The month of January has been a rather volatile one for financial markets. In particular, in the USA, where the markets over there are heavy with technology companies with enormous market valuations; a few of these companies, including Apple, Microsoft, Amazon and Alphabet, currently have market valuations in the trillions of dollars. Already back in 2019, when the NASDAQ index, which includes those megacap tech names, was hovering around 8000 points I wrote an article where I expressed my concerns that I thought the index was looking very frothy. In 2009, toward the end of the Financial Crisis, the NASDAQ was below 1500 points. In a decade it had increased over five times in value. At the height of the 1999-2000 dotcom bubble, the NASDAQ hit an at the time all-time high of over 5000 points. It would be another fifteen years before the NASDAQ would breach 5000 points again.
Back in 2019, some analysts expressed concerns about the heady valuation of several US tech stocks and that with the NASDAQ trading at over 8000 points, it was ripe for a correction. Towards the end of February the following year, those analysts got their wish when global markets began to dramatically correct in response to the outbreak of the COVID-19 pandemic. Investors began to panic and growth/tech heavy indices like the NASDAQ began to drop in value. In January of 2020, the NASDAQ had reach an at the time all time high of over 9000 points. By March of that year, it was trading in the 6000s.
Although, those who had been predicting a crash the previous year may have felt vindicated for a brief moment, very few could have foreseen the response by the Federal Reserve (Fed) and how it would promptly intervene with a dramatic increase in the US money supply and an enormous expansion of the Fed’s balance sheet. As a consequence, the NASDAQ duly rebounded from March 2020 and would embark on a mind-blowing run lasting many months. By November 2021, the NASDAQ hit a fresh all time high of over 16,000 points; more than doubling from it’s mid March 2020 level and almost doubling from it’s 8000+ level from back in 2019 when I wrote my article expressing concerns about it’s then heady valuation.
When the pandemic began to sink in and the Fed reacted via it’s huge financial stimulus programme essentially flooding the US economy with lots of new money, investors began to favour a certain group of stocks that became all the rage as they thought would thrive in this new pandemic environment. Governments around the world imposed multi-month long lockdowns and for many people at the time, there was a feeling that this pandemic would never end. Thus investors turned to technology stocks; stocks investors concluded would benefit the most from a stay-at-home environment. These stocks, already commanding rich valuations before the start of the pandemic, began to get even more crazy. At the same time, boring old school blue chip value stocks began to sell off even more. The travel and hospitality sector suffered greatly by global lockdowns and travel restrictions. The oil and gas industry too had a tough time with the price of a barrel of crude oil briefly entering negative territory. Sentiment in both those two sectors was completely shot to pieces, whilst the technology sector was in full on mania mode. But it wasn’t just the big tech names like Microsoft, Apple and Alphabet that were doing well, a new crop of technology stocks that became darlings during the pandemic, such as Zoom and Peloton, went on an epic tear.
As 2020 turned to 2021, this madness showed no signs of abating. In fact it all reached a brand new level of craziness. With many in the US receiving their COVID-19 financial stimulus cheques, which were originally intended to alleviate the financial burdens of those affected by the pandemic, a large portion of those cheques were used for speculation in the markets. A handful of stocks began to command valuations that just simply made no sense. One example was the struggling video game retailer, Gamestop. At the time it was one of the most heavily shorted stocks in the country. Until a group of investors from the social media site Reddit began to drive up the price of the stock massively with the intention of sticking it to the hedge funds who had large short positions on the stock. In the month of January 2021, Gamestop stock rocketed in value from just under $20 a share to over $300 before crashing to around $40 the following month. Many naïve and inexperienced investors got suckered into this micro rally and got badly burnt on the way down. It didn’t matter that this was fundamentally a worthless stock with no credibility.
In addition to those shenanigans, the beginning of 2021 saw another heady bull market emerging in the cryptocurrencies space with the price of Bitcoin entering the new year on a new high. But the increase in the price of Bitcoin during this period paled in comparison to other even more speculative areas of the crypto space. One of these was the booming popularity of NFTs or Non Fungible Tokens. These tokens are digital files that can be bought and sold with certain cryptocurrencies. During the first few months of 2021 this area of the market reached a complete fever pitch with a some individual NFTs even fetching millions of dollars. An NFT by an artist called Beeple fetched over $60m – an eyewatering amount of money; the kind of money that would exceed even the kind of money fetched for some of the best known and highly prized paintings by the most famous old masters of the ages.
Yet by the end of the year, cracks were already starting to appear. The last 13 years since the Financial Crisis has been dominated by a period of extremely loose monetary policy. It is no surprise that such a long period of rock bottom interest rates has led to one of the longest and most spectacular bull markets in history. And because of this it feels artificial. Wages have not gone up anywhere near the same level during this time period. In fact they have been rather stagnant. This has resulted in the USA experiencing a level of inequality not last seen since the 1920s. Or more specifically, the end of the 1920s. The so called Roaring Twenties ended with an epic stock market crash leading to a brutal multi-year long Depression. The Dow Jones Industrial Average (DJIA) hit a high of over 6000 points in August 1929, at the apex of the 1920s stock market bubble. In December 1920, the DJIA was just over 1000 points. When the this near decade long bubble burst during the last few months of 1929, the DJIA continued to crumble over the next few years during the Depression reaching just 910 points in May 1932. This was less than the low breached by the DJIA in 1920. In a little under a few years, all the gains the DJIA had accumulated had been more than wiped out. The next time the DJIA went over 6000 points was in 1959; a staggering thirty years since that level was last reached.
Many investors and analysts like to compare the current stock market boom, especially over the last few years, with the dotcom boom of the late 1990s. Whilst there are many similarities, namely with all the exuberant valuations of many tech stocks with poor fundamentals, I find the stock market boom of the Roaring Twenties a better comparison. This is especially true when measuring inequality in the USA over a 100-120 period. The incredibly loose monetary policy over the last 13 years had made this current bubble not only one of the largest in financial history, but also one of the most dangerous. Total US government debt before the 2008 Financial Crisis was already very high. However, between Q1 2008 and Q3 2021, total US government debt has near trippled from $9.4tn to $28.4tn. This is an astonishing increase for such a comparatively brief time period in US history.
During the last year, inflation has began to rear its ugly head. Some have been taken by surprise by this inflation, but I am anything but surprised. This was a long time coming. It is amazing that it has taken so long to appear. Of course, the super lax monetary policy of the last 13 years has seen incredible asset price inflation, but not so much consumer price inflation. But this all began to change last year when the US rate of inflation hit 6.8%, it’s highest level since 1982. The Federal Reserve now finds itself in a difficult position as even just a very modest raise in interest rates can have reverberating effects on the US stock market and economy as a whole. Over a decade of rock bottom interests in the US has, as already stated, almost tripled the total amount of US government debt and created a stock market bubble of absolutely epic proportions. In November 2008, the NASDAQ was trading below 1500 points. In November 2021, exactly 13 years later, the NASDAQ traded above 16,000 points. This is a more than ten-fold increase of absolutely dazzling asset price inflation. So much is now at stake, yet this bull market has never looked more fragile.
As of now, US interest rates still stand at zero. However, the last month has seen the NASDAQ fall quite sharply in value. By the end of last week, the NASDAQ was trading at 13770 points. Whilst this is a not inconsiderable drop from the 16,000 points plus high of last November, it is still more than double the low it reached during the brief stock market correction of February-April 2020. Moreover, it is still more than 9 times the value that it was in November 2008. What has been interesting is that the NASDAQ falls of the last month occurred before any interest rate hikes. The Fed intends to raise interest rates in tiny increments. However, the real question here is how much of a problem will inflation continue to be? This is where the Fed under Jerome Powell has really been asleep at the wheel completely underestimating the long term consequences of a decade plus of uber low interest rates, quantitative easing and cheap and easy money. Some economists make forecasts as if their projections will come into fruition with complete certainty. Yet the truth is no one can predict the future, regardless of one’s credentials and brain power. Not so long ago, the prevailing narrative was that inflation would be ‘transitory’. I didn’t and still today don’t agree with this narrative. I also don’t believe that the sole root of this inflation is the supply side shocks induced by COVID-19. As I have already mentioned, I am simply just surprised that, after over a decade of very loose monetary policy, it has taken so long to rear it’s ugly head.
What can really cause the current bubble to unwind much more is precisely if inflation continues to be a much longer term headache. The Fed may want to only slowly increase rates by small amounts, but what happens if inflation were to get worse and go into double digits? If inflation were to get out of control, I suspect that the Fed would have to increase interest rates by much more than it originally intended. This would bring an abrupt end to the cheap money era that has prevailed for so long. The biggest winners of this era have been growth stocks – particularly those in the technology sector. Invariably, companies with weak fundamentals would be trading on gargantuan market valuations. These companies would not be making any money and would be burning through cash. Yet often investors would be attracted to them by the story they projected rather than doing a deep dive into their financial statements. The cheap money era has been particularly favourable for startup companies not even publicly listed yet. It wouldn’t matter whether or not these companies were making any money. With so much cheap money sloshing about Venture Capitalist funds would throw ever more money towards them. In such an environment valuations do not seem to matter. And this is why I find this current rise in inflation very interesting as there is every chance that it will force the Fed to raise interest rates by much more than it was expecting thus bringing an end to this party. All of a sudden valuations will actually start to matter and all those companies that had heady valuations without ever making a profit will be in real trouble.
Already some of the darling stocks of the pandemic have had drawdowns of more than 50%. The video teleconferencing platform Zoom, which became increasingly popular as the pandemic unfolded, saw it’s stock motor from $76 at the beginning of January 2020 to a peak of over $550 in November of that year. Last week the stock traded below $140. The other darling of the pandemic, the exercise equipment and media company Peloton, saw it’s stock increase from around $30 at the very start of 2020 to over $160 just before the end of that year. Today it currently trades at $25 more than wiping out it’s 2020 gains.
The larger and more robust tech titans like Apple, Microsoft and Amazon have also experienced drops during the last month but they have overall still managed to hold on to their mega valuations. Apple recently hit a market cap of $3tn making it the most valuable company by market cap on the planet. At the beginning of the year it traded at over $180. Today, it’s trading at $170 with a market cap of nearly $2.8tn. It was only in 2018, when Apple became the first company to reach a $1tn market cap. In just a few years it has trebled its market cap. This is simply amazing growth for such a juggernaut of a company. Yet Apple is not cut from the same cloth of the more speculative tech stocks. Where Apple substantially differs is that it is a colossal cash generating machine of a company. Apple has a very rock solid moat and phenomenal pricing power. Even with at a near $2.8tn market cap, it currently trades on a not unreasonable PE of 28. Apple and the other tech stocks with solid cashflows that don’t need to raise money, will likely fare much better, despite their rich market caps, than the more fundamentally shaky tech stocks that still don’t generate adequate cash flows. However, Apple is not completely immune from any future shocks. I suspect that a continued rise in inflation will not only put a bigger strain on the finances of consumers, it will also further inflate the prices of important raw materials that are integral to Apple products. There could also be unforeseen future problems in China that severely affect the manufacturing capacity of Apple products.
Over the last 13 years whenever there has been a sharp correction in US equity markets it wouldn’t last for very long. The Fed would promptly intervene by pumping liquidity and thus causing the markets to sharply recover all it’s lost gains. The bull market would continue to just hit new highs. It is because of this that the USA still hasn’t experienced a prolonged bear market since the last Financial Crisis. For some time investors have simply taken it for granted that the Fed would just simply come to the rescue whenever there was any major market turbulence and stocks would duly rebound. But what if this time, the Fed finds that it has limited options to calm a plunging stock market? Higher than predicted inflation will almost certainly force the Fed to substantially increase interest rates. Money at much higher rates will cease to be cheap and the market, like a raging drug addict, will find that it is unable to get it’s usual fix of central bank stimulus. I suspect this will all have the affect of leading to markets being volatile and plunging to bigger lows over a much larger time frame leading to a bear market of many months or even years.
Don’t think the tech heavy US markets could experience a painful multi-year long bear market? Well, think again. It took almost 30 years for the Dow Jones Industrial Average to reach it’s all time high reached at the height of the Roaring Twenties stock market boom. When the dotcom bubble of the late 1990s burst in 2000, it took the NASDAQ 15 years to reach it’s all time high reached at the height of that bubble. Some stock market indices never again reach their all time high. Japan in the 1980s experienced an absolutely wild stock market and real estate boom. At the very end of that decade, the Nikkei 225, was trading at an all time high at over 38,000 points. Over the next year in 1990, the Nikkei 225 almost halved in value and over the next several years drifted downwards eventually bottoming below 8,000 points in 2003. The Nikkei has since recovered and as of today trades at around 27,000 points. Yet this is still short of it’s all time high it reached more than thirty years ago.
By Nicholas Peart
January 31st 2022
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