What Will Finally Crash This Market
Last week I tried to point out a simple investing concept that I’ll return to frequently in the future:
Stocks aren’t a casino game.
Stocks actually have value and utility, and this isn’t always represented by their prices.
(This is actually a pretty controversial idea among two groups: Proponents of the “efficient market hypothesis” and degenerate speculators. In the future, I’ll explain why both of these positions can be useful for making money at times, but are otherwise stupid ideas that can make you poorer in the long run.)
The reason I drew attention to that is because that premise — that stocks have an underlying value that allows us to make investment decisions — applies to overall markets, too.
I briefly touched on this in a previous installment that pointed out how to easily spot a “bubble” using this chart:
The blue line of the chart shows the price of the S&P 500 index. The green line shows the combined earnings of all the companies in that index.
The S&P 500 is the index that Wall Street uses to measure the overall performance of the stock market. Earnings is a company’s net profit.
The more “disconnected” the price line is from its underlying earnings, the more likely the price is to decline or move sideways in the future.
That’s what I mean when I say a market is “overvalued.”
That finding, by the way, won Robert Shiller a fake Nobel Prize.
(There is no “Nobel Prize” for economics. Just a separate prize funded by a Swedish bank that’s distributed by the Nobel Prize Committee.)
If you look at the ratio between price and earnings, you’ll see this:
Basically, the market looks more overvalued than it did the year the Great Depression began…
And we are quickly approaching the point where the market looks as overvalued as it did at the height of the Dot-Com Bubble.
And that’s what I want to talk about today…
Because we’re seeing echoes of the Dot-Com Bubble today, and we can learn something valuable from it…
Both about where to put our money, AND what to avoid.
Partying Like it’s 1999
Have you ever heard the story of Pets.com?
It’s one of the most famous stories in stock market history, and I think that story can teach us something about the current stock market, and give us some insight about what to expect and prepare for in the coming months.
In 1995, everyone was talking about the “new economy” and the “information superhighway.” The internet held huge promise, but few people predicted the enormity of its impact.
That year there were just 16 million internet users. By 2000 there were 361 million. Today, that number is in the billions.
Recognizing the massive growth potential, investors starting throwing money at web-based companies — even though they didn’t fully understand the technology.
Web companies raised a total of $1 billion in 34 IPOs in 1997, rising to $2 billion in 45 deals in 1998, and then exploding to $24.1 billion in 292 IPOs in 1999. (Source.)
Even more impressive was the fact that the average stock IPO in 1999 and 2000 shot up 88% on its first day of trading. That’s how excited people were about internet stocks.
These huge, fast gains enticed more and more amateur investors to trade in the stock market…
Throwing their money at any company with dot-com in the name or an association with the Internet.
Instead of traditional fundamental metrics like profit, earnings, or debt, investors were making their decisions based on “eyeballs” and web page views.
Because of this, investors paid exorbitant prices for companies with no prospects of making any profits.
(Is this starting to sound like the year 2021 to you yet?)
One such company was Pets.com.
If you remember this era, you might recognize the online pet supply purveyor’s sock puppet mascot.
It made appearances at the 1999 Macy’s Thanksgiving parade and in ads for the 2000 Super Bowl. It was even interviewed by People magazine and appeared on Good Morning America.
What did the company make?
All I can tell you is: They sold pet supplies online.
The company’s IPO raised over $82.5 million.
But Pets.com was a terribly run company.
Despite only earning $8.8 million in revenue in the second quarter of 2000, they spent $17 million on marketing alone.
Pets.com went from IPO to liquidation in just 268 days. And more than $300 million of investment capital evaporated.
The Pets.com story represents everything wrong with the internet bubble that boosted stock prices and finally collapsed in 2001.
From peak to trough, the Nasdaq lost 78% of its value over the next 2 years.
Some of the businesses that survived, like Apple and Amazon, went on to produce some of the biggest gains in history… But their stock price also suffered when the overall markets declined, and investors had to wait years to see their portfolios climb again.
Now here’s the thing to understand about the internet bubble…
You’re reading this with an electronic device connected to the internet.
(Shocking, I know.)
So listen…
The people who were excited about the internet in the late 1990s?
Futurists like Ray Kurzweil and George Gilder?
The people who promoted the revolutionary promise of the internet, even as the stock market bubble soared and soared?
They weren’t technically wrong.
They were just hyped for a trend that wouldn’t become viable for another 10 to 20 years.
Unfortunately, in investing…
If you’re too early or too late to an idea? Well, the end result is hardly different than being actually wrong.
And that, I think, is what’s going on in the stock market today, especially with electric vehicle stocks.
Rivian Seems Like the Canary in the Coal Mine for This Market
Let’s do some roleplay…
“I have a business proposition for you.
Would you like to become a part owner in a business?
This business is an electric vehicle stock, and it is all the rage right now!
Now, bear in mind…
This company you’re buying into?
It’s never sold a car at market.
It’s 12 years old, but has no revenue.
Oh, and by the time it does start making and selling its cars at scale, it’ll probably have heaps of competitors from the biggest automakers in the world.
And since its IPO, the company’s stock has gone up 92% in a few days, so you’re missing out on these big gains.
Now, how about you sign this contract and give us your money?”
How would you respond to the pitch above?
If it were me, personally, I’d run from the room.
And that’s how I feel about Rivian stock.
After its IPO, as I write this, Rivian’s value has soared past the carmaker Volkswagen’s market cap of $137 billion.
Volkswagen makes 40,000 cars per day. They also announced plans to start making electric vehicles that only costs €20,000. And they pull in over $200 billion in revenue per year.
Rivian?
Which is now the third most valuable carmaker in the world?
Rivian has been in business for 12 years and has never generated any revenue.
Now, I’m extremely bullish on electric vehicles. I personally think electric autonomous vehicles are an inevitable part of our future.
It’s one of the reasons why, in one of the newsletters I write in Japan, I recommended a $9 electric vehicle stock which actually (another shocker) has sales and has made and delivered vehicles this year.
But I’m also a realist.
By 2040, EVs will only make up 33% of all the cars on the road.
Except for companies that can make money now, the hype around the big transformative EV revolution is maybe 10 to 20 years too early.
Good for short term trades.
Terrible if you can’t stomach wild swings up and down (like me).
Really, it shouldn’t make sense to you that an electric car company with no sales, gargantuan losses, and high competition should be one of the most valuable car companies in the world right now.
Bubbles Aren’t New (And Neither Is The Aftermath)
History is filled with popped bubbles.
The Dutch Tulip bubble gripped Holland in the 1630s. Records show that tulip prices rose by 20-fold or more. When the bubble crashed, prices fell by 99%.
The South Sea bubble swept across England in 1720. Stories of South American riches sent shares of the South Sea Company surging by over eight times. When the bubble collapsed, not only did shares of the South Sea Company drop below their pre-bubble prices, but it sent England into an economic crisis, too.
The Japanese stock market bubble saw loose bank lending policies take the Nikkei index to nearly 39,000 in 1989. When Japan raised rates, the bubble popped. The Nikkei eventually dropped to below 8,000, reducing the value of the index by 80%.
But perhaps the most iconic bubble in modern history — aside from the dot-com collapse — is the 2008 housing crisis. At the end of that year, the Case-Shiller home price index reported the largest drop in its history.
If you began or have been investing since 2008…
You’ve been investing in a really WEIRD market.
Loose lending policies, central banks purchasing assets to stabilize prices, terrible rates on fixed income, debt debt debt and more debt…
The pricing mechanisms of the market is…
Well, it’s out of whack.
So if you were to ask me:
“Is Rivian the 2021 version of Pets.com?”
And my answer is:
No. Probably not. Pets.com went bankrupt. All 300 or so employees were fired. $300 million was lost.
When a company can’t make any money or afford its absurd spending… that is what should happen.
But Rivian?
Rivian, as I write, has close to 10,000 employees at a time when policymakers are trying to pump up employment numbers.
And if Rivian went bankrupt, it would erase billions of dollars of value from a frail and recovering market.
I doubt the “powers that be” want to see this happen. And so the interventionists will likely intervene, if need be.
If anything, Rivian is a canary in the coal mine...
It’s struggling to breathe.
And that’s telling you that there’s poison in the air.
So if you want to invest…
Be careful. Be conservative. Be judicious.
Buy the things you can have faith in.
You can still make money in this buck wild market…
But don’t be surprised if you see everything you own go into the red, at least until the gap between prices and fundamentals begins to close.
Which, if we’re being completely honest, could take years.
Or months.
It remains to be seen.
