Investment

Up, Up, and Up the markets goes – when will the good times end?

Time and again, investors have come unstuck during momentum-driven markets by falling in love with a good corporate story, untroubled by sordid financial reality.

Goldman Sachs has just produced an index of non-profitable tech-driven companies whose share prices have tripled since the Covid crash of March 2020, after travelling sideways for years.

Everyone is chasing everything, regardless of what it is, whether it’s a penny stock with a similar name to so something Elon Musk mentioned in a tweet, or whether it’s Tesla stock itself

The companies include fuel cell specialist Plug Power, electric car specialist Nio and online outfit BiliBili.  Relatively established companies – such as Pinterest, Snap, Peloton and Spotify – are also constituents.

Several of them have intriguing prospects and promise to disrupt their sectors enormously. Others will not fare so well. But none of this matters to investors right now.  Strategist Jim Bianco of Bianco Research says: “The chart says a lot about today’s market.”

Cathie Wood, founder of Ark Securities, became the world’s top-performing equity manager in 2020 after spotting key innovation trends. She has now become a stock market icon, with her brand attached to clothing merchandise.

Companies are raising bond and equity finance at twice the normal rate. New listings are also producing pleasant pricing opportunities, thanks to cheery narratives served up by companies yet to come unstuck in the public arena.

Over the last twelve months, an ETF sponsored by Renaissance Capital, which tracks IPO prices, generated a 110% rise, or six times returns from the S&P 500.

Blank-cheque companies (SPACs) have enjoyed an even more amazing run after raising $6 billion a week during 2021, to create cash totalling $90 billion.

SPACs provide a speedy, and effective, route for entrepreneurs, and family offices, to list their companies on the stock market via a reverse takeover. The terms tend to be softer than an IPO. But investors are happy to travel hopefully.

Sentiment has been boosted by the Federal Reserve sticking to a policy of keeping loan rates at rock bottom to keep the US ticking over during the pandemic.

Traders have been inspired to follow their dreams by borrowing money secured by their stock holdings.

Wolf Richter has a commercial background and writes a blog called Wolf Street. He recently calculated US borrowings on margin rose by $63 billion in November and a further $56 billion in December. This took the total to $780 billion, a year-on-year rise of $200 billion.

The data supplied by Finra, only comprises part of total leverage. But there is little doubt that debt has super-charged their purchases of the market’s hottest stocks.

Richter says: “Everyone is chasing everything, regardless of what it is, whether it’s a penny stock with a similar name to so something Elon Musk mentioned in a tweet, or whether it’s Tesla stock itself, or any of the electric vehicle makers or presumed EV makers that might never mass-produce EVs….”

Private investors have also gained the opportunity to buy and sell stock without paying commission through Robinhood and other dealing services.

They often hunt in packs using messaging carried by Reddit and other sites.  They recently bought into loss-making video game retailer GameStop to counter other investors with short positions equivalent to 140% of stock in issue. The squeeze on the shorts has multiplied GameStop shares several times over.

BlackBerry has just become another target for the Robinhood crowd following news it wanted to move into cybersecurity.

That was all the punters needed to hear and their buying activity promptly pushed up its share price by a half.

Investors will, no doubt, continue to buy stocks as long as they keep moving higher.  Then it will be up to the regulators, and the Fed, to decide when to make their life tougher.

It is quite possible that the regulators will seek to cool off parts of the market. Treasury secretary Janet Yellen, for example, said that she expects to see more effective regulation of bitcoin. We could also see greater regulation of margin debt by the Biden administration plus greater scrutiny of SPACs.

It is, however, a tightening of the Fed’s monetary policy, leading to a hike in interest rates, which is most likely to stop the euphoria, as was the case after the dot.com bubble of 2000 and the credit boom of 2006.

This could happen if, or when, we see a resurgence in the rate of inflation, anticipated in Family Capital on 12 January. Global economies are already seeing sharp rises in a range of manufactured goods, agricultural items and oil.

Stress in supply lines is leading to a rise in freight costs. Parts of the residential property market are heating up, producing a rise in building materials. The cost of services is at an elevated level. The rise in the value of stock market assets is another aspect to the trend: the richer people feel, the more likely they are to buy goods and services.

The latest CPI data has been reassuring, but many believe it flatters to deceive. In its 22 January update, purchasing data provider IHS Markit said: “Inflationary pressures intensified as supplier delays and shortages pushed input prices higher. The rate of input cost inflation was the fastest on record.”

It must be said, excellent returns can be generated in periods of exuberance. With Covid-19 still stalking the world, the Fed will not apply the brakes too fiercely for a while. It has already said it will be happy with a modest rise of inflation.

Even so, let’s be careful out there.

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