Juggling Dynamite

When does this financial bubble burst? Who can say; that it will, is without a doubt.  At the moment, virtually no one thinks that the burst is imminent. On the other hand, this is typical of bubble tops.  GMO’s Q3 quarterly letter here summarizes 2020 well.

Perhaps it was the lockdown that left people with plenty of time on their hands and no sports to bet on, but this year has seen more crazy activity in the stock market than anything we have seen since 2000 (chart on left shows share prices to sales of US growth companies sinec 1970.)

Whether it was Hertz stock rising 10-fold in the spring as a high beta recovery play despite the fact that the company was bankrupt and shareholders wouldn’t have benefitted from a recovery even if it happened, or Kodak stock rising 30-fold after announcing it was going to start making chemicals to enable the production of Covid-19 treatments, very odd and speculative things have been going on.

As a more traditionally Growth-y example, Tesla has risen some 800% since the fall of 2019 on the back of 17% growth in vehicles sold. It now has a greater market cap than the sum of all the other U.S. automakers, all the European automakers, and all the Korean automakers, with Honda, Mazda, and Nissan thrown in for good measure. That collection of companies sold approximately 100 times as many cars as Tesla did in 2019. But Tesla isn’t the craziest thing that happened this year, and that is true even if we restrict ourselves to looking only at electric vehicle companies named after Nikola Tesla.

This spring a would-be Tesla called Nikola went public via a reverse merger with a SPAC9 at a valuation of $3 billion. In the 2020 EV frenzy, it rose 10-fold to a market cap of about $30 billion. This company is a rare bird in the stock market, a pre-revenue manufacturing company. In fact, Nikola is not only pre-revenue, having never sold any vehicles it has produced, it has also never produced a vehicle. Further, it has not even built the factory in which it aspires to build the trucks that it has yet to sell. This summer, a report came out detailing allegations that almost all of the claims of Nikola’s Elon Musk wannabe founder over the few years of its existence were lies. That founder, Trevor Milton, was forced to resign and the company has yet to meaningfully refute any of the claims made in the report. The stock duly fell, but even after information came out showing that pretty much everything the company has claimed to accomplish in its history was a lie, it still has a market cap more than three times its value at its public debut less than a year ago – a valuation that was presumably predicated on the company’s claims actually being true.

With a combination of some the highest valuations ever seen and clear corresponding manic investor behavior, it seems clear to us that Growth stocks are indeed in a bubble.

Security trading has become a major pastime for regular folks during the COVID-19 lockdown.  This will be a painful malinvestment of time and funds for most.  See a common story in He thought day-trading would be a thrill.  He ended up losing $127,000.

Studies have shown that most day traders lose big.

“On average, day traders do horribly, and the percentage that end up sustaining success are in the low single digits,” Steenbarger says. Here is a direct audio link.

Those hoping that the market plunge between February and March was enough to launch the next secular expansion in stock prices overlook a mountain of historical evidence.  For some illuminating charts and commentary on this topic, read the latest from Lance Roberts,   The “roaring 20s”–the fundamental problem of the bullish view. Here is just one important takeaway:

Let’s also not forget the singular most important fact.

Our history’s previous secular bull markets grew from extreme under-valuations, washed-out financial markets, and extremely negative sentiment. 

Such was not the case over the last decade as the Federal Reserve and Government have pumped more than $36 Trillion into the economy to keep it “afloat.” 

As I have explained many times, extreme asset prices are no free lunch and have historically been cured by a collapse in said asset prices or a long period of stagnant prices that works to restore attractive investment metrics once more.  Given that today’s stock market capitalizations (price x shares) as a ratio of economic growth (GDP) (charted below) are the most extreme ever recorded–nearing 4 standard deviations from the mean (far right green circle below), this suggests the correction period yet to come will also be extreme.
A decade of zero to negative real total returns (including dividends and before fees) is also suggested by the present S&P 500 price divided by an average of corporate earnings for the last ten years, adjusted for inflation (CAPE).  The pink circle below plots the present reading above 35 and all other years since 1881 (bottom axis) and the annualized returns over the decade that followed each point (left axis).  The only three worse readings were in 1999, 2000 and 2001–and sure enough, predictably, the decade following each did deliver negative real returns.   Go figure; the price paid does matter!
Nil to negative total returns for present holders for the next decade is a best-case scenario presuming they are able to hold throughout and not need or want to sell or withdraw any income or pay any investment fees.  Any of these actions during the correcting period will make returns more negative.

Low yields are one thing, but try inputting a decade of nil to negative compound growth into financial projections and see what happens to hopes, plans and dreams.  Most financial plans today are set up to fail miserably.  Failing financially is miserable indeed, especially later in life when there is less time to go back to work and make back losses.

To avoid the math of loss and chart a more stable course, one needs to take proactive steps ahead of the herd.  Thinking people can do it.