After yesterday’s mini-panic, stocks in the US rallied strongly overnight. The major indices were up around 1.5%. That mild move masked a lot of the craziness going on in parts of the market.
By now, you’ve probably heard of what’s going on in a group of heavily shorted stocks like GameStop Corp. Or I should say, formerly heavily shorted.
In short, a bunch of retail traders got together to engineer a ‘short squeeze’ and push a share price higher. When a manager is ‘short’ stock, it means they have borrowed it and sold it. In order to get out of their position, they must buy it back.
In a short squeeze, where supply is limited, forced buybacks can send a share price soaring. This is good for those that ‘long’ the stock, but a disaster for the short sellers.
GameStop Corp started the year at $19.
Overnight, it ramped to a high of $468 at the open and at the time of writing was $255 per share.
Adding to the insanity, ASX-listed GME Resources (GME is the ticker for GameStop) rallied 60% yesterday…
Sounds crazy, I know.
The game has been rigged for decades
But what do you expect when you force idleness on a population and shower them with money? For one thing, it gives people time to think about how they’ve been screwed by the system and Wall Street in particular over the years.
Wall Street is the classic ‘heads I win, tails you lose’ entity. The game has been rigged for decades. But now the little guy has the means to fight back. That Wall Street don’t like it is hilarious.
They’ve created a monster. And they can’t control it.
But this ramping of insignificant stocks is all just a sideshow.
The bigger issue here is the dysfunctional system this is all occurring in. I’ve been saying for ages now we’re operating in a broken system. This is just one small example of it.
Another example is the sky-high price of Tesla, bitcoin, Afterpay, etc. Money for nothing has exacerbated the moves in all these securities, as well as thousands of others.
Yesterday, you got a small taste of what happens when the mood turns sour. As the Financial Review reports:
‘Tech stocks suffered the hardest hit since a 5.4 per cent slide on November 10 as the S&P/ASX All Technology Index slumped 4 per cent.
‘Big losers on Thursday included Xero (down 6.3 per cent), Kogan.com (down 6 per cent) and Pro Medicus (down 5.9 per cent).
‘The buy now, pay later sector also copped a battering. Afterpay slumped 6.2 per cent, Zip tumbled 5.9 per cent and Sezzle fell 3.8 per cent.’
We’ve seen this play out before. That is, sharp falls in tech, only for the share price rise to resume. If you’re on this trend, it’s a very dangerous game to play.
The valuations are clearly insane. But they clearly don’t matter to investors right now either.
Take Afterpay Ltd [ASX:APT] for example. It has a market capitalisation of nearly $40 billion. Punters obviously aren’t buying it for this year’s earnings. But even based on 2023 consensus earnings, it trades on a price-earnings multiple of 167 times.
It’s in cuckoo land.
Based on those earnings, APT will generate a return on equity of just 11.9%, putting it on par with most well-run, ‘old economy’ industrial stocks.
What that means is, if you bought it at book or equity value, the business (in FY23) would generate a 11.9% return for its owners. But the company doesn’t trade anywhere near its book value. It trades at nearly 17 times expected book value in 2023!
11.9 divided by 17 = 0.7%. That’s the business return those buying at these prices can expect. I would consider that a fortuitous outcome.
Tech investors don’t think like that though. In their world, capital is patient and first movers will benefit from the network effect. They will be the dominant player in their industry, build a massive moat around their business, and run a virtual monopoly.
That’s the narrative. That’s the story they’re telling themselves as they ignore the crazy valuations and focus on the ‘long term’.
Nothing is cheap
Except that every ‘investor’ in every stock thinks this way. For every Afterpay there are 10 other competitors who think their price should contain a network effect and dominant moat premium.
It’s not going to end well.
In my view, the best way to play this crazy market is the same way the game has always been played. Buy companies that have revenue and earnings, and don’t pay stupid prices for those earnings.
If the history of the stock market has told us anything, it’s that fads come and go. Like flies to a pile of sh*t, capital will spend some time sniffing around. But when it realises it’s just a pile of sh*t, it will flee.
Be boring. Invest smartly. And over time, you’ll come out on top. Just don’t expect to buy companies ‘cheap’ these days. Nothing is cheap. And to be honest, it never was. Like Einstein told us, everything is relative.
Stocks are only cheap relative to what else you can put your money into.
Vern would argue that stocks aren’t cheap relative to cash. In the short term, he probably has a point. But longer term, with Biden, Yellen and Powell running the show, and the populist Morrison and QE-starting RBA holding court in Australia, cash is the last place I want to be.
It only provides a thin veneer of safety.
So buy stocks!
But be smart about it. There are crazies everywhere.
Editor, The Rum Rebellion