Wednesday Negative Sum Investing Advice
Every stock market bubble has a kernel of fundamentals to it.
In the 1920s, it was the advent of a revolutionary new medium of communication.
Sales of radio sets rose 1,300% between 1922 and 1928, making the Radio Corporation of America "the speculative symbol of the time," in the words of John Kenneth Galbraith.
The speculation was not without merit: RCA's earnings rose 700% between 1925 and 1929, not far off the 900% rise in its share price.
In the 1990s it was the internet, of course.
The dotcom bubble is best remembered for its excesses, like pets.com, but there was real money being made, too: Cisco's revenue rose 850% between 1995 and 2000.
The stock was up 4,000%.
And in the aughts, the symbol of the times was Countrywide Financial, which fueled the housing bubble by increasing its mortgage lending 10-fold between 2000 and 2007.
Countrywide's stock was up a modest 592% (possibly because it had already rallied 23,000% over the prior two decades).
The speculative symbol of the 2020s is likely to be Nvidia, of course.
And also for good reason: The chip maker's revenue rose from $5 billion in 2015 to $27 billion in 2022, a 440% increase. And growth is still accelerating — they did $13.5 billion of revenue last quarter alone.
But the stock has risen even faster, up 8,600% since 2015.
That certainly makes the stock look speculative. Valuation-guru Aswath Damodaran says that even if Nvidia wins 100% of the most bullish expectations for the GPU market over the next decade, he still can't justify the current stock price.
Many still manage it, however: 93% of sell-side analysts have a buy rating on the stock. 0% have a sell rating.
Does that mean we've hit the irrationally exuberant bubble phase of the market?
I don't think we're even close.
Money has been flowing out of risky equities and into risk-free money market funds.
VCs are having their worst year in some time.
And the market for new issues has been dormant.
Having traded equities through two major stock market bubbles, I can assure you that this is not what they feel like.
The better question is, are we at the start of a bubble?
There are signs we might be.
I Predict Offerings
Bubbles, in my opinion, are best measured in IPOs — new issues are where investors' irrational exuberance takes its purest, most manic form.
And with three major deals in the pipeline — Arm Holdings, Klaviyo, and Instacart — the IPO market may be about to re-ignite.
Arm is expected to list at a $60+ billion valuation, giving us another large-cap AI semiconductor stock to pay way too much for, Klaviyo is the type of software company that institutional investors will lose their minds over, and Instacart feels like a throwback to the dotcom days (if we can get excited about food delivery again, we can get excited about anything).
SPACs may be on their way back, too: Shares of the recently listed electric vehicle maker VinFast fell 44% on Tuesday. And yet it still has a market cap of $100 billion — more than GM and Ford combined.
That one certainly has bubble vibes.
But we'd need a lot more of them to make it official.
In 2022 there were only 13 IPOs of any substance in the US and this year has been only marginally better.
In the 1990s, by contrast, the US market averaged roughly one IPO per day — for the entire decade.
We did have 86 SPACs in 2022, but that was down from 613 in 2021.
613 new issues in a year is what a bubble feels like — but longer and broader than just one year of SPAC mania.
Could it happen?
The AI narrative certainly seems as worthy of an investing bubble as radio, the internet, or subprime mortgages.
And we have the dry powder to make it happen: There is now $1.5 trillion sitting idle in US money market funds.
What's lacking is something to do with it — we can't all just buy Nvidia.
Fortunately, 35% of the most recent cohort of startups at Y Combinator are AI-related.
When those start IPOing, you'll know we're near the top.
Rationally irrational investing
If they do manage to IPO, I suspect it will be because Nvidia made AI look profitable in the same way that RCA made radio look profitable.
When economist Irving Fisher predicted that stocks had reached a permanently high plateau, he did so because "realized and prospective increases in earnings, to a very large extent, had justified [their] rise."
(Black Monday was 12 days later.)
You can similarly argue (as all those sell-side analysts do) that rising earnings justify Nvidia's stock price: It trades on a forward earnings multiple of only about 25x.
For the Nvidia mania to turn into a market-wide mania, we'll have to assume lots of others will cash in on AI, too.
Professor Damodaran, however, thinks AI will prove to be "negative sum," which doesn't bode well for our investment returns.
Still, Damodaran himself has only sold half his Nvidia shares.
He acknowledges this is not rational — "rationality is the first casualty when it comes to investing" — but can't help thinking there might be more to come.
Does that mean we are at the start of a new bubble?
Probably not.
But sometimes you have to make a few irrationally exuberant bets.
Just in case another history-making mania is coming.
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