Anyone with an entrepreneurial bone in his body in 1720 Britain had his own cash shell company. Charles Mackay, in his classic history Extraordinary Popular Delusions and the Madness of Crowds, called them “Bubble-Companies”. The most famous one (which I’m afraid we can’t prove actually existed) was set-up for “an undertaking of great advantage, but nobody to know what it is”.
The adventurer behind the scheme did know, of course. He collected the cash, issued worthless shares and “set off for the continent”. It sounds silly but it wasn’t much sillier than many of the other bubble companies of the time. My personal favourites include undertakings for the “paving the streets of London”, “importing walnut trees from Virginia”, and “extracting silver from lead”.
No one made any money from these shells, bar their brilliant promoters, and you could say much the same of the shell-company boom of 1999. UK investors may remember Knutsford, a shell designed to invest in ailing retailers: its shares soared from 2p to 270p before going the same way as the idea that you can make money extracting silver from lead. Nothing says “bubble collapse coming” quite like a cash-shell boom.
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Spacs – the new “bubble companies”?
Which brings us to today’s Spacs, or special purpose acquisition companies. These sound grander than bubble companies but come to much the same thing: listed shells that hold no operating businesses but intend to acquire them. There were seven US Spac listings in 2010; there have been more than 100 in 2020, including a $4bn launch from hedge fund billionaire Bill Ackman.
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When you combine the rise of Spacs with other recent market dynamics, there is good reason to worry we may be in a bubble again.
Retail investors have become increasingly active, as often happens in bubbles. The pace of share-price growth of superstar tech companies such as Apple, Microsoft, Facebook, Alphabet and Amazon has been eye-watering – even after its recent falls, the Nasdaq is up over 50% since March. And then there is the nasty underlying economic situation, from which markets appear to be disconnected. It’s all a bubble, right? No wonder global equities are down 7% from their recent September highs.
Valuations aren’t as high this time round
Yet it might not be so simple. Take the Spacs first. They aren’t of the “nobody to know what it is” type of the 1720s. Nor are they the obviously exploitative type of the late 1990s. They are more an attempt by private companies to list, without having to endure trying public regulations and the expensive services of investment banks.
Then there are valuations. In a real bubble, price/earnings (p/e) ratios hit obviously silly levels: 45 to 70 times perhaps, suggests Credit Suisse strategist Andrew Garthwaite. But Nasdaq itself is currently on 31 times forward earnings. The US market as a whole is on a p/e of 22 times and a p/e of 28 times the earnings of the past 12 months, versus historical averages of 15 and 18.
That is not cheap, but it’s not bubble levels either. Take out the big technology stocks and the US’s median trailing p/e slips to 26 times. Markets elsewhere may look relatively expensive, but there are few extremes (some recent Chinese share flotations aside).
There is also a lot of performance dispersion. As of the middle of this month, notes Schroders, the S&P 500 was up about 6% this year. But remove the five tech superstars, and stocks are down 2%. Even those tech giants are not as bubbly as you might think: they have huge revenues and profits. In fact, their profits account for a fifth of S&P 500 future earnings, almost as much as their quarter share of the S&P 500’s $29trn market capitalisation.
Market volatility is down to the virus and governments’ reactions
So if the recent market falls were not, in fact, the start of the popping of a bubble, what was going on? The answer is policy. Markets react to virus news; more than that, they react to the government’s reaction to the virus. The March market crash was an obvious response to the appalling deflationary shock of lockdown. The subsequent rebound was a reaction to the stunning inflationary shock of massive state support.
Now, in just the same way, second-wave hysteria is rising and lockdowns are returning. So markets fell in response: the FTSE 100 dropped 3.4% last Monday following a weekend of lockdown speculation. But then on Tuesday, the UK government ordered the lockdown-lite requirement that pubs must shut at 10pm. And, on Thursday, chancellor Rishi Sunak created another market-boosting and potentially inflationary measure: a less generous, but still expensive, pay-people-not-to-work scheme.
The same may happen in the US. Chris Wood, an equities strategist at US investment bank Jefferies, notes that anyone who thinks the US Federal Reserve will not act before its next scheduled meeting in December has missed the fact that in our new world, “it is the Fed which follows the markets, not the other way round”.
I believe we are nearer the end of the pandemic than the beginning, which helps the chance of synchronised global growth next year. Policymakers stand ready to support markets and incomes everywhere. Next year may even see inflation return. So, for now, hold on to equities — at least until someone offers to sell you an imported walnut tree.
• This article was first published in the Financial Times
