As it pertains to the current market, I’m not certain what is going on in the heads of many investors as they continue to direct a fire hose full of dollars into a very narrow group of tech and internet stocks. For example the current market capitalization of Apple (AAPL – $1.663 trillion) plus that of Microsoft (MSFT – $1.620 trillion), just two in vogue equities, is 40% higher than the June 1, market capitalization of the entire Russell 2000 index ($2.3 trillion). This is reminiscent of March of 2000 when Cisco Corp. (NASDAQ:CSCO) became the most valuable company in the world at a $569 billion market cap (7/10/2020 close $197 billion). At the time this surpassed GE‘s $500 billion market cap.
“The tech stock rally is getting scary … “
According to Ben Levisohn in this week’s Barron’s “The Tech Stock Rally Is Getting Scary. Why There’s Is No Way To Escape It.”
Despite the fact that this narrow group of stocks has gone crazy the author points to the feeling among investors who see their seeming invincibility in the face of the pandemic as a rationale for chasing these names. In my opinion this opinion assumes that COVID19 will be a permanent fixture on our investment scene. It will not be.
Levisohn makes the the point, “Like an Escher drawing hanging in a student’s dorm room, the stock market has begun to look rational and irrational simultaneously. Nowhere is that more obvious than in the Nasdaq”Composite.”
He continues:” Yet, there comes a point when even the soundest argument starts to sound specious, even to those making it, and that seems to be what is happening now. Deutsche Bank analyst Jeriel Ong went on record with his worries about Apple’s rally, yet left his Buy rating intact and raised his price target to $400 from $380.”
“It’s Deja Vu all over again”
As a young broker, I lived thru the “Nifty-Fifty” period of the early 1970’s. To a degree it was very much like the one we are now experiencing. The market had collapsed to 600 on the Dow Industrials. This was on the heels of the Penn Central railroad bankruptcy and the peak in 1966 (around Dow 950) of a secular bull market where, as Warren Buffett would quip, we “got to see who was swimming naked.” There were a lot of companies swimming au natural.
Portfolio managers flocked to the safety of large cap dependable growth stocks (“Nifty Fifty”), “ruler stocks” (you could place a ruler under their upward-trending chart patterns and they would track beautifully, no hiccups). They were “one decision” stocks. You just buy ’em and hold ’em. Many of these names sold at multiples of 50 times earnings and higher… names like Polaroid, Eastman Kodak, Avon Products, Xerox, IBM and Merck.
This worked until it did not. The secular bear market deepened in the 1970s. these stocks because of their valuations were destroyed. For some it took more than a decade to regain their former stature. Some never did.
Remember, Cisco was the largest market cap company in the world at the 2000 peak of the dot.com bubble-$569 billion. For Cisco it has been 20 years and its market cap is still $372 billion below its 2000 peak.
Are we headed into another secular bear market like the 70s?
Certainly… one of these days. I don’t now is the moment. Even if the current market leadership brakes I have a very tough time seeing this turn into a rout. First and foremost there is $2.3 trillion in stimulus (with maybe more to come) bolstering the economy. Interest rates are incredibly low (.67% on the UST 10-year) with a Fed that appears in absolutely no hurry to change policy. There is a record $5 trillion in money market funds and significant assets in bonds paying nothing. All of this represents a huge amount of dry powder. The cash hoard speaks volumes to the fact that most people were fearful about and did not trust the 11 year secular bull market run that began in 2009. They still don’t (AAII survey 7/8/2020).
To me it would seem that there are big opportunities to be had away from the large cap tech area as the economy returns to normal (post Covid) footing. We are certainly not there yet. By July of 2021 this certainly could become more apparent and by then if you choose not to act now, you could be too late. The market is a forward-looking mechanism.
What were they thinking of?
I have to give kudos to a favorite source of mine Jeff Miller (his current post suggests we may want to think about hedging) kudos for the question and my title. His latest post pointed me to a great article by Jesse Felder,”‘What were you thinking?’ Part Deux”
Felder put up a post several years ago using a quote from Scott McNeely, founder and CEO of dot.com star Sun Microsystems. I think his words bear special relevance to certain of today’s high flyers.
“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
I’m certain that there are questions in the minds of many about what happens if the Democrats sweep in November. My answer is that it may have a short-term deleterious effect on the market. Longer run it means very little. In the final analysis, like the Republicans, the Democrats will want to remain in power. There may be tax increases but it is unlikely they would risk throwing the economy under the bus to please fringe elements of the party. If you would like a more in-depth discussion on this topic see “Biden big lead”
A final point… I am very bullish on the broad market. My cautionary post today reflects valuation concerns about large but narrow sector of the market. Year-to-date the Russell 2000 is down 14.7% while the Nasdaq composite is notching new records daily and is up over 18.33%. Many tech names will probably do fine in the long term but taking a few chips off the table may be in order at this point. A focus on the broad market may be more rewarding as we move forward.
In the interest of full disclosure I have sold covered calls against my Apple position. I am also long individual small cap growth and value issues.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.