Good Surprises
Global stocks gained over 9% in the first four months of 2021. After such a strong recovery at the end of 2020, few expected such gains to continue this year.
The passage of a large stimulus package added to the enthusiasm for stocks, but the economy also outperformed most economist’s expectations.
As more are vaccinated, people are planning trips, dining out and socializing in larger groups. You can cut the pent-up demand with a knife. The excitement has lifted the economic data, as retail sales, manufacturing, services, and housing indexes are all beating forecasts. Jobs also improved as some industries race to rehire employees.
All this translates into higher earnings expectations for stocks. At the beginning of the year, analysts estimated 2021 S&P 500 earnings to be $166 per share, implying 35% earnings growth in 2021. Those estimates have been revised up, now implying a 44% rebound in earnings in 2021. The good news percolated into stock prices, continuing to drive markets higher.
Some of the good feelings about the stock market seem to be supported by the recovery in profits and the economy. But are investors just getting a little too excited? In general, maybe not, but there are some areas of the market that appear overhyped.
Here are a few noteworthy examples:
Over $100 billion of new stock has been sold through special purpose acquisition companies (or SPACs) this year. A SPAC is a shell company that seeks a merger with a private company, effectively taking it public. At the outset, each unit of SPAC stock typically represents $10 in cash. Prior to the merger announcement, many SPAC shares have traded higher, sometimes much higher than $10 cash value, effectively acting as a barometer on enthusiasm for offerings. Without knowing anything of the future target, what odds should one give on a hot deal? Will $10 be worth $15, $20, or $40 overnight?
To wit, a deli in New Jersey is supposedly worth $100 million. This deli generated just $13,976 in sales last year and has one location. What it may lack in operations, it makes up for with a public listing on a stock exchange. This amounts to a shell company that happens to own a deli, which could be attractive for another company looking to sell stock into the public markets without the due diligence, and regulatory disclosures, of a high-profile IPO. Are a few hoagies and a clean public listing worth $100 million?
Mania over cryptocurrency kicked into a higher gear. Dogecoin, originally created to satirize other cryptocurrencies, returned approximately 5,600% in April, reaching a market capitalization of nearly $35 billion. That return greatly outpaced the “veteran” crypto asset, Bitcoin, which struggled to surpass $63,000 per coin.
Most SPACs will likely underperform the market just like IPOs have historically. There will continue to be hot deals, but there will be many duds along the way. In fact, the good times may have already passed. The Financial Times reports that of the 41 SPACs that have executed deals since 2020, only three are near their share price peaks. The average decline for this cohort of new stocks is 39%.
We have no insight into the future of Bitcoin or any other cryptocurrency. Cryptocurrency is a bit like art – beauty and value are in the eye of the beholder. It’s unclear if cryptocurrency ultimately has real value for society. Will it be the future preferred global unit of account? Unlikely, but as long as there is belief, much like physical gold, it will continue to trade hands and turn heads. There may be some interesting new uses for digital currencies, but the future intrinsic value is not at all clear.
What it All Means
There is nothing new about excessive optimism and manias. Should you feel bad if you missed the Door Dash SPAC or didn’t get into Bitcoin at $20? Absolutely not. It can be a lot of fun to put some money in young, unproven startups or novelty assets. But it can all go horribly wrong too.
The feeling of missing out can have a strong influence over us. But to live and invest well, it is not necessary to chase the hottest investment fads. Getting caught up in one mania or another could waylay the best made plans.
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