The Graph above shows on a logarithmic scale the 2000 technical bubble in the US. A common question asked in recent weeks is whether we are again observing a US tech bubble in 2020.
There are certainly elements of similarity. During the 2000 tech bubble, the US market (top yellow line) was at times trading three times above its 1997 level, with extreme increases in valuations of companies such as Microsoft in late 2000. Microsoft was and is a real company, but with $1 of earnings per share (EPS), it was trading at $US100 being a valuation of 100 times EPS i.e. the value is equal to 100 years of earnings. Burrell commentary at the time was that Microsoft did not need to lose money, simply that the rate of growth of earnings would become more realistic and the stock would correct. This occurred with Microsoft falling from $100 to $50 then to $25 finally $15 – were it stayed for the next decade. In aggregate, the US market fell from its high in 2000 and the Australian market (bottom blue line), which had been rather the tortoise, caught the hare in 2004 and went above it.
On Wednesday 26th August 2020, the Australian Financial Review reported as follows; “Leading sell-side bull Morgan Stanley lifted its Afterpay valuation from $101 to $106 and said it was realistic for Afterpay to trade on an enterprise value 31 times the broker’s estimate for revenue. Afterpay will have to deliver 78 percent revenue growth in financial 2021 to meet that forecast, based on the broker’s estimate of a full-year net loss of $31 million (and revenue of $520 million) when it posts financial 2020 results”.
Burrell would usually value companies on a price earnings (P/E) multiple of 10 – 18 times, depending on growth. Here we have a company that is being valued on 31 times REVENUE and that revenue number needs to grow by 78% to achieve the forecast for next year. That is the 2020 tech bubble.
Further evidence that the Afterpay article may be the ‘canary in the coalmine’ is that Tesla undertook a stock split in the last 48 hours. The stock appreciated materially on that stock split, even though in theory there should be no change in the underlying value of the business (enterprise value). Tesla took the opportunity to raise $US5B from retail investors by selling shares directly into market, which is permitted in the US but generally not in Australia.
Other features of the above graph include the fact that markets can remain above fair value for extended periods and that bubbles can take several years to correct – in 2000, it took seven years for the tortoise to catch the hare.
It is important to be wary of false conclusions e.g. that the whole US market is overvalued. It is the technology stocks such as Amazon and Tesla in the US and Afterpay in Australia that have an exciting story to tell to retail investors that has allowed the markets to reprice them at atmospheric valuation multiples. The majority of value and growth at reasonable price stocks both in the US market and in Australia are trading at reasonable valuation multiples. Indeed, in the 2000 tech bubble, with the exception of a few companies that tried to convince us that they owned the internet such as Melbourne IT, the Australian market did not participate in the 2000 tech bubble. Burrell see some similarity, even though it is masked by the adverse impact of COVID-19 on June quarter earnings and the 2020 earnings reports delivered in the past fortnight.
The August Blog – The Second Innings remains apt in its description of influences upon the current Australian market. Since 10th June 2020, the market has continued to trade in a band of +/- 200 points around the 6000 level. The first over in the second innings in the COVID-19 match was the reporting season. While expectations were reduced due to the lost June 2020 quarter for many businesses, statutory profits were in many cases messy. Key issues included a number of material write-downs in asset values, the Victorian second lockdown resulting in companies reluctant to issue guidance for the forthcoming quarters and whether a dividend would be paid. Companies that declared a dividend were mostly viewed favourably, whereas those that did not tended to have adverse market movements. Telstra created their own confusing message by declaring a dividend, but saying that they were unsure, they could continue to pay in the future at the same rate. Your diarist queries whether this is part of the ongoing lobbying campaign by the telcos to improve the slim margins they now receive as NBN resellers. The forthcoming US election has created unprecedented funding for medical research towards a vaccine. Markets seem to be assuming a permanent vaccine such as for Polio or MMR. The more likely outcome is that the early vaccines will have a short-term protection such as existing flu vaccines that require an annual inoculation. The most promising and more permanent vaccine is that under development by the University of Queensland using the “Cap” technology, although this most likely has a 2020 timeline.
Low interest rates are supportive of stock prices. Cash rates in Australia are 0.25% for 1-3 years and 1% for 10-year funds. This leads to the TINA effect i.e. “there is no alternative” to investing in stocks and property as other sectors simply are providing almost no return. The US announcement by the Fed that the they would target an inflation level above 2% was interpreted by the US market as meaning that there are likely no US interest rate rises for some years. Such issues in markets seldom last for long periods and it may be that towards the end of 2021 we see the FED tap on the interest rate brakes, partly to take some of the steam out of the property and stock asset bubbles.
The US presidential election is dominating US markets currently. At the Stockbrokers and Financial Advisers Association conference held last week in Australia by video, the former politician Lindsay Tanner in a particularly good paper noted that while Biden has had the benefit of the opinion polls to date, the race is likely much closer. He observed that it takes a charismatic contender to unseat a sitting President and contenders that are not charismatic have largely failed in the modern era. The question will be whether sufficient voters vote against Trump and so there is a change in President, as well as the US Senate. Democrat control would allow corporate tax rates to be increased from 21% to 28% and more inclusive medical government policies to be implemented.
COVID-19 is the other elephant is the room in the US with over 185,000 deaths to date. To place that in perspective, a documentary on the five-night WWII blitz in Liverpool saw 2000 people killed. It is a close race between some type of vaccine together with other COVID-19 measures to bring the pandemic under control versus Biden, if successful, causing a Victorian style six-week shutdown in the US early in 2021.
One commentator says that no matter which party wins in the November presidential election, the US market is likely to have a downward correction.
So the second innings has commenced with a reasonable score during the reporting season, but there are a number of difficult overs including bouncers to be faced between now and Christmas. Burrell has generally been cautions in terms of further overseas investment until these geo-political issues show come clarity. In terms of Australia, the chart above commends steady investing based on independent research and thoughtful insights as to how companies are being impacted by COVID-19.
Lastly, while the Australian government has played a good innings on COVID-19, many business people are concerned at the lack of engagement between the Chinese and Australian governments. Where is Julie Bishop?
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