It’s time to avoid crowds
Human behaviour has a tremendous impact on investing — more so than most realize — and one of our biggest weaknesses is the tendency to constantly compare and contrast ourselves to others.
For example, a 1995 study by the Harvard School of Public Health indicated that people will forgo a stronger income scenario in favour of a weaker one as long as it meant earning more than their neighbours.
Unfortunately, many in the investment world are keenly aware of this and will structure their marketing efforts accordingly. As a result, you have a compounding of momentum or trends in the market as investors buy at or near market tops for fear of not doing as well as or better than others.
For the same reason, investors piled into technology stocks in 2000 with only the promise of earnings in some distant future, and into housing-related investments in 2007 that were backstopped by very low incomes.
In our opinion, the action in today’s market is not altogether different: It has an initial public offerings market dominated by unprofitable companies, record high multiples for consumer stocks, and the subprime market has returned but this time with wheels behind it.
Unprofitable stocks represent a whopping 61% of company IPOs, the highest level since 2000, Jay Ritter, a finance professor and IPO expert at the University of Florida, has pointed out.
This may only be the tip of the iceberg given the recent success of Twitter Inc.’s IPO. Twitter’s share price rocketed over 70% on the open as it received orders for roughly 30 times the number of shares offered at its US$26 IPO price thanks to very strong demand by retail investors.
It’s to the point at which even the Securities and Exchange Commission is voicing concerns investors are not acting rationally as the number of users or followers commands more attention than how these figures are translated into corporate profitability.
We wonder if this is a natural progression from other sectors, such as the consumer space, whereby stock valuations have reached all-time highs.
For example, some consumersector companies in Canada that have a flat organic growth outlook in a heavily saturated market are trading at more than 20 times annualized Q3 earnings. Perhaps it helps issuing low-cost debt to buy back stock to generate per-share growth.
The subprime car market, meanwhile, is following a trend not unlike what transpired in the U.S. housing bubble: No money down and bad credit? No problem. Low rates and eight-year amortizations will also help keep those payments down.
In conclusion, we believe the momentum behind this compareand-contrast rally should continue as long as the U.S. Federal Reserve’s stimulus or asset-inflation policy does not start to experience the natural laws of diminishing returns.
Let’s just hope the Fed is still strong enough to continue to motivate consumers to spend more than their neighbours and investors to continue to buy stocks as they set new highs.