Bubblelicious or the New Normal? What Market Segments May be Telling Us

One of the challenges that investors, large and small, tend to face is recognizing when investments seem overextended. More often than not, the evidence bears itself out after the fact. Other times, it seems a bit more obvious on the front end. When we're in the thick of it, we're not so sure.

Jim Bianco of Bianco Research (@biancoresearch) shared the chart above via Twitter on Wednesday, January 20th. It is a chart of the Goldman Sachs Non-Profitable Technology Index over the past seven years. As the name implies, this index consists of upstart technology and e-commerce companies that have yet to turn a profit. Truth be told, until his post, I did not know such an index even existed. I struggle even while writing this to imagine a group of finance folks sitting around a table several years ago saying, "You know what we need? We need an index that tracks nothing but unprofitable tech companies." My head hurts just thinking about it. That index? It's up over 400% since March of 2020. How does that make your head feel?

One need not be an expert in analyzing stock market charts to think that the performance since March of 2020 might be on the high side of frothy. Looking back over the six years prior, we can see when investors didn't have much of an appetite for unprofitable companies, as is often the case when investing in general. If it were offered as a basket investment (it doesn't appear to be), it would have required an incredible amount of patience with negative net returns over that time.

Since March of 2020, however, investor interest in these companies has surged. The common denominator seems on the surface to be Covid-19. To this day, most of us are still working, shopping, dining, exercising, and entertaining ourselves from home. If any industry has benefitted from Covid, it's been tech, but does that explain the meteoric rise in hydrogen companies or electric car companies where the only revenue they can show is from the install of solar on the CEO's roof? Or have investors, like a moth to a bug zapper, been sucked in by the light, creating an element of delusion that these companies represent the new normal? Is this emblematic of a bigger momentum or emotional bubble issue that could be brewing for the markets?

For years, social scientists have tried to figure out what makes investors tick. One popular theory is that markets and investors tend to go through sentiment or emotional phases that look like the chart above, courtesy of Hofstra University. There are many others out there if you Google "Phases of the Investor Cycle." Some are quite entertaining, but the theme is consistent.

The chart breaks market cycles into four distinctive phases, starting with the stealth phase when the so-called "Smart Money" puts cash to work and into areas that markets may have yet to appreciate. It is also often a time when social interest in the stock market is somewhat deflated. Eventually, we move through the awareness phase before reaching the all too memorable mania phase. In the mania phase, the general public has caught wind of market successes and has done a full-on cannonball into the speculative swimming pool in fear of "missing out." The Smart Money heads for the exits, seeking greener pastures and perhaps apologizing a bit along the way for missing out on the boom times. At the same time, the most enthusiastic investors keep bidding investments higher. Mania eventually leads to the elevator shaft, metaphorically speaking (for most) when capitulation takes root. During the blow-off phase, the cycle rolls over at maximum despair back to the stealth phase. When comparing the two charts, where might you think we are in the cycle? Did Covid take us from despair straight to mania? It seems plausible.

We all know someone who, in the past, played hot potato a little too long when it came to their investment portfolio. They got too greedy, too leveraged, and way too concentrated, and had no process to rebalance their holdings. Maybe it was during the dot.com boom in the late 90s, the real estate hysteria that led to a financial crisis, the oil price explosion in 2008, or the gold boom in 2012? For those who have seen our fair share of market cycles, it's easy to feel a little foolish or perplexed that during a pandemic with mass unemployment and massive stimulus just to keep the wheels on the tracks, the top-performing companies would have been those losing $1.50 or many multiples more for every $1 generated in revenue. And forget about earnings. Profits are for suckers. In fact, per a Financial Times article on the 20th centered on this same index, the author speculated that "if they were making profits, it would be an admission that their end markets aren’t as big, or as lucrative, as once thought."

Bubble or the new normal? The markets will decide.

UPDATE: October 2022

Thanks to the Daily Shot, we now have an update on the performance of this index. It has fully round tripped (and then some) to it’s post-covid pre-surge levels, relative to the S&P 500. I think this answers our question for us.

Brian Aberle, CFP®
President, Aberle Investment Management

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