Since our last monthly update we have seen the Presidential election mostly come and go, have seen the coronavirus cases spike, and have learned of two successful vaccines. The country is split in terms of satisfaction with the outcome of the election, but investors are looking past the surge in the virus to the potential endgame the vaccines present. That optimism is reflected in the performance of the S&P 500 index. Year-to-date the Index has generated a total return of 13.5% at the time of this writing. It seems investors are anticipating that the economy will return to the growth it was experiencing this time last year, before anyone was locked down and working from home. Surely there is pent up demand for travel and leisure activities. However, there is still an outsized number of people out of work and with the recent uptick in cases we can likely expect that number to climb further.
The Federal Reserve continues to verbally assure the public that they will keep monetary policy and interest rates at ultra-stimulative levels even after growth returns. However, in doing so, they stimulate merger and acquisition demand which is supportive of equities. Similarly, the ultra-low rate environment does not deter corporations from the practice of selling debt to buy back shares in their outstanding stock, as they’ve done since the Fed first cut rates in 2008. However, it seems to us that in addition to the institutional stock purchaser driving prices higher, so too are retail investors. Never before has equity trading offered such a level playing field. The traditional stock brokerages have driven the cost of buying and selling shares close to zero. In addition, newcomer Robinhood Financial, charges zero commission and offers tutorials to novice traders. These novices trade stocks based on concepts and rumors, turning a blind eye to valuation. Examples abound of stock prices trading at absurd Price/Earnings multiples simply based on a hope.
One that comes to mind is Tesla. Tesla, as everyone knows, was the first mover in the now booming electric vehicle market. They sell an attractive vehicle that owners seem to love. However, Tesla trades at 183 times expected 2020 earnings and the carmaker is just barely profitable. The Tesla shareholders point to the growth potential should everyone ultimately move to an electronic vehicle, which is a valid point. But Tesla is no longer the sole occupant of the electric vehicle space. In fact, every major auto manufacturer has an electric vehicle in their product offering. Even General Motors plans on rolling out an electric Hummer in the near future. But with CEO Elon Musk holding an outsized position in the stock, it’s difficult to short as short sellers have come to realize time and again.
The “Robinhooders” have applied the Tesla story to the Chinese car manufacturer NIO. NIO traded at $4.02 a share at the start of the year, but its price has skyrocketed this year, recently trading as high as $50 a share. The investment thesis is that NIO will become the Tesla of China and with it will come a similar valuation. That’s despite losing well in excess of $1 billion a quarter since they began operation in 2017 and expect to incur losses for the foreseeable future.
The point is not to pick on Tesla, NIO or even the Robinhood traders; it’s to point to just a small sampling of what has become a large bubble in stock prices. When stock prices are rising, it’s easy for the retail traders to believe that they will rise forever. However, when prices correct, and enter a bear market, it’ll no longer be fun for retail traders to participate. The Fed should take note of the retail stock trading and start to plan for an exit from ultra-stimulative monetary policy.
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