In this Adviser You Can Talk To Podcast, Chairman Dan Wiener and I, Chief Investment Officer Jim Lowell, discuss if we’re in a market bubble and if any investment opportunities are still attractive to us.
Hello. This is Jim Lowell, and I’m the chief investment officer at Adviser Investments. I’m here with another Adviser You Can Talk To Podcast, and I’m joined by Dan Wiener, Chairman of Adviser Investments. And today we’re going to discuss whether or not we think we’re in a market bubble. Market prices being driven rapidly higher by fear of missing out rather than fundamentals like earnings, interest rates and economic data. How do we at Adviser Investments manage near term risks, including the risk of irrational exuberance in market bubbles while pursuing long-term returns? Dan, let’s jump right in. What is a market bubble? And do you think we’re in one?
Well, I hoped you were going to ask me that question because, first of all, there is no definition of a stock market bubble. It’s very easy to define what a bear market is, a stock market correction, even what signifies a new bull market, but what is a bubble? To my way of thinking, it’s when stocks of all kinds are selling at inflated prices relative to their historical or expected earnings, relative to any reasonable approximation of their book value. At prices that are well beyond what a stock could reasonably expect to pay in terms of dividends.
But it’s also when companies don’t have viable businesses and they’re valued as if they do. Those, to me, are bubbles. I think when we talk about bubbles, a lot of times people, ourselves included, think back to the late ’90s or 2000 when we had a classic bubble. But it was a tech bubble. It was tech stocks where you had not just low earnings or no earnings in these stocks, but they were selling at incredibly high prices based solely on unrealistic expectations about their potential for growth.
You had pets.com as the classic example. But Cisco was in a bubble. JDS Uniphase was a bubble stock. Many, many other stocks followed suit, but it really was in the tech sector. It wasn’t the market as a whole. Because when that bubble popped and the market cratered, and actually the market went down from August of 2000 until it bottomed out in October of 2002. But in 2000, when that market fell down, health care did really well. So, clearly, the entire market wasn’t in a bubble.
In the past year, we’ve seen companies like WeWork. They were definitely in a bubble and that bubble burst before it got to the public markets. But the way it was being valued by private investors, that was a bubble. So, I’m sorry, I don’t think we’re in a bubble right now, but I do think that there’s big bifurcation in the market between some of the mega-cap tech stocks, some of the hot stocks: The Pelotons, the Teslas, the Zooms, the Etsys. They could be in a bubble. But there’s a lot, a lot, a lot of stocks that are not.
You know Dan, I think that’s exactly right. When I think of bubbles, I think of manias. So, you mentioned pets.com. That was the stock puppet for the ages. I think of tulip bulbs, Florida swampland in the 1920s. And I’d say, we’re not seeing signs of that kind of mania so much as, maybe you could characterize it as manic momentum, which like the tides can work both ways. Currently positively, but for good reasons as well as hopeful outcomes. It’s not as if the drive into technology names is just simply willy-nilly. There are fundamental reasons to like technology names. Many of those companies are real companies with real artists, real products. And we know that the coronavirus, while it’s cast a pall of uncertainty over the global economy, has actually accrued to the benefit of many, many technology companies.
And with Fed fiscal and furlough stimulus, not just here but globally, and hope for a vaccine, there’s reasons to think that we’re not so much in a bubble as we are in obviously a massively supported market rally. And I would say, technology is not the whole market as you pointed out. And technology is different this time. One of the phrases that we do not like to use on any frequency, but the reality is that you can hardly even brush your teeth without having technology involved these days. It’s become ubiquitous and real. And in terms of the crowds clamoring for and focus on technology stocks, I mean, we don’t think it’s wrong minded, but it does create vast areas of market sectors, industries, regions that are absolutely being overlooked. And what matters to us, of course, is which companies are best positioned to provide goods and services to meet the highest and most sustained consumer demand, not just U.S. but global consumer demand, business-to-business demands in times of COVID-19 and hopefully, soon, beyond such time.
Sure. The term bubble is really great for headlines. I mean, it can really suck you into a story. But how do you call this a stock market bubble when sectors like the consumer discretionary sector, which of course is being driven by Amazon, and the technology sector are up over 20% for the year? But REITs, utilities, industrials, financials, energy stocks, they’re all in the negative category. They are at losses for the year. So, very hard to call the entire market a bubble. I think it’s simplistic to say, look at Apple, Microsoft or Amazon, they’ve had these fantastic gains over the last 18 months or so, and say, they’re in a bubble. But I personally, I think it comes down much more to, how do you get a valuation on a stock if you have no idea what they’re going to earn?
And we’ve seen over the past year, since the COVID outbreak and the shutdown of the economy, that corporate management has been unable or unwilling to make predictions about their expectations for earnings, given that they really don’t know how quickly the economy is going to respond to the stimulus. They don’t know how quickly it’s going to rebound. But you do have companies, as you said, like the Apples, the Microsofts, the Zooms, Amazon, that do have a good view on where their earnings are going to come from because their businesses continue to prosper. So, they may not be in a bubble. They may actually be well valued and you might say that the rest of the stocks in the market are actually undervalued because of uncertainty.
So, Jim, if you buy my premise where some stocks are highly valued and are probably closer to a possible short-term pop, like we saw last week, and others are undervalued…you’re chief investment officer, talk about where we’re finding the values in the market today?
Absolutely. And as chief investment officer, I’m complemented by Jeff DeMaso, our director of investment research, and a team of excellent analysts to scour the globe for managers who are expert in bull, bear and in different markets, and who are constantly focusing on ways in which they can enhance, not just the return side of the portfolio, but also mitigate near term risks that are known and also the potential for unknown risks. I’d say opportunities abide and abound in this marketplace. And that in fact, crisis while profoundly uncomfortable, actually help to create those opportunities. Whether it’s still within the technology sector where, of course, superior stock selection will be key or in, as you mentioned, some of the more value-oriented areas of the market, which really have been overlooked, discounted, underappreciated here in the U.S. but also globally. And speaking of the globe, the world is a vast marketplace with a lot of complex intricacies that interrelate the markets, but also separate them.
So we think the lost decade in Europe creates profound opportunities, plentiful opportunities in the hands of a good stock picker. We also think in the emerging markets, which behave differently, emerging market to emerging market, but also relate to the overall macro market trends of the leadership markets, that there are absolute opportunities. We think in the small- and mid-cap names, perhaps in particular, companies in the emerging and international space that cater to their own consumers so they don’t get involved in issues like currency or trade wars. They have probably some high potential for long-term returns, even if the near-term road, especially with regard to emerging markets, is always bumpy.
I think you’re hitting on one of my favorite topics, which is, the small-, mid-cap arena overseas. It’s something you don’t hear a lot about, particularly when people are focused on what’s going on in the U.S. And you’ve got Apple, which is, Apple stock by itself is bigger than the entire FTSE 100. But one of our analysts did a lot of looking at small-caps overseas and determined that you do not pay a higher risk premium for the higher returns overseas in the same way that you do in the U.S.
That’s absolutely right. And her analysis, Dan, really changed the way you and I viewed the small-cap marketplace in emerging markets.
I was going to say, [it’s] one of the reasons why we believe in our collective IQ rather than just our own individual acumen. I would also say that, while we certainly like the international and emerging markets, the small- to mid-cap names, there’s also one major marketplace that we think benefits from a duopoly.
So, U.S. being on one side of the duopoly, China being on the other. And while we know that trade war issues are always going to be present (after all, fairness is a concept, and like beauty it’s often in the eye of the beholder), we think that over the next one, three, five, 10 foreseeable future years, that it’s going to be in the best economic and political self-interest to trade more not less, between U.S. and China.
And by the way, that kind of trade relationship accrues to the benefits of small- and mid-cap companies that cater to China, that cater to the U.S. So we do think there’s a virtuous circle even if the current immediate cycle still has that pall of uncertainty thanks to COVID-19.
When you were talking about an economic duopoly, I thought you were talking about Amazon and Walmart. They are their own economies I think.
Listen, since we’ve talked about this divergence in the market, one of my favorite topics, we’ve talked about this several times: The persistence of headlines claiming that value stocks are going to make a comeback. The corollary is, of course, that growth stocks are really overvalued suggests to me that, I guess, we have to address this again, particularly given that a week ago we saw these growth momentum stocks, the Apples, the Amazons, the Teslas all take a dive. They dove, what? About 11% overall before rebounding. And of course, the headline writers were trotting it out once again. Value’s going to make a comeback.
What do you think about the growth versus value debate?
I think it’s wise to be agnostic. What we want are managers who know how to find growth at discounted prices, which is obviously a good value, but there’s also real value in necessary businesses that at least in momentum times like these get overlooked and underappreciated. So, we think they have hidden and unlocked growth potential. We focus on managers whose track records, as I said, in bull, bear or in different markets, have withstood the test of many turbulent times. Not that past performance is any guarantee of future results, but the managers we invest in tend not to be wedded to a particular growth or value style. They are flexible, focused on the best investment ideas at the best price that they think will tend to fare well over an investment [timeline] rather than a trading or momentum timeline.
Do you have any further thoughts on that Dan?
Well, I’m going to back up a second and say, you’re repeating the SEC’s line about past investment performance not guaranteeing future results. But, in fact, the way we analyze managers, is we do look a lot at their past performance. And we look at their past performance over various market conditions and economic conditions. And we look at their portfolios, and we look at whether they continue to pursue the same strategy with the same vigor and same analysis as that. And if they have, you know what? I think past performance does give you a very good indicator as to how they’re going to do in the future. I mean, if it didn’t, where would we be?
It would be a fool’s errand not to incorporate it into your judgment of how, where, when and why to invest completely.
Yeah. Yep, yep. Yep.
So, Dan, we’ve touched on some of the opportunities we see, but what could burst this market’s bubble? And could a tech bubble bursting lead to a broader market sell off? And maybe a corollary: How do we safeguard against sudden and possibly sustained losses not just today, but in the future in our portfolios for our clients?
Yeah. Well, first of all, I do think that you would see a broader market sell off if the most popular stocks all of a sudden burst. If you saw big drawdowns on those stocks. I don’t think that that means that the entire market goes down forever. So sustained, I’m not so sure. But yes, typically there’s a lot of momentum in the market. And if the popular stocks, if the popular kids all of a sudden break out with acne, everybody is going to.
But as I said, I don’t think we’re in a bubble. I do think we’re at some pretty rich short-term valuations, which means that there’s an opportunity here for short-term disruptions. I’ll tick off a few and I’m sure you’ve got 40 more to give me:
Rebounding infections from the coronavirus. Big, big rebound as kids go back to school. Kids go back to college. People try to reopen offices and businesses. If we see a big rebound in infections, that could lead to more economic shutdown and then people get worried and they take their profits.
Vaccines that get distributed, and then they’re found to be either impotent or possibly lethal. There were some questions earlier last week about whether some of these early vaccine tests, whether there were some negative reactions.
Political dysfunction. I mean, we’ve already got it. There’s probably a lot more to come as the election approaches. And the comments from the spokesperson, from the HHS the other day about militaristic implications, keeping your guns and ammunition at the ready. That worries me quite a lot, because if people listened to that there could be some blood in the streets, which would not be good.
A large corporate fraud is always a possibility. A big fraud could send the market down.
Extremely high and unexpected inflation. So, there’s been a lot of talk recently about both the fact that inflation does seem to be rising a little bit, that investors have expectations for higher inflation down the road, if you look at the relationship between inflation-protected bonds and nominal bonds. And then of course, the Federal Reserve Bank has said that they are going to let inflation run a little hotter than normal. They think that that’s a good thing. So, all in all, while there’s an expectation that we’re going to see higher inflation, if we got a big burst of high and unexpected inflation that could send stocks down at least on the short term.
I don’t like to say it, but a political assassination on either side of the aisle, given the extreme divisions in the country today, could definitely have an implications for the stock market and martial law. We’ve seen a lot of talk about law and order, if that led to some lockdown in major cities, I hope we don’t get there.
But all of those things are the kinds of things that could drive at least a short-term fast drop in stock market. So, that’s just a few of the bullet-point ideas I have about what could throw the market into a spin at least temporarily. All of course, would be in my view, short lived phenomenon, but it would happen.
So, Jim, I’m sure that if I came up with 10 ideas you are going to come up with 20, what do you think?
So, from rebounding coronavirus infections, those will be measured against mortality rates and age of populations most vulnerable to infection and mortality. So, in effect, it’s a known risk, maybe quantifiable.
Political dysfunction. Clearly nothing new. But the imagination of what might go wrong after votes are cast continues to escalate above and beyond prior election hysterias, and this go around the issue of how one can vote or whether or not such votes could be accurately and fairly counted is clearly more concerning than at any time prior.
I agree [on] major corporate fraud, always a possibility. Maybe if it was Tesla, that could really rock the markets for a while before the markets plug back into the reality and charge ahead with the understanding that Tesla’s not the whole market.
Major geopolitical events. War, natural disaster, earthquake, manmade disaster, think of Fukushima, can never be ruled out. But our job is to rule them in and add rational measure to the investment discipline that we practice.
Right. I mean, we’re in a time where all of those could still happen. It’s just that we are compounding it with the overhang of the pandemic, the overhang of a very contentious election season. And as you said, political dysfunction is just above and beyond.
No question about it. We’re always looking at the risks that could impinge not just long-term performance, but near-term performance as well. And I would say that extremely high inflation would be extremely unexpected, but it wouldn’t happen overnight. But nevertheless, with so much money sloshing around the image of workers with wheelbarrows of worthless Deutsche Marks does run through my mind occasionally at 2:00 AM.
Overall though, our discipline is always focused on being able to manage risk meaningfully well. And so, we continue to stick to our discipline that has helped us stay the course through many, many difficult market moments.
We’ve been talking bubbles and there’s another bubble out there, I think. And that’s a bubble in the number of companies that are racing to come up with a vaccine for the coronavirus. For months, Jim, I think, and you were one of the first to say that the medical data was going to be driving the way we frame both the assessments of the economy, assessments for further stock market moves, and of course, earnings that would drive stocks. Where are we? Where do you think we are in that bubble?
I think medical data still is the most important factor in terms of understanding where we are, where we may be going economically speaking and market wise, in the very near term. I mean, if there was suddenly global consensus that no vaccine could ever be found, that would be concerning. But is it probable? Absolutely not. As you mentioned, we’ve got many, many brilliant companies riding to the COVID-19 rescue. And I think that it’s rational to be hopeful that a vaccine will be found, probably irrational to think that a vaccine will be found this side of this year, or that it could be implemented on scale globally, even any time next year.
So, we’re going to be in this state of uncertainty for some time to come. But belief in better days as a way of fulfilling its own destiny is human nature, and while it certainly has some ills, it also has some tremendous strengths. And one of the things that we have witnessed over the last several months is just how as a country, as a nation, as a world, we really can come together and address some of the most extreme issues. We, obviously, are always capable of doing better. Dan, with that, let’s wrap this up. And let’s hold off comments on third quarter to the third quarter where we can weigh back in while we get more recent economic data.
Gee, I thought we’d talk about the V-shaped recovery. Now it’s starting to look like that old-fashioned division sign we used to do when we did long division in grade school. It’s starting back and now starting to flatten out.
Well, we will see what kind of recovery we get. We are in, I would say, slow recovery, not no recovery. We can be thankful for that. We know that there are reasons why slow recovery, not no recovery can sustain itself, but we also know there could be some negative impacts to it. So, it’ll be a stairstep pattern. One that we are obviously together with the investment team paying day-to-day attention to.
And on that note, this has been Jim Lowell and…
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