Perhaps the
most striking feature of the sharemarket’s remarkable rebound from its
March lows has been how concentrated the core of that resurgence has
been in a handful of stocks.
It is a small number of very large US technology stocks that are at the heart of the market’s seeming indifference to the ravages of the coronavirus through the US and global economies, a phenomenon that is drawing parallels with the dotcom bubble and bust 20 years ago.
It is a small number of very large US technology stocks that are at the heart of the market’s seeming indifference to the ravages of the coronavirus through the US and global economies, a phenomenon that is drawing parallels with the dotcom bubble and bust 20 years ago.
Five
stocks – Amazon, Apple, Alphabet (Google’s parent), Facebook and
Microsoft – now account for about $US6.5 trillion ($9.37 trillion) or
more than 25 per cent of the S&P 500’s capitalisation of just over
$US25 trillion. Rarely has the market’s dependence been so reliant on
the performance of so few.
When
the severity of the coronavirus dawned on investors, shares in the big
tech companies plunged along with the rest of the market, but not as
much. The tech giants fell almost as much as the rest of the market
(which includes them) from mid-February to late March – around 30 per
cent against the overall market’s 33 per cent fall. Amazon, a perceived
beneficiary of the pandemic, was the outlier, falling only about 12.5
per cent.
As the S&P 500 bounced in response to the unprecedented actions of the US Federal Reserve board and the $US2.9 trillion fiscal package approved by the US congress, the tech stocks produced an exaggerated response.
The overall market rebounded 40 per cent to be only 7 per cent below its February highs but the "Big Five" produced gains ranging from more than 50 per cent to more than 60 per cent.
It’s not dotcom bubble territory, yet. In February 2000, when the Nasdaq market was far more heavily focused on technology stocks than it is today, its stocks were trading on an average PE of more than 100.
The overall market rebounded 40 per cent to be only 7 per cent below its February highs but the "Big Five" produced gains ranging from more than 50 per cent to more than 60 per cent.
The
broader FAANG+ index, which includes Netflix, Alibaba, Nvidia, Baidu,
Tesla and Twitter – initially fell 30 per cent before rebounding 66 per
cent to be more than 15 per cent higher than its February peak.
To
provide some perspective on the market’s valuations of those stocks,
the S&P 500’s stocks trade on a price-earnings ratio of 22 and on a
multiple of sales to earnings of 2.3. The FAANG+ stocks trade on a PE
ratio of 49 and a sales multiple of 6.8.It’s not dotcom bubble territory, yet. In February 2000, when the Nasdaq market was far more heavily focused on technology stocks than it is today, its stocks were trading on an average PE of more than 100.
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Technology companies are benefiting from the lockdowns and the surge in the number of people working from home in response to the pandemic but justifying their valuations requires heroic assumptions about their ability to sustainably grow their cash flows and earnings into the distant future.
Rarely has the market’s dependence been so reliant on the performance of so few.
It
might be doable. In 2000, for instance, Amazon had a market
capitalisation of about $US76 billion. Today it’s valued at more than
$US1.5 trillion. Apple was valued at less than $US5 billion in 2000.
Today it's worth $US1.6 trillion. Microsoft had a market cap of about
$US500 billion in 2000; today it’s $US1.6 trillion.
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Nevertheless,
it is also worth considering the lead up to 2000 when professional fund
managers were trading anything with a "dotcom" label regardless of the
lack of earnings or any discernible pathway to profitability.
Some acknowledged they were playing "pass-the-parcel," or a version of the "Greater Fool Theory," backing themselves to unload the dross before the market inevitably purged itself.
Some acknowledged they were playing "pass-the-parcel," or a version of the "Greater Fool Theory," backing themselves to unload the dross before the market inevitably purged itself.
In
the search for returns in an environment where only the sharemarket has
been offering anything positive, the natural inclination of investors,
particularly the retail investors that have played a major role in the
market’s comeback since March, is to chase the highest-performing stocks
in what becomes a very circular and self-fuelling process.
That’s
not to denigrate the FAANG+ stocks or, indeed, some of their smaller
fellow travellers. It’s hard to argue that an Amazon, or indeed a Tesla,
doesn’t have substance and exciting future prospects but the question
of how much value to attribute to their ability to generate the cash
flows that validate their future cash flows is a live one in the current
environment.
At
the start of May even Tesla's chief executive Elon Musk said publicly
that Tesla’s shares were over-valued. They were trading around $US700 at
the time. They closed at $US1389.86 on Tuesday.
Closer to home Afterpay is raising $800 million at $66 a share. In February its shares hit $39 before plummeting to $8.90 in March and then rebounding to $68 ahead of the capital raising.
In the long run, it is questionable whether that is sustainable. In the meantime, however, ultra-low returns from the alternatives and markets flooded with central bank liquidity mean that cash has to find a home somewhere and, in recent months, it has flooded into equities and the more speculative end of the market in particular.
Closer to home Afterpay is raising $800 million at $66 a share. In February its shares hit $39 before plummeting to $8.90 in March and then rebounding to $68 ahead of the capital raising.
This
is a loss-making company with a market capitalisation of $18 billion
and a price-to-sales ratio of more than 44. The revenue growth is
impressive but the valuation is an act of faith reminiscent of the
dotcom era when undefined potential – the less defined the better – was
more valuable than actual earnings.
The "blue sky" valuations of
the technology stocks and the ebullience within the broader sharemarket
despite the persistence of the pandemic, which is spreading rapidly
again in the US and has regained a strong foothold here, underscore how
much of the market’s strength and the valuations of individual companies
are reliant on the absence of alternatives rather than fundamentals.In the long run, it is questionable whether that is sustainable. In the meantime, however, ultra-low returns from the alternatives and markets flooded with central bank liquidity mean that cash has to find a home somewhere and, in recent months, it has flooded into equities and the more speculative end of the market in particular.
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