A dangerous frenzy in the stockmarkets

Is Alibaba's record-breaking New York float a sign that investors are getting overexcited?

It can hardly be a coincidence, says Randall W Forsyth in Barron's, that advertisements for testosterone supplements are often shown on financial cable channels.

High testosterone levels instil the winner's effect', "a useful evolutionary tendency toward confidence for those heading into battle, as well as for successful traders".

But it also "eventually leads to hubris with the predictable results seen in 2008". The bullishness in the US stock-market is looking increasingly irrational.

Last week, the Chinese internet giant, Alibaba, the biggest initial public offering (IPO) or flotation in US history, soared on its first day of trading, jumping to a price/earnings ratio of 61.

Regardless of Alibaba's impressive growth potential, this looks very high, especially considering its dodgy corporate governance. Shareholder rights are so weak that the Hong Kong stockmarket would not allow the company to list there.

The US market is in the midst of a boom in flotations not seen since the dotcom bubble burst, says James Mackintosh in the FT. An IPO frenzy is a sign that "investors are overexcited".

What's more, adds Mackintosh, "leveraged loans are not just flashing red but have a wailing siren and a man walking in front waving a flag". These are loans for private-equity groups buying companies that already have a lot of debt.

More than a third of such loans this year were worth more than six times the target company's earnings. That's only slightly below the multiple seen at the peak of the credit bubble in 2007.

Moreover, a record 60% of loans are currently covenant-light', with less creditor protection than usual.

There are several other signs of irrational exuberance. Margin debt, whereby investors borrow money to play the stockmarket, has reached record levels. The share buyback boom, which has artificially inflated earnings per share, looks set to run out of steam, as we noted last week.

Finally, valuations are high. The market's forward price/earnings ratio of just under 16 is close to record levels. A far more reliable gauge, the cyclically adjusted price earnings ratio, looks extremely high (see next story).

In short, the market is looking extremely stretched just as the US Federal Reserve is set to reverse the liquidity spree of recent years by hiking interest rates.

Recommended

Emerging markets: the Brics never lived up to their promise – but is now the time to buy?
Emerging markets

Emerging markets: the Brics never lived up to their promise – but is now the time to buy?

Twenty years ago hopes were high for Brazil, Russia, India and China – the “Brics” emerging-market economies. But only China has beaten expectations. …
18 Oct 2021
Three dividend stocks from the dynamic Asia/Pacific region
Share tips

Three dividend stocks from the dynamic Asia/Pacific region

Professional investor Sat Duhra of the Henderson Far East Income investment trust highlights three of his favourite stocks.
18 Oct 2021
India: the next global growth engine
Emerging markets

India: the next global growth engine

India's stockmarket is booming, up by 37% so far this year, and the BSE Sensex index has delivered an annualised return over the last five years of mo…
15 Oct 2021
Central banks must carry the can for the state we're in
Economy

Central banks must carry the can for the state we're in

Central banks’ efforts to prevent markets adjusting have led to a dangerous social and financial disequilibrium, says Tim Lee.
13 Oct 2021

Most Popular

How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021
How to invest in SMRs – the future of green energy
Energy

How to invest in SMRs – the future of green energy

The UK’s electricity supply needs to be more robust for days when the wind doesn’t blow. We need nuclear power, says Dominic Frisby. And the future of…
6 Oct 2021
Why the world’s most important economic data release has unnerved markets
US Economy

Why the world’s most important economic data release has unnerved markets

The US added only 194,000 jobs in September, far shorter than the 500,000 that were expected. John Stepek explains why markets didn't react as they no…
11 Oct 2021