We start this edition of Market Factors with a comparison of current market leaders with the tech giants of the late 1990s, and move to a value manager’s argument that the investment style is a profitable hedge for investors. The diversion describes what DARPA, the research wing of the U.S. military, is up to and we look ahead to the important data releases for the coming week.
The ticker over the main trading floor of the New York Stock Exchange as the Dow industrial average passes the 10,000.00 point level for the first time in March 1999.Mike Segar/Reuters
Equities
No 1990s-style market frenzy yet
Many investors are too quick to equate the current market with the late 1990s. Yes, technology stocks dominate the U.S. benchmark and yes, the overall market is expensive relative to history. But I was there in the late 1990s, on a major trading floor, and this is nothing in comparison.
Alan Gula, an analyst at Baltimore-based Stansberry Research, attempted to explain the frenzy of the previous tech bubble in a recent report. He opens by writing, “It was a proper mania complete with unbelievably reckless trading, out-of-control price action, and beyond absurd valuations.”
Mr. Gula pointed out some recent-ish IPO insanity: Newsmax rose 730 per cent on the first day of trading last March and Circle Internet jumped 168 per cent on its first day. That’s nuts - but in 1999, ludicrous stock jumps were an everyday occurrence. The report notes that there were 470 common stock new issues in 1999 and the average return on the first day of trading was 71 per cent.
The major equity benchmarks didn’t just climb, they rocketed higher. Between 1995 and March 2000 the Nasdaq was up 1080 per cent (not a typo). The current trailing five-year appreciation for the Nasdaq 100 is 125 per cent.
The most popular tech stocks now are cheap relative to the tech leaders of the late ’90s. According to Goldman Sachs research, the biggest company back then, Microsoft Corp., was trading at 69 times forward earnings. Nvidia Corp is the biggest now and it trades 30 times forward estimates. Cisco Systems was the second biggest stock back in 1999 and it traded at 101 times forward earnings.
Microsoft, now the second largest stock, is trading at 32 times forward earnings.
All in, Mr. Gula found that 62 of the biggest 1,000 companies in March 2000 had PE ratios above 100. Currently there are 29, including Tesla Inc., Palantir Technologies, Snowflake, and Cloudflare.
Mr. Gula grants that the S&P 500 is enduring record concentration but the stocks are not getting insanely expensive as their market capitalization swells. Tesla Inc. is the only stock at truly absurd valuations – 218 times next fiscal year’s earnings.
The comparison between now and the late 1990s provides valuable perspective for investors. For one, it implies the potential for tech stocks to rally much stronger and for longer. This is not a foregone conclusion of course and relatedly, if the market does peak soon we can expect the market-related damage to be much less severe than in 2000.
Richard Bernstein, chief executive of Richard Bernstein Advisors LLC, speaks during the Reuters Global Investment 2019 Outlook Summit, in New York, November 12, 2018.BRENDAN MCDERMID/Reuters
Strategies
The case for value
I recently met with a value-oriented fund manager I’ve known since before the first technology bubble collapsed. The manager’s decently grounded belief is that the onset of inflationary pressure represents the beginning of a new, extended cycle of value stock outperformance.
I am aware that asking a value manager whether cheap stocks are set to outperform is like asking a barber if you need a trim. The timing is interesting, though. The technology domination of the S&P 500 is excessive and temporary, so a value portfolio with minimal tech exposure would help protect portfolio assets in the event of a tech sell-off.
Value stocks are an interesting prospect as a hedge against volatility even if they don’t immediately outperform. There are sectors and regions that have been ignored in favour of U.S. technology for years and are now inexpensive relative to history.
The trailing performance of neglected stocks sucks but that’s part of what might make them attractive. As RB Advisors founder Richard Bernstein is fond of saying, “returns are best where capital is scarce” and capital is certainly not scarce in the AI-related technology sector.
Diversions
Watch out for insect-shaped drones
Italian-American academic Mariana Mazzucato famously started her talks by holding up an iPhone and describing how most of the major technology – the internet, GPS, touchscreens and lithium-ion batteries – were developed initially by the U.S. military and intelligence community. (Her point was that the public sector’s ability to innovate is underrated).
A post on the Futurism website described what DARPA, the research wing of the U.S. military, is up to: insect-sized spy drones. The drones use thin wings flapping rapidly just like real bugs. The mini-machines are not carrying microphones or cameras yet but DARPA’s near-unlimited budget should take care of that shortly.
Allegedly DARPA’s development of a 10-centimetre long mechanical cockroach is well underway, an alarming thought for the week.
The essentials
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Globe Investor highlights
Tim Shufelt looks at how the Canadian stock market became great again and also reports on household holdings of stocks hitting record levels
David Berman warns against jumping into Freeport-McMoRan’s shares after their big selloff last week
Larry MacDonald’s TSX short sales report this month reports on how stocks with the highest short positions are scoring sizeable price gains. Meanwhile, a little-known drone maker has become the most shorted TSX stock based on percentage of float
Reuters reports on how global investors are looking past AI hype to long-term opportunities from government spending
What’s up next
There’s not much in the way of domestic economic news on tap this week as the S&P Global Manufacturing PMI survey on Wednesday is about it. For corporate results there’s Richelieu Hardware Ltd ($0.405 per share expected) on Tuesday and Novagold Resources Inc. (US$0.038) on Wednesday.
The Americans get the ISM Manufacturing PMI survey for September on Wednesday and economists expect a slightly contractionary 49.2 result. U.S. factory orders for August will be released Thursday and a 0.1 per cent month-over-month increase is projected. The perennially overhyped non-farm payroll data is out Friday and economists expect 50,000 new jobs created. The projected unemployment rate for September is part of the same report, and it’s expected at 4.3 per cent.
For U.S. profit reports there’s Nike Inc. ($0.277) on Tuesday and Constellation Brands Inc. ($3.424) next Monday.
See our full earnings and economic calendar here