Dow Jones recently estimated that technology stocks account for nearly 40% of the S&P 500 index, against a peak of 37% during 1999’s dot-com bubble.
Back then, they were operationally weak, making them an overpriced speculation on the future, as soon as interest rates rose. As for now, no one knows which way to jump.
With central banks keeping interest rates close to zero investors seem to be happiest to trust to a nice story involving a bit of disruption without worrying too much about the detail
Tech stocks are certainly operationally sound and positioned to benefit from disruption and the pandemic. But their share ratings are not only too high but failing to price in pending investigations of their market dominance.
Elsewhere, old economy stocks are cheap but they could stay that way as a result of the way uncertainty is undermining consumer demand and debt plus the price of oil and property.
The markets continue to need massive support from central banks, led by the Federal Reserve, to function during this period of uncertainty. But this has left everyone in liquidity trap marooned in an anxious market, chasing momentum and unwilling, or unable, to develop a long-term strategy.
Rather than fiscal relief to encourage consumer demand we are only getting political uncertainty, typified by the US presidential election.
Perhaps this will change but Andrew Dyson, chief executive of asset manager QMA, is worried because Covid-19 is continually robbing investors of their long-term conviction.
“There is no real precedent we can use to guide us with any confidence,” he says. “I see shorter-termism strengthening across the industry and its decision chain. If we were right to try and focus on the long term before, then we will surely regret losing sight of it now.”
The market has become desperately short of consistent, reliable, data relating to companies and economies. Even when quarterly, or monthly, data happens to be accurate it becomes outdated as soon as the pandemic changes direction.
The parameters which normally drive the market have ceased to work.
Asset manager Verdad has carried out research into whether or not the market cares about profitability in Europe. It says: “The most profitable small value firms have returned -23.6% year-to-date (versus -11.1% in the broader small value category). The most profitable large growth firms returned 3.1% (versus 6.4% in broader large growth). It appears investors would have been better off ignoring profitability.”
According to hedge fund Winton: “The lock down poses a challenge for investment managers whose strategies seek to predict asset prices using models based on fundamental relationships.”
With central banks keeping interest rates close to zero investors seem to be happiest to trust to a nice story involving a bit of disruption without worrying too much about the detail.
Shares rally because of short-term factors. Long-term investments are short-term bets which have gone wrong.
Dyson says: “Rather than acknowledging what we can’t know, we start putting too much emphasis on the short term data than is available. The rate of change of short-term data gets hugely extrapolated, or interpreted far beyond its relevance.”
Diminishing interest in the worth of fundamental data is a big factor behind the death of value investing outlined in Family Capital early this year.
Ted Aronson’s $10 billion AJO Partners of the US is the latest value fund to shutter, following an exodus of clients.
Investors are continuing to switch to passive funds which are tending to strengthen growth stocks. Asset managers employ plenty of active managers who are capable of betting the other way, but they tend to keep switching to growth.
Momentum has been increased by retail investors. Many of them use accounts offered by the likes of Robinhood, which offers commission-free trading. Its clients love to chase a trend, but rarely bother with what lies behind it.
For the record, the most popular stock on the Robinhood list is Virgin Galactic, which is years away from making a profit but happens to be the world’s leader in space tourism. Which makes a nice story until you remember space tourism doesn’t exist yet.
The venture capital industry has been another valuable source of tech-driven growth. Many of the world’s largest businesses, like Uber and Tesla, have evolved out of the sector.
Third-quarter VC exits were the second-highest on record at $104 billion according to the National Venture Capital Association, with levels of investment staying resilient at $37.8 billion.
Again, venture capital promoters are lucky because they only need to offer investors a decent tech-driven story rather than hitting a revenue target.
VC also has an ability to hide its tracks when the going gets tough. Family offices can ask some pretty smart questions. But investors often fail to trouble themselves with inconvenient details. And the same goes double with private equity.
That’s because VC, and private equity, have been adept at pulling off a succession of funding rounds. At some point, if targets get missed, they need to offer generous terms to new investors which put earlier ones at a disadvantage. But problems have been few.
Listings through blank-cheque SPACs are an excellent way to achieve a smooth listing of a private company. They also minimise the time available for critical analysis before an IPO takes place. But again, most times, the listing process has been working well.
Large VC concerns have badly disappointed their backers from time to time. Examples include WeWork (office rentals) Juul Labs (vape distribution) and Nikola Motor (electric trucks). Larger ventures like Uber and Space X have been burning through capital.
But liquidity is continuing to flow, defying a 2012 survey of the industry by Harvard Business School which warned that 75% of VC start-ups were doomed to fail.