurs indiscriminately across entire
indices, regardless of fundamentals. The very giants that have anchored portfolios could become
accelerants of volatility, not because of business weakness, but because of their index weightings.
Liquidity mismatches between ETF wrappers and underlying assets further raise the risk of forced
selling, particularly in less liquid sectors. Thematic and leveraged ETFs compound fragility, magnifying
reversals in niche areas and transmitting stress across markets.

This structural change, absent in earlier manias, may sharpen the speed and synchronization of future
crashes. Markets are more homogenous, as passive strategies herd investors into the same securities.

In a correction, outflows from passive vehicles could create a powerful new feedback loop, amplifying
the cyclical drivers that history has always shown. The plumbing of markets has changed, and with it,
the way bubbles inflate and deflate.

Taken together, the enduring lessons of history and the new realities of passive investing provide a
framework for survival.

Valuations still warn when expectations outrun earnings. Leverage still determines the violence of
declines. Liquidity still fuels cycles, and psychology still distorts judgment. Fraud still emerges when
scrutiny fades. But now, the architecture of passive flows must be added to the calculus. Ignoring this
modern factor risks underestimating how quickly reversals can escalate.

For investors, the mandate is clear. History equips us to recognize familiar signals: stretched
valuations, abundant credit, euphoric narratives, and creeping fraud. Modern market structure requires
adding passive flows to the watchlist, monitoring how capital enters and exits indices, and
understanding the concentration risks embedded in benchmarks.

Together, these insights allow for a disciplined approach: scaling exposure when exuberance peaks,
reducing leverage in frothy conditions, scrutinizing narratives and financials, and preparing to act
when crashes create generational opportunities.

The cycles of optimism and collapse are as old as markets. Technologies evolve, but human behavior
and financial dynamics remain constant.

What is new is the infrastructure through which capital moves. AI may prove transformative, just as
railroads, electricity, and the internet were. Passive investing may remain a low-cost tool for long-
term savers. But both phenomena also contain the seeds of instability.

By integrating the timeless lessons of history with an awareness of structural change, investors can
preserve capital through the turbulence and position themselves to seize the opportunities that
inevitably emerge when the froth recedes.

SEPTEMBER ‘25 39
About

Santigo Capital Research is an amalgamation of ideas, experiences, and investing disciplines sourced
over decades from the minds of Brent Johnson and Michael Peregrine.

Explore this topic further, and additional market insights from the creators, at SantiagoCapital.com.

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