Are US growth stocks getting out of hand?


Over the past four years, the stellar winning streak of US growth stocks has put value stocks to shame. Thanks to the quantitative easing policies the government and the Fed rolled out last year to flood the market with liquidity, and a surge of retail inflows, tech stocks have notched record highs – similar to the elevated levels that precipitated the collapse of the dotcom bubble in 2000. Understandably, retail investors have resorted to online day-trading to ease pandemic boredom, with many of them diving into the market to chase momentum. While the lofty gains have befuddled most investors, some, including professional investors, have begun to wonder: are growth stocks overheated? Is now the time to shift some parts of the portfolio to value stocks?

You have probably heard the story about Joe Kennedy and the shoeshine boy. Just before the Wall Street Crash of 1929, as Joseph Kennedy Sr. got his shoes shined, the shoeshine boy started sharing with the father of the US’s 35th President his take on stocks, prompting Kennedy to realise that the market might have been overheated. Shortly after he sold his entire stock holdings, the market crashed, hard.

In fact, whenever the stock market overheats, it releases all sorts of signals. The question is, however, whether investors are able to catch them and interpret them accurately.

Indeed, it’s not easy to remove oneself from the growth stock-fueled euphoria. Deciphering these signals is already a tough feat, those who are able to act on them in a timely manner like what Joe Kennedy Sr. did are far and few between. As economist John Maynard Keynes once said, “the markets can remain irrational longer than you can remain solvent.”

Through our analysis below, we hope to share with you our views on why the market looks overheated. But we will leave it up to you to decide whether valuations have peaked.

Firstly, some stocks’ valuations have soared to frothy levels. The only way investors can rationalise the sky-high valuations is if they factor future earnings predictions into their analysis. One of the most cited examples is an electric vehicle (EV) maker, which only sold around half a million vehicles last year, and accounted for less than 1% of the global auto market share in 2019[1], [2]. Even so, in this January, its market cap once well exceeded that of the 14 biggest automakers across Europe, US, Japan and Korea combined2. Together, they made up over 86% of the total market share in 2019[3]. There’s no question that this particular EV maker has an innovative vision, and is committed to realising it, but even the greatest company has a limit to which its value can grow. So unless it is going to monopolise the auto industry, we think its current valuation is unsustainable. This, in a way, reflects the state of most growth stocks.

Secondly, speculative stocks have begun to crop up in the market. 480 IPOs took place in the US last year, the highest number in 21 years, of which over 200 went public as SPACs (Special Purpose Acquisition Company), far above year 2019’s figures[4], [5]. So what’s a SPAC? A SPAC is basically a shell corporation, or “blank check” company as some would say. Within two years of a SPAC’s IPO, the sponsor would typically seek to identify potential assets for acquisition. So a SPAC investor has very little idea of what the acquisition target company will be, and at what price. The acquired company can also bypass the registration process that would otherwise be required in a conventional IPO process. Ultimately, the quality of the target company lies in the hands of the company management. So SPACs are in a way slightly speculative, and are considered risky. Last year’s SPAC rush also indicated the enormous amount of money that have been sloshing around in the market. In our view, an expanded risk appetite is a tell-tale sign that the stock market has indeed become frothy.

Thirdly, if we calculate the overall valuations of US stocks using the Buffett indicator, which compares the total value of the stock market to GDP, it has already exceeded the level seen in the dotcom bubble – certainly not reasonably priced at the moment[6].


[1] Source: CNBC, as of Jan 2021

[2] Source: CompaniesMarketCap.com, as of Jan 2021

[3] Source: Autocar, As of Jan 2021

[4] Source: StockAnalysis, as of Jan 2021

[5] Source: Yahoo Finance, as of Jan 2021

[6] Source: Buffett Indicator, as of Jan 2021


Disclaimer

This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

Investments involve risks. Past performance is not indicative of future performance. You may lose part or all of your investment. You should not make an investment decision solely based on this information. Each Fund may have different underlying investments and be exposed to a number of different risk, prior to investing, please read the offering documents of the respective funds for details, including risk factors. If you have any queries, please contact your financial advisor and seek professional advice. This material is issued by Zeal Asset Management Limited and has not been reviewed by the Securities and Futures Commission in Hong Kong.

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