The Rising Impact of Market Speculation
February 5, 2021
By Mike Moreland
VP - Investments
My colleague Ted Hanson wrote a commentary last week about the train wreck trading in GameStop, and the ongoing battle between beleaguered hedge funds and thousands of online day traders. I won’t take sides; my feelings are the same, as a lifelong Hawkeye, as when Nebraska plays Minnesota – may they both lose, badly.
The bigger discussion is the growing impact of speculation on the financial markets. We’ve said many times that the first beneficiaries of monetary accommodation and fiscal stimulus are the financial markets. This remains true today – in spades. The actions of the federal government in the last year flooded the banking system with cash. Covid-induced lockdowns limited the ability to spend those dollars productively. Where to turn? The most obvious choice is also the easiest – get into the stock market.
Over the Top Capitalization
The S&P 500 is up about 70% from its trough less than a year ago. Valuations are stretched by every standard measurement – except those related to interest rates, suppressed to near record lows by global central banks. And, by any standards, markets are getting frothy. Let’s look at an example of ‘things that shouldn’t be, but are.’ – Tesla.
This is not an indictment of Tesla as a company. Tesla may well be the model for the transportation industry in years to come. The concern, however, is whether the current price already reflects that –and more – and is venturing through the boundaries of irrational exuberance. Tesla’s sales and earnings are only slivers of the total automobile market, yet its market value is equal to that of every other global car company combined.
There’s no rule that the sales, earnings, and capitalization of companies in an industry have to be proportional – but that’s the way it generally works over time. Tesla is definitely an industry disruptor, but enthusiasm for its stock appears over-the-top. To someone like me, who is perfectly happy with a twelve-year-old Toyota truck, Tesla is a prime example of speculative excess starting to appear.
Balancing Your Bets
This doesn’t mean we’re at the end of this cycle, or even that we can see it from here. It does mean that caution is warranted. As noted by John Maynard Keynes, the preeminent economist of the early twentieth century, ‘Markets can remain irrational longer than you can remain solvent.’ It’s a lesson to keep in mind in times such as this. Employ discipline, invest conservatively and diversify. Don’t try to pick the top (or the bottom) with all-in bets.
Keeping an Eye on SPACs
To close, you may have noticed over time that I’m a history buff. Charles Mackay’s 1841 Extraordinary Popular Delusions and the Madness of Crowds, primarily a study of crowd psychology, discusses some of the famous economic bubbles of the past – the Mississippi Company, the South Sea Company, and Dutch tulip mania, all of the early eighteenth century. Fortunes were made and lost. Sir Isaac Newton, rumored to be an investor in the South Sea Company, said, ‘I can calculate the movement of the stars, but not the madness of men.’
We’re not at this stage – yet. But there are more signs deserving attention. Special Purpose Acquisition Companies (SPACs) are essentially blank-check investment pools designed to buy properties or bring firms to market without the traditional rigor of an initial public offering process. While a niche product for years, they are starting to grow in size and scope. Looking back, a lesser-known feature of the Roaring Twenties were ‘blind pools’, in which investors tossed money into vehicles with no firm targets. Most ended poorly. While today’s SPACs are not identical, and have firmer guardrails than in the past, their growth is evidence of the scramble to find a home for capital.
But SPACs are a story for another day; it’s time to close. Stay safe, and please let us know what you want to achieve in your life. We’ll do our best to help you get there.