A lot of “bubble talk” is making the rounds. We concur with the recently published opinion of Ray Dalio, who sees bubbles in certain areas of emerging technology stocks, but not in the market as a whole. Market valuations are getting elevated, but are not in a bubble; stock prices overall are high, but not extremely high. Dalio sees two metrics in particular indicating that overall market valuation is not out of control: first, earnings growth looking ahead is enough to justify stocks’ premium to bonds; and second, commodity and real estate markets, broad capital expenditures, and mergers and acquisitions activity don’t show that businesses are becoming overly optimistic about the future and pouring money in that could be unwarranted. That’s a classic bubble situation, and it isn’t happening yet.
While some emerging tech areas may be bubbly, that isn’t a reason to write them off as unworthy of your attention. Emerging tech will be great, but from a long-term perspective, you can’t just pay anything for it; that growth needs to come at a reasonable price. As we noted above, the definition of “reasonable” may already be shifting, but it is not infinitely malleable. Until a healthy correction occurs, we would be cautious on infinite and extremely high P/E stocks, as we noted in our recent conference call.
Basing price evaluation on earnings projected five to ten years into the future when investing in the market’s current new tech darlings is unwise. Historically, that has been an expensive proposition, and with very few exceptions, investors have suffered losses as a result. There have been some exceptions, such as Amazon [AMZN], or companies that have been successful in repeated transformation of their business models. Tesla [TSLA] is another example, driven by the particular genius of its founder’s vision, rather than constant self-invention. Such companies are very much the exception; the chances that a given insanely valued tech stock is truly in that rarefied company is slim.
As the market rotates, there will be opportunities where valuations remain subdued and have a chance to catch up with the overall market multiple. “Picks and shovels” with reasonable valuations are one example — companies in various sectors and industries which provide the physical infrastructure necessary for upcoming technological marvels to be implemented. Some of these we’ve consistently mentioned over the past months include tech hardware such as 5G infrastructure, sensors, networking gear, and next-gen semis. The tech acceleration theme associated with the pandemic is real, and not everything is trading at the valuation of the frothy software companies.
Thanks for listening; we welcome your calls and questions.
