“I can show, really precisely, that there are two warranted prices for a share. The one I prefer is based on such fundamentals as earnings and growth rates, but the bubble is rational in a certain sense. The expectation of growth produces the growth, which confirms the expectation; people will buy it because it went up. But once you are convinced that it is not growing anymore, nobody wants to hold a stock because it is overvalued. Everybody wants to get out and it collapses, beyond the fundamentals.”
Franco Modigliani, March 2000
At the start of the millennium, the dotcom bubble was at its peak. Internet stocks, despite many of them having no earnings, were trading at historically high valuations. New IPO’s of technology stocks were occurring almost daily. Companies that added the suffix “.com” were seeing their share prices rally. People were quitting their jobs to become day traders.
In January 2000 during Superbowl XXXIV, there were adverts from 14 dotcoms founded during the bubble who paid over $2 million each for a 30 second slot. The technology heavy NASDAQ Index was up 145%, while Warren Buffett’s Berkshire Hathaway was down 44%, an almost 190% level of underperformance. Glamour stocks were on a seemingly unending upward trajectory while value stocks (many of which were seen as old economy) languished. Then something changed, investors began to focus on fundamentals such as earnings and cashflows and those same value stocks that were shunned went on to trounce glamour stocks for the next 14 years.
To examine if 2021 / 2022 is showing signs of 1999 / 2000 we must examine two issues. Firstly, we need to examine the parallels of the current bubble versus the dotcom bubble. Secondly, we need to examine if there are signs of the bubble bursting.
The current bubble shows numerous similarities to the behaviours mentioned above which we saw at the start of the millennium. Glamour stocks are trading at historically higher multiples. Record numbers of companies are going public (via Special Purpose Acquisition Company (SPAC) in many cases - a SPAC is a company that has no commercial operations and is formed strictly to raise capital through an IPO).
People are quitting their jobs to become day traders (with cryptocurrencies and options trading being the particularly hot areas). We are even seeing adverts for cryptocurrencies on the sides of Dublin Bus buses. Many of the best-known value managers including Warren Buffett have endured years of painful underperformance. Glamour stocks are on a seemingly unending upward trajectory while value stocks are languishing.
To quantify the similarities, we can look at valuation levels. In 2021 we reached the extremes we saw in late 1999 when comparing valuations of value stocks versus glamour stocks (see Chart 1). The second chart shows that this is a universal trend, we are in the 90th percentile of relative valuations in every region globally.
Chart 1: Value stocks are really cheap
Source: BCA, November 2021
Chart 2: Relative value across countries
Source: Research Affiliates, September 2021
There are also a huge number of stocks trading at obscene valuations of over 10 times and 20 times sales.
Chart 3: Total market cap of stocks with Price to Sales >20x
Source: Kailash Capital, September 2021
Now that we have shown that we are in a bubble equivalent to what we saw in 2000 we need to ask if things are changing under the surface, is the bubble bursting. We believe there are now numerous indications that the bubble in glamour stocks is bursting.
Firstly, SPAC’s have started to crack. Some of the biggest SPAC’s from the last two years are now down over 80% from their all-time highs. The SPAC IPO index is down 32% from its all-time highs.
Chart 4: SPAC IPO performance YTD
Source: Bloomberg, December 2021
Chart 5: Percentage of stocks in the Nasdaq Composite down 50% and 20% from 200-day high
Source: Societe Generale, December 2021
So, if the bubble we are in is bursting how bad could it get? For the egregiously expensive stocks it could get very bad. Historically buying stocks that trade at over 10x sales has been a terrible idea. Over the last 32 years, stocks that traded at levels greater than 10x sales have returned a compound annual return of -0.3%, versus the broad market which has returned almost 11%. Stocks that have traded at over 20x sales have fared even worse losing 80% of their value in the dotcom era.
Chart 6: Return of $1 invested at peak of dotcom bubble in stocks with Price to Sales >20x
Source: Kailash, September 2021
There is no reason something similar cannot happen again. While the larger names in the Nasdaq are not as expensive as they were in 2000, there are plenty of expensive stocks that could replicate the 83% peak to trough fall that the Nasdaq witnessed from 2000 to 2002.
The question is what lessons can be learnt from the crash of 1999 / 2000? The obvious one is that the decline in glamour assets can come quickly. The other lesson is that not all investors shared the pain. Its collapse ushered in a golden era for value investors, like us. From 2000 to 2013 the lowest quintile of stocks by Price to Earnings multiple in the US delivered 586.8% returns versus the Standard & Poor’s 500 Index that only delivered 64%.
We remain positioned away from the areas of the market that are at risk of a 1999 / 2000 correction and believe that our investments are positioned correctly for the next economic and market cycle.
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The latest views and insights from the team can be found here.
Webinar and Q&A replay
Patrick Lawless, Niall Dineen and John Mattimoe held an interactive discussion, where they spoke about the key macro drivers that have been influencing markets this year as well as looking at what may lie ahead in 2022.
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