This “jam tomorrow” bull market may be nearing its end

We’ve read a lot this week and at the end of last about Softbank being the “Nasdaq whale”. Apparently the Japanese hedge fund/private equity giant/highly-leveraged sci-fi visionary/WeWork patsy/whatever has been making big bets on US tech stocks.

All of its messing about with options (basically leveraged bets on the market) has reportedly helped to both fuel the recent surge to record highs – and the recent slide. It’s interesting stuff – but I’m not going to go into all the options malarkey this morning.

The Nasdaq has been long overdue a reality check. The real question now is – are we heading for a wider crash?

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Make no bones about it – the US stockmarket is wildly overvalued

There was a fascinating piece in yesterday’s FT from Andrew Parlin, founder of a US investment advisory firm. He was comparing today’s US stockmarket with his experiences during Japan’s bubble in the late 1980s.

You’ll have heard plenty of “US bubble” statistics by now, no doubt. But Parlin pulled out some very striking ones that just emphasise how expensive this market is.

Here’s one: 6.2% of all stocks in the US currently trade at a price/sales ratio of more than ten. We’ve only seen that surpassed once – at the peak of the dotcom bubble in March 2000, when the statistic hit 6.6%.

Why is that significant? Because a price/sales ratio of ten is really, really high. It means that for every $10 in sales – not profits – investors are willing to pay $1.

To get an idea of how unusual that is, Parlin points out that if a company trading on a price/sales ratio of ten, were to earn net profit margins of 20% – “a very high margin indeed” – its price/earnings ratio would be “an extremely expensive 50 times".

Parlin also notes that the ratio of market capitalisation to GDP (sometimes known as Warren Buffett’s favourite bubble indicator) in the US is now just under 200%. The previous high was at around 140% in the dotcom bubble – which is the same ratio Japan hit in 1989, when its bubble burst.

Don’t get me wrong. As Dominic pointed out yesterday, it’s been easier (and safer) to ignore the fundamentals in this massive bull run. And if you are trying to call the top – or at least get an idea of whether it’s time to get out – then the reality is that the only semi-useful timing indicator available to you is technical analysis (charting).

However, it is useful to remind ourselves occasionally that history indicates that this is highly unlikely to last.

This could signal the end of the “jam tomorrow” bubble

So what could end it, at a fundamental level?

Let’s have a think. The tech bubble is part of the “long duration” bubble. Or as I prefer to call it, the “jam tomorrow” bubble. This is built on the belief that money tomorrow is worth pretty much the same as it is today. It might even be worth more.

In other words, the “discount rate” – the rate at which investors reduce the value of expected future profits to account for inflation and risk – is incredibly low, or in some cases, even negative.

To put it even more simply, the view today is that a bird in the hand is not necessarily worth two in the bush. In fact, investors reckon that the two in the bush look a far more worthwhile bet.

Why are investors willing to pay so much for tech stocks? Tech stocks are broadly built on spending money today to build networks that will enable them to semi-monopolise entire business sectors tomorrow.

If money tomorrow is worth as much as money today, then you don’t care how much someone spends right now, if their future income is deemed near-infinite.

Now, even that has a limit (presumably). And one thing to remember about the current jitters in the Nasdaq is that, even by its own standards, the market had run far away and ahead of itself, and probably needed to take a breather in any case.

But has anything fundamental changed, to damage this underlying “jam tomorrow” story?

Possibly. If the Federal Reserve – America’s central bank – becomes increasingly committed to pushing inflation higher, then the “jam tomorrow” case becomes less appealing. Even if the Fed suppresses interest rates (as I suspect it will, via financial repression), higher inflation means tomorrow’s money is definitely worth less than today’s.

That undermines the “jam tomorrow” case. It means the bird in the hand starts to look more appealing once again.

So, just maybe, this is a warning sign of what happens when the market really starts to believe in the inflation case.

Now, Merryn and I discussed this on the podcast late last week. And at that point, I have to say, my gut feeling was that this isn’t “the big one”, whatever that is.

To be clear, we might well see volatility. We might even see a correction (ie, a 10%-plus drop in the market). But I can see the Fed getting rattled by this and trying to step in to reassure the market somehow.

However, as and when we start to see inflation genuinely perk up, and we then see that the Fed is genuine about not doing anything about it – well then we might see a much bigger reaction.

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