On Friday, 21 February, This Tech Bubble Indicator Lists on the ASX

Dear Reader,

Yesterday, I talked about the tech sector. I showed you some anecdotal signs of irrational, ‘bubbly’ behaviour that usually occurs towards the end of the cycle.

Thinking Facebook is recession proof, for example…

The things we tell ourselves!

I’ve got another one for you…

On Friday 21 February, a new index launches on the ASX. It’s called the S&P/ASX All Technology Index. According to the Financial Review (FR), it will be a smaller version of the NASDAQ.

Uh-oh…

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The FR reported in December that the index:

‘…would give investors an increased opportunity to tap into the growth of the tech sector, even if it was outside their typical area of expertise, while offering smaller tech companies the opportunity to emerge from the shadows of the WAAAX stocks and raise their profile among a broader spread of potential investors.’

Increasing investor fervour towards tech

The WAAAX stocks are the Aussie version of the US FAANG stocks. The acronym comprises the larger tech stocks: Wisetech, Afterpay, Appen, Altium and Xero.

The existing Tech index only has 13 stocks in it, all from the ASX 200. The new one will be much broader.

This is just another sign of the increasing investor fervour towards tech.

Don’t get me wrong. Longer term, this is a great thing for Australia. The more that our market can diversify away from resources and financials, the healthier it will be.

Anything that encourages investment in innovation rather than houses is a good thing.

However, it’s the psychology of it that I’m interested in here. These things (new index listings) usually occur at a time of high investor interest. When a sector is hot, there is usually little value from an investment perspective.

Over the longer term, that is…

In the short term, this is like waving a red flag at a bull.

ETF funds offering to mirror the performance of this new tech index will pop up. More capital will flow into the sector. Shares prices will rise, which in turn will attract more capital.

Have fun while it lasts though. Following the crowd feels good, and in the short term, it is often profitable. But if you believe the hype, you’ll never see the gathering storm.

The making of another tech bubble

My crystal ball is as busted and murky as anyone’s. But based on history, I see all the makings of another tech bubble forming.

The launch of a broad ASX tech index on Friday is just another anecdotal sign.

Moving to the other end of the spectrum now, Karen Maley writes in the FR today that private equity investors see an opportunity in the mortgage broking space.

Boring, right?

The RBA is now considering negative interest rates.’ Click here to watch this interview with US economist and gold expert Jim Rickards.

Maybe. But boring often points to opportunity. And given I recommended mortgage broker Mortgage Choice Ltd [ASX:MOC] to subscribers of my advisory Crisis & Opportunity last year, I can only concur with the private equity view.

Mortgage broking stands in stark contrast to tech. It’s uncool. It’s old. They struggle to see the opportunity. That’s why private equity is interested.

When I recommended the stock last year, I knew it wasn’t a popular pick. I could tell by the lack of volume that went through on the day following my report. So the next week I wrote another article pointing out the juicy value on offer:

Maybe I was all too rational about it. Maybe the prospect of a 9% return, when government bonds are offering 1%, wasn’t enough?

Perhaps I should have pointed out that if the market changes its tune on MOC and the prospect of a 9% return turns into the prospect of a 6% return (due to share price appreciation) that means the share price will have jumped 50%.

How does that work?

The thing to understand is that when I say a company has an ‘earnings yield of 9%’, it doesn’t mean your return is 9%. If the stock market didn’t adjust prices everyday, and you just owned the business at a set price (and could only sell at that price) then yes, you would get that return.

But the market does adjust prices everyday. One day it doesn’t think much of a business and the price is so low that it offers a ‘return’ of 9% (as is the case with MOC).

But maybe a few things change. Maybe the housing market isn’t so bad after all. Maybe demand for mortgages increases to provide a bit of earnings growth. All of a sudden, the market price adjusts so that MOC trades on an earnings yield of 6%, which is more in line with similar, healthy cash flow businesses.

Here’s a rough way of seeing how the pricing works.

Assume a business earns $100.

At a 9% capitalisation rate, that business is worth $1,111 ($100/0.09).

At a 6% capitalisation rate, the business is worth $1,666 ($100/0.06).

The different between the two figures is 50%.

Of course, there’s no guarantee that this re-rating will occur for MOC. Clearly the market is wary of it. But in my view, it’s a good risk/reward trade off and worthy of consideration for a small portion of your portfolio.

Since I wrote that, the stock price is up around 30%. MOC reports half-year results tomorrow. It will give you a good idea of conditions in the mortgage broking industry.

Judging by the share price rally over the past few weeks, the news should be good.

Regards,


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Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

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