If you’re looking at the unemployment rate or GDP figures, it would seem obvious that we’re in the middle of the worst economic crisis in decades.
If you’re looking at the stock markets, though, you would have to conclude that we’ve more than recovered from any sort of business disruption. The NASDAQ, in particular, has nearly doubled from its March low and is currently showing a weekly, monthly, YTD, and annual trend that is virtually unprecedented:
But these returns and apparent stock recovery in the midst of an ongoing economic crisis beg the question: is this just another bubble? Bullish investors insist there’s no bubble, and what we’re seeing is a new paradigm developing where technology companies accelerate their dominance over more traditional brick and mortar industries.
Tech firms adapted quickest
Unsurprisingly, firms focused on technology were the quickest to adapt to the changes 2020 brought. Indeed, many of their operations were conveniently digital to begin with, so allowing workers to work remotely became a matter of formality rather than a new shift in procedures. It won’t matter much for the team if Bob’s desk is in his home office instead of cubicle 23, and many large firms were already using online video for meetings whose membership spans multiple locations. In fact, many firms and employees are reporting enhanced productivity and focus in their new work from home environments.
In addition to that adaptability, online retailers like Amazon and service providers like Zoom saw a massive surge in customers. Stuck at home, and with many physical stores closed, demand rose sharply for all types of digital shopping, productivity, and entertainment services.
Tech evangelists declared that the future had arrived, and in response, the broader NASDAQ index has surged to record high after record high. As of September 1, 2020, we’ve seen 41 days close on such a record! Not bad for being in the middle of a pandemic, huh?
Bubble warnings and red flags ahead
It may well be true that the tech sector’s advance against the traditional economy has accelerated – and we might also be in a bubble. Most bubbles do start off with some sort of new advancement or competitive concept, but they get carried away when investors overvalue these reforms and overestimate how much new profit they’ll generate.
And when some of these stock valuations even make sense from a perspective of linear extrapolation, we’re also increasingly inundated with stories of people who are ready to “go back to normal” and spend more time offline. Those linear growth extrapolations probably won’t hold up so well.
There are also a growing number of warnings and indicators that suggest equities – in general – are significantly overpriced right now. While tech stocks have led the charge, the S&P500 and Dow Jones Industrial Average are also picking up record highs on much more questionable earnings data. There are also a few technology companies defying investing fundamentals. Is it panic buying by inexperienced investors? Is it future-proofing your portfolio?
Time will tell, but here are a few specific warnings to watch out for:
Return to “normal”
While many existing businesses won’t survive mandatory closures and social distancing regulations, some significant amount of demand will return for physical businesses. Many still prefer to go to stores and browse physical objects they can hold. Others miss going out to eat, or viewing an art gallery in person instead of online. Concerts and other events are likely experiencing a significant amount of pent up demand that could pull demand back away from online spending just as soon as a vaccine becomes available.
Eventually, many businesses will return to the office. Not all, of course, but it will be enough to bring down Zoom’s peak sales figures. It won’t hurt Amazon’s profitability, but it’s certainly going to slow their growth. There may even be a quarter or two of negative growth when things start trending back toward the baseline, again.
The new normal won’t be like the normal we knew before 2020, but it will certainly slow things down for tech as spending starts to shift offline again.
The VIX index attempts to measure market volatility by comparing the spread on S&P500 futures. The higher VIX reads, the more “uncertain” the market is about what prices are going to look like a month from now. Historically, a rising VIX value corresponds with a falling market, and the rare occasions where they both move in the same direction appears to signify a turning point.
Regardless of whether or not that pattern holds up, growing volatility does represent growing uncertainty and growing differences in what investors expect to happen in the near future.
Big hype and low volume
Does it seem like everyone you know is talking about the stock market these days? Many experts and financial advisors are concerned about the number of small time investors who are jumping in now, just as professionals are backing off.
These low volume price surges are often indicators that a rally is in its late stages. People experience a natural fear of missing out, and when this occurs with a stock rally the prices can get pretty high before they crash back down again. This behavioral pattern charts as a blow off top.
Too big to explain
It’s great that these companies have made a mark in investor’s minds, but the fundamentals don’t necessarily support these prices and market capitalization figures.
Historically, the Price/Earnings ratio of equities has hovered around 15 or 16. A lower number indicates a good value, and a higher number indicates that a stock is overpriced or expected to grow.
Tesla is clocking in here with an estimated 2020 P/E ratio of 859! So while there’s definitely an expectation of growth, remember that the entire Nasdaq Composite Index is also full of tech stocks expecting to grow: and they’re at a P/E closer to 28. Even that 28 is above the historic mean.
But maybe Tesla really is the next growth story. Maybe they’ll eclipse other car makers someday.
What about our earlier example, Zoom?
Yahoo Finance puts their trailing 12-month PE at a mind-boggling 2,708. Each $457 share is earning about fifteen cents a year. Of course they’re growing, but we’d need to see a decade of growth like this quarter’s before that valuation started to look valuable. That doesn’t seem… sustainable.
Bubble or tech triumph?
After reviewing the evidence – I can’t help but conclude both are probably somewhat true. While tech is outperforming other stock sectors, equities in general are showing signs of being overpriced. Worse, there appears to be a mania in the markets that’s being driven by new investors who don’t necessarily have much trading experience.
So what’s next? Well, there are a lot of ways this can play out. There might be a sudden run up in prices followed by an even steeper crash. Things might also just flatten out for a while, or trade up and down sharply without really going anywhere. It’s even possible that the markets will just continue rising on the inflationary effects of unprecedented monetary policy.
Over the long run, buying in regularly with each paycheck and holding through the chaos is a proven strategy. There are times like these, though, where it can be tempted to take a little bit to the sidelines just in case a new buying opportunity is on the way.