After seeing hugely successful IPO’s from DoorDash and AirBnB, many of us may think back to the late 90’s yet again. Anything with a dotcom attached to the name saw first day trades doubling or tripling their offering prices during the previous bubble. Hundreds of companies sprang from nowhere. Most of them don’t even exist today. The only winners were the few that survived, those that sold quickly, and the underwriters that got their commissions. Today companies are much larger, and have revenues and an established customer base. However, 111% gains on the first day of trading?
When a food delivery company opens up with an 80% gain and a $60B valuation and a home rental operation doubles in value to over $100B in a matter of minutes, one can’t help but be concerned about another bubble forming. Neither company is profitable yet. Neither company even existed before 2008. For comparison purposes, AirBnB is now larger than Marriot, Hyatt, Expedia#, and United Airlines…combined! These are staggering numbers and do bring a level of concern to us as disciplined investors.
Is this year similar to 2000 (the end of the growth bull market) or 1997 (the beginning of a great time to be aggressive)? Do these two IPO’s mark a top, or is it just the start of pent-up demand for many new companies to come to market? When firms of this size are newly listed, investors need to raise cash in order to buy them. Does this mean “regular” stocks get sold and a disciplined investor can’t make money?
To answer these questions, we should take a step back and compare the previous growth bubble. In the late 90’s, the Nifty Fifty, or the 50 largest technology stocks, dominated the major averages, while the remaining 450 S&P stocks were actually in a bear market. Today, we have a decent rotation among sectors. Sure, the travel related industry, retailers and commodity stocks suffered more than most during the shutdown, but that has flipped recently. My cyclical BEACHBODY index (Booking, Expedia, AutoNation, Carnival, Hilton, Boeing#, Omnicom, Delta Air Lines and Yelp) is now up 45% since November, while the S&P is up 12%. The hyper growth FANG group is only up 7%. This broadening out of the rally is very positive and very unlike the late 90’s.
Second, and most importantly, is valuation. Sure there are mini-bubbles in IPO’s today and certain segments of the market. However, we are nowhere near the 50+ P/E the NASDAQ averaged decades ago. The S&P is a bit elevated, trading at 20x – 22x next year’s estimates depending on the economist. That is hardly excessive, yet.
The other side of P/E’s are interest rates. 10-year Treasuries were 5.5% in 1998 versus 0.9% today. Fed Funds were 5.5% versus 0% today. Using historical comparisons of rates to earnings, one can even argue for a 30X P/E being cheap in the current environment. We won’t go there, but the point remains. We’re not grossly overvalued this time. The S&P’s dividend yield is ~60% higher than long-term fixed income yields. If this is a bubble, it is nowhere near the size of the dotcom bust.
One needs to also consider what just happened over the past nine months. Stay-at-home orders precipitated a massive restricting of business activities. In order to survive, billions of dollars were spent getting digitized. This innovation pulled forward multiple revenue streams. Taco Bell is now at your doorstep for lunch. A bar of soap is delivered to your house in a couple of hours. Conferences with friends across the globe from your couch. New movies straight to your living room instead of a theater. Sending cash instantaneously to friends and family. Gift cards delivered within seconds.
All of this was a foregone conclusion to occur, but not in just nine months. Many of the features we are now accustomed to weren’t expected until 2025 or later. Innovation and revenues are being pulled forward. Winning companies have adjusted. They spent capital without penalty in 2020 and are being rewarded with higher prices based on expectations of improved returns down the road. The amount of progress this year is truly staggering. Companies that improved their long-term value and are taking market share should be rewarded. We can argue that some stocks went too far too fast, but the reality is that the future is quite different and exciting. Today’s P/E may not fully take into account the windfalls coming over the next few years. Growth may come back faster, and stronger than many expect. That’s an uber bullish take, but not out of the realm of possibilities.
Lastly, the Federal Reserve is nowhere near slowing down their money printing machine. Back in 1999, The Fed raised rates 3 times and 3 more times in 2000. This helped slow down inflation, which was running over 3%. When the Fed is tightening, they eventually win out. Coupled with 50+ P/E’s, the subsequent bear market was not entirely surprising. Today, 2% inflation would be a surprise. Fed funds are expected to stay near 0% for years. When the Fed is loose, animal spirits arise and growth expands. Valuations and stock prices can keep rising until the punch bowl is pulled back.
Granted, this leads to malinvestment as we may be seeing in the IPO market today. There is an ETF that tracks IPO’s, aptly with the symbol IPO. This fund is up 113% this year, in the middle of a pandemic. The average P/E is a negative 44. I’m not even sure how they calculate that, but I know it’s a horrible number.
Questionable expansions/investments are less of a concern when there are minimal costs to borrow money. Projects that should be declined get funded. SPAC’s are taking advantage of free money. Investors are forced out on the risk curve with yields so low. The end result is a bull market in stocks that runs further than many expect.
Again, we may have overshot in the near-term with the recent spike in stock prices. Smart money, aka the institutional investor, is not aggressively buying this market. History shows that institutions have the upper hand with tremendous experience and access to data and key business leaders. They hardly lose out. Many other metrics, like call option buying, moving averages and bull/bear ratios are also pointing to excesses in stock prices in the short run. However, the aforementioned factors lead us to believe any drop from here could be a buying opportunity for those who missed the latest rally.
As with any market call, stick to your discipline. If some of your stocks doubled in a few months, take some chips off the table. Stay true to your asset allocation. Review your financial plan. Are you ahead of the game? Recall the old Wall Street mantra “bulls make money, bears make money, pigs get slaughtered.” The future is still bright but some of the frothiness makes a disciplined investor a tad nervous here.
John Kerry turns 77 today. The first performer to win an Oscar, Tony, Emmy and Grammy was Rita Moreno. She is now 89.
James Vogt, 610-260-2214