from the Provident Investment Management blog
Eleven years into this bull market, it’s déjà vu all over again. It is starting to feel like we are back in the bubble conditions of the 1990s, or at least getting there. It is not so much the overall market that has me bothered. I am concerned about specific cases…a lot of specific cases. A slightly alarming number of stocks have come uncoupled from economic reality.
Let me start on a fairly positive note by saying that in the context of prevailing interest rates, overall stock valuations are not crazy — not in most cases anyway. In a world of ultra-low interest rates, it makes sense that stock valuations are levitating above historical averages. According to data from Finviz.com, for the 62 U.S. companies with market capitalizations over $100 billion, the median trailing P/E is 27. This equates to a median “earnings yield” of 3.7%, meaning $100 invested in large stocks is earning $3.70 in corporate profits. That is low by historical standards (valuations are high), but it looks okay compared to 10-year Treasuries yielding 1.4%. It is possible that the market continues to trade at roughly this same valuation for a long time, advancing at the rate that corporate earnings grow. The stock market is one of two places where things can go up without coming back down.
The other is space. You may be aware of the recent untamed rally in Tesla’s stock. Have you also heard of Virgin Galactic (NYSE: SPCE), which has quadrupled since December? Virgin Galactic aspires to take leisure travelers to space, and the market has awarded it a $6 billion valuation despite producing almost no revenue. It is effectively just an idea — not even an original one — with a $6 billion valuation. Where does all that money come from?
Then there is Carvana Co. (NYSE: CVNA), which puts a 21st century spin on retailing used cars. I’ve actually bought two cars from the company and would recommend the experience, but I wouldn’t touch the stock. Much fiercer online competition is coming from incumbent CarMax (NYSE: KMX). CarMax sells more than twice as many cars as Carvana, and generates more than five times as much gross profit, with a healthy net profit as well, compared to Carvana’s losses. The market values both companies about equally right now. For the same price, would you rather own the most successful company in the market, or a hot growth story that has never sniffed profitability? In this case, and many cases, the market prefers the hot new story right now.
I could go on. It is hard to choose favorite examples in this market — that’s my point. I do have to add one more, Beyond Meat, Inc. (NASDAQ: BYND), to my list of 2020 market lowlights. Investors have slapped an almost $8 billion valuation on a company that produces a high-end substitute for low-end meat. The company has plenty of competition, although the competitors are not well known because overall consumer demand is still modest. If there is ever a decent-sized market for competitors to fight over, Beyond Meat will be one of many, many players. The market is pretending that plant-based meat is the future and Beyond Meat is the future of plant-based meat. That’s two big speculations built on top of each other. It’s like betting on the Detroit Lions to win next year’s Super Bowl and win it by at least three touchdowns.
Watching a panoply of questionable companies reach huge valuations in the stock market, I can’t shake the feeling that I’m stuck in the derivative sequel of a movie that was popular twenty years ago — the fabulous Dot-com bubble. I’ve seen this story play out once before, and I’m not keen on the current rehash.
From my perspective, the Dot-com bubble was almost fun. In the late 1990s I was a teenager with a budding interest in business and investing. Those were great times to get interested in the market! After school I would set out my homework in front of the TV and listen to CNBC personalities like Maria Bartiromo and Sue Herera rattling off the fanciful names of technology companies whose stock prices were up 50% or 100% since I’d marched off to school in the morning. At the apex of the bubble in 1999, every single trading day seemed to bring another fabulous adventure — a hot IPO increasing 300% or a big acquisition. By the time the bubble inevitably deflated, I was a freshman in college and paying a little less attention to the market’s day-to-day swings. My overall memories of that bubble period are mostly quite positive. A blend of science fiction and dark comedy, the Dot-com bubble was a spectacle!
I’ll say this in defense of Dot-com era speculators. Looking back on the two decades since, we can now all agree that the world really was on the precipice of a technology revolution enabled by the internet. The spoils just haven’t been spread around the way that the buying frenzy implied. How were investors to know that Amazon would effectively eat all the other Dot-com retailers or that web search would be dominated by another company that didn’t come public until 2004? Investors were on to something, but often backed wrong horses.
Today’s frenzy doesn’t have a theme to latch onto, not yet anyway. Take my examples from above. What is the common thread between electric vehicles, recreational space travel, a slick used car website, and fake meat? The only thing I can think of is that many conform to a 1970s or 1980s vision of the future. They also all seem to be companies that fundamental stock analysts find maximally offensive. Their financial reports either barely exist or are impossible to decipher. Investors don’t care. This time around, the bubble almost feels intentional — like investors are actively trying to immolate their capital. Karl Marx famously quipped that history repeats itself “the first time as tragedy, the second time as farce.” Indeed, it’s hard to find a better descriptor of this current frenzy than “farce.” Until I can find some unifying theme that explains this speculative push, I am simply referring to it as a Bad Idea Bubble. Got a bad idea? Take it public. The worse the idea the better.
To circle back around, if investors can avoid the absolute worst stuff out there, what’s left doesn’t look so bad. The stock market could always be improved by removing its worst elements — that would still be true in a world where every single stock is solid, respectable, and inexpensive. Here in early 2020, the market’s worst elements seem to be bigger and more egregious than usual. They also seem to go up every single day. It won’t go on forever. We’ve seen this movie before.