It’s best not to run with the herd
Human behaviour has always had a meaningful influence over equity markets: Investors buy new highs for fear of missing out, catch falling knives while trying to time a bottom, and sell at lows in order to avoid further losses.
It is no different in today’s environment as is evident by investor action in the technology and energy sectors. Fortunately, there are some simple but very effective warning signs to help one avoid following the herd over a potential approaching cliff.
The first warning sign is what is often termed the most expensive four words on Wall Street: This time it’s different.
History has shown that most things in life, including markets, mean revert so investors should exercise caution during large standard deviation events or extreme action.
In this regard, Nasdaq has now returned to its previous all-time high set in 2000 and pundits, both here and in the United States, are all saying the dreaded “this time it’s different.”
To be fair, they make a compelling argument. Tech only makes up 43% of Nasdaq compared to 65% in 2000, there are 2,500 fewer companies in the index and the median company age has risen to 25 from 15 years. Nasdaq’s price-earnings ratio is now only 20x compared to more than 100x in 2000, thanks to the domination of such titans as Apple Inc., Microsoft Corp. and Google Inc.
But Nasdaq’s return to its record high may be indicative of some broader underlying risks, such as Mark Cuban’s concerns about investors chasing the private tech sector despite zero liquidity and record-setting valuations.
“People we used to call individual or small investors, are now called Angels. Angels. Why do they call them Angels? Maybe because they grant wishes?” he was quoted saying.
Venture-backed companies such as ride-sharing app Uber Technologies Inc. (worth US$40 billion) and photo-messaging app Snapchat (worth US$19 billion) are just the tip of the iceberg.
There are plenty of other startups with little to no earnings and billion-dollar valuations, some of which have found their way onto Nasdaq.
It’s a completely different story on the energy markets, thanks to oil prices being halved in the past year. That said, there is an interesting dichotomy happening here in Alberta. Despite the sell-off, it feels a lot like 2007 with many spending as if oil was still US$100 per barrel.
It may surprise those in the East, but it’s nearly impossible to get into a decent restaurant in Calgary. Resort hotels are almost fully booked on weekends, shopping malls are packed even on weekdays and there are still waiting lists for luxury SUVs.
A similar situation is playing out with oil stocks, with retail investors piling into dilutive bought deals while institutional investors take a more cautious approach to allocations.
Simply look at the share price performance of Canadian Natural Resources Ltd. (CNQ/NYSE) and Suncor Energy Inc. (SU/NYSE). They are down only 19% and 12%, respectively, over the past 12 months, while oil is down nearly 50%. So many oil companies are now factoring in oil prices of US$70 per barrel in their valuations.
We think this is because the prevailing attitude about oil and the energy market is that “it will come back, it always does.” This is a very dangerous position to take, especially considering North American production continues to set new record highs and there is the real risk that we will run out of storage capacity as speculators arbitrage the contango.
In conclusion, exercising a little common sense and stepping away from the herd can go a long way in helping to prevent investors from making a baaa’d decision.