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Not to worry anyone, but the phrase “irrational exuberance” keeps cropping up conversations with investors. This is not normal, and not a great sign.
The famous term was apparently dreamt up in the bath by former Federal Reserve chair Alan Greenspan, and unleashed in a televised speech he delivered in 1996. At the time, the ill-fated dotcom bubble was in full swing, with the share price of dozens of untested, unprofitable tech companies soaring to the moon, often on the flimsiest of rationales.
“Lower risk premiums imply higher prices of stocks and other earning assets . . . ,” Greenspan said on that fateful day. “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” Markets dropped sharply in response to what was clearly, in retrospect, an early skirmish in the ugly market collapse in the following years.
One does not need a tinfoil hat or a particular fondness for hyperbolic finance bro YouTubers to spot echoes of that period of financial market history today, given the blistering rally in tech stocks including Meta, Microsoft and Nvidia. And you would need to have been living under a rock for the past year or so to fail to understand why these three stocks are so crucial to the wider market. Between them, they account for about half of the gains in the entire S&P 500 so far this year, according to calculations by Deutsche Bank, and together with Apple, Alphabet, Amazon and the stumbling Tesla, they account for more than a quarter of the index’s entire market capitalisation.
The concentration is, in itself, enough reason to give many investors pause, although Deutsche Bank also calculates that if anything, performance concentration is even more extreme in Europe, where just three stocks — ASML, Novo Nordisk and SAP — account for more than all the gains in the Stoxx 600 this year. Without them, that index has dropped by 0.3 per cent.
But it is the glassy-eyed belief that these US stocks’ ascent represent some kind of new revolutionary productivity paradigm, led by artificial intelligence and spilling its bounty across corporate America, that is really stirring memories of the dotcom boom and bust.
“We’ve been here before,” said macro strategist Benjamin Picton at Rabobank. “New era thinking is certainly not new, and eye-watering valuations on stocks with a compelling narrative behind them is a tale as old as time. For most of us, the dotcom boom happened during our lifetimes. Before that was the Nifty Fifty, and the Roaring Twenties before that, and the Railway Mania, and the South Sea Bubble, and John Law’s Folly, and Tulip Mania and so on.” None of them ended well.
Clearly, Microsoft today is not the pets.com of 1999 — perhaps the most famous flash-in-the-pan failures of that era. In fact, there’s a decent argument that Microsoft stock is a haven asset at this point rather than any kind of speculative bet.
But the runaway performance of chip designer Nvidia is starting to jangle nerves. The stock is up 50 per cent so far this year (it’s only February!) and it trades at a price to trailing earnings ratio approaching 100 times. Anything that Nvidia touches turns to gold. News this week that it had bought stakes in a clutch of other AI-related companies sent their stocks soaring. Voice-assistant company SoundHound and medical device specialist Nano-X leapt more than 50 per cent.
Wall Street analysts are overwhelmingly positive on Nvidia. Just about everyone seems to love this stock, for good or for ill. But some investors just can’t make it make sense. “Despite all the hyperbole and the meteoric stock price ascent, many analysts freely admit that forecasting the next five years, let alone the next 10, for this stock, is nigh-on impossible,” wrote Toby Clothier at hedge fund Chameleon Global Capital Management, in a note this week. For him, the rally is far out of whack with any reasonable analysis of the company’s discounted cash flow. We are in what Clothier describes as the “tulip stage” where “literally anything can happen”.
Salman Ahmed, global head of macro at Fidelity International in London, feels that the impressive commercial performance behind many of these star companies is enough to give him comfort in the stocks, although the sheer popularity of bets on them opens up the risk of what he calls a “technical correction”. The Vix index — one measure of investor anxiety — is still well contained, but beneath the surface options markets do betray some anxiety that the music might stop, or at least pause, in the coming months, he noted.
Fund managers do need to be nimble enough to dodge the fallout if the AI frenzy suddenly stops. But they know this. Despite all the unsettling signs and the irrational exuberance chatter, the onus is still on the doubters to prove the case for a crash.
“We expect volatility to stay lower for a little longer and expect no bigger setback in markets — unless ‘something new’ happens,” wrote the cross-asset strategists at Deutsche Bank this week. “But counting on ‘something new’ happening is wishful thinking, not a strategy.”
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