The Last Whoosh!!

It feels like an everything bubble

In a podcast discussion with renowned equity portfolio manager John Hussman (1), newsletter author Jesse Felder spoke of an “everything bubble.” We can understand why it feels that way – after all we’ve spent enough time recently highlighting the folly of BitCoin, with its inherent value of zero, being bid up to a price of almost USD 50,000 because of a Tweet from the founder of an electric vehicle manufacturer whose share price is equivalent to 1,200 years of earnings (we get the concept of buy & hold but once you get beyond a millennia to get your money back, that’s a bit rich for us) while the world’s attention was focused on GameStop rising over 18,700% from its lowest point last year before falling back again by over 90%. But actually, is it an everything bubble?

We’ve spent much of the last 6 months commenting that markets seem to be suffering from various bouts of cognitive dissonance, because of the difficulties of processing so much data that is unfamiliar in both scale and scope. A favourite soapbox has been our complaints about the outpourings of enthusiasm for the falling unemployment numbers on a weekly or monthly basis when, if we step back and take a look at the number of Americans in employment, it’s on a trajectory towards 14 million less workers by the end of this year than would have been projected a year ago.

So, when we turn to look instead at capital markets, especially equity markets, what numbers can we trust?

Comparing the ‘last whooshes’ of past Cycles – why the Price / Sales multiples can help

Price to Revenue Ratio isn’t always the best indicator for the purpose of relative valuations, the more important factors being the margins (i.e. in a market of limited competition the price to sales should be higher as margins are stronger and marketing related costs, less) but for the purpose of comparing past peaks and troughs, and comparisons of where the market is today compared to major pivot points over several decades, then this ratio is more useful during times of distress, as sales are relatively more meaningful and can be less volatile than net profit as net margins which can easily be destroyed by firms intent on maintaining market share, or manipulated during a major downturn but, unlike profits, sales can’t turn negative.

Price to sales can also better capture the last phases of a bubble market as stocks go crazy even without a great deal of actual sales growth, while prices can sometimes completely ignore profit, usually on the basis of extraordinary sales growth. The DotCom bubble grew out of 1999 on the view that all internet companies were going to grow by a factor of several hundred times but with handful of exceptions that were around at that time, such as Amazon, Google and Microsoft, sales never did take off. Although of course, when we talk about tech, we need to be mindful that the magic of creative financing can boost what are reported as sales in ways that we plan to discuss in an upcoming online event. But for now, let’s take the numbers at face (but not Facebook) value.

Yet to achieve the level seen in the DotCom era

As you can see over the past 33 years, the peak of price to sales occurred during the DotCom bubble. This time, in 2021 we can see that the price to sales is way over what it was in 2008 but, so far, hasn’t reached the levels of 1999/2000 and might not do so given that so many of the DotCom era internet stocks had no profits at all, unless, the market continues to build up frenzies on stocks such as Tesla, AMC or GameStop but Reddit would need to find a good deal more of these plays if prices are to match those that were delivered at the start of this millennium. While lower interest rates undoubtedly provide a degree of justifiable support for share prices this time, the same can’t be said for the other side of the equation, sales.

All except the lowest 10% of price/sales have surpassed their 2000 peak. The Fed’s target benchmark rate closed the year of 1999 at 5.41% compared to between 0-0.25% and the average dividend yield (retrospectively) at the end of 1999 was 1.17% in 1999 compared to 1.51% today. Given how much higher rates were in 1999 but the lower dividend yield, growth expectations were higher, and/or profitability lower. This could signify that although markets have risen to beyond the 2000 peak they might still have some way to go – but it’s highly risky as today there aren’t the enormous growth expectations across the board today as there wrongly were for Internet stocks in 1999/20.

The chart below shows how investors were pricing the “good stocks” in the S&P 500 as of January 22. (2)

Each line represents a decile (10%) of the S&P 500, ranked by price/revenue ratios.

Among the stocks in the top valuation decile at the 2000 market peak, the median drawdown loss by October 2002 was about 80%.

Yet many stocks in the broad market were actually reasonably valued from a historical perspective even at the 2000 market peak. In recent weeks, that top valuation decile has eclipsed its 2000 peak. The difference from 2000 is that every other decile just hit the highest level in history as well.

The current situation would not be as risky if the stocks in the highest price/sales deciles accounted for a small percentage of S&P 500 market capitalization. Unfortunately, that is not the case. The largest S&P 500 components by market capitalization have eclipsed the price/revenue multiples observed among the largest stocks at the 2000 pre-collapse peak, while the smallest S&P 500 components have eclipsed the price/sales multiples observed at the 2007 pre-crash peak.

New reasoning to ignore intrinsic value is nothing new

The willingness of investors to abandon historical standards of value has played out at other cycle extremes. The poster-granddad for value investors, Warren Buffett, has described the ratio of publicly traded companies as a percentage of GDP as “the best single measure of where valuations stand at any given moment”.(3) Using the Wilshire 5000 index as the broadest proxy of public companies, that indicates a much more systemic overvaluation issue than we’ve seen in previous episodes:

Previously, the Nifty Fifty stocks captivated investors for the significant part of a decade prior to its demise in 1973 and was one of the first revivals of widespread appetite for high-risk investing since the 1929 boom-bust. We also saw another recurrence with the DotCom bubble echoed in today’s ‘cult’ trading of Bitcoin and alternative cryptos. The new super ‘retail herd power’ that caused many to trade GameStop shares leading to its share price to spike multiple times is similar to Bitcoin in that both claimed to be onto something new, some unprecedented, uncharted territory (GameStop was said to be able to reach USD 1,000). In 1929, these trading frenzies were known as the Go-Go era. But we can see what happens, when it chickens come home to roost:

Blue Chip Performance: 1973-1974.

• Du Pont -58.4%
• Eastman Kodak -62.1%
• Exxon -46.9%
• Ford Motor -64.8%
• General Electric -60.5%
• General Motors -71.2%
• Goodyear -63.0%
• IBM -58.8%
• McDonalds -72.4%
• Mobil -59.8%
• Motorola -54.3%
• PepsiCo -67.0%
• Philip Morris -50.3%
• Polaroid -90.2%
• Sears -66.2%
• Sony -80.9%
• Westinghouse -83.1%

There weren’t everything bubbles back then and there probably isn’t today but the feeding frenzy across so many stocks in US markets is alarming. There are pockets of value but they’re getting scarcer and, in general, the bigger the market cap, the greater the bubble. The overvaluation of median stocks, and especially of the largest stocks is an alarming sign. It doesn’t have to be an everything bubble for the bursting to have cataclysmic fallout but it’s looking like a too many things bubble.

(1)https://podcasts.apple.com/us/podcast/39-john-hussman-on-navigating-one-most-overextended/id1242377947

(2) https://www.hussmanfunds.com/comment/mc210201/

(3) • Chart: Are We in a Stock Market Bubble? | Statista