Recently, it seems like every day we read a headline about a new SPAC, crypto coin, NFT, or IPO that doubles in value in practically minutes. Many of these “investments” have no actual revenue, and little or no use. These headlines are reminiscent of the Internet Bubble that burst in 2000. What is causing this seemingly reckless and dangerous behavior in Special Purpose Acquisition Companies (SPAC), crypto coins (with no actual purpose), Non-Fungible Tokens (NFT), and Initial Public Offerings (IPO)?
Besides the cause of the behavior, there are other serious questions to be contemplated. What is the likely outcome of the behavior for these “investments”? What about traditional asset classes? Most importantly, what do these speculative investments mean for your portfolio at Osborne Partners? These questions should be constantly analyzed as we manage portfolios through this unique environment.
In defining these investments, first, a Special Purpose Acquisition Company (SPAC) is not a newly invented investment. A SPAC is simply a fancy name for the old Blank Check Companies. The investor hands someone money, and they eventually decide to buy a private company that will be brought to the public capital markets. Outside of the blockchain technology that is the backbone to many crypto coins and currency, many (most) cryptos seemingly have no purpose or value except to rise and fall in value. Next, NFTs are simply digital files, for example art or a short video, that are on a blockchain ledger. They are designed not to be copied (although they can be copied) and owned as an asset. Just like a collector owns an original Francis Bacon painting, they can own an original Beeple NFT.
IPOs are fairly well known. In some environments, only the healthiest, highest growing or most proven companies are able to tap the public markets in an IPO. In other, more speculative times, companies that do not have these characteristics (yet or ever) can find investor demand for an IPO.
Speculative periods usually have a few things in common – easy access to money through very loose monetary policy (high money supply), low interest rates, and “greater fools,” or all three simultaneously. Often investors purchasing speculative investments will understand that they are significantly overvalued or even worthless. However, these investors also think they will be able to ride the speculative wave and sell to a “greater fool” before the speculative furry ends. These characteristics were present during Tulip Mania in the 1600s, the Mississippi Company bubble in the 1700s, and the Internet Bubble in the 2000s, just to name a few. Based on the environment over the past year, today’s speculation should not be a major surprise. The pandemic caused a major recession. The recession caused the Federal Reserve to lower short-term interest rates to zero, while expanding the money supply. Personal loan rates plummeted, margin rates were low, and mortgage rates reached record lows.
However, this recession is not typical. Millions of people were forced to stay at home. Many worked from home, while others lost their jobs. At the same time, the government enacted $3 trillion in economic stimulus, with a meaningful portion in the form of direct stimulus checks. For example, the latest $900 million in stimulus included $600 million in direct stimulus checks to individuals. Additionally, professional and college sports were postponed or canceled, while entertainment and leisure travel was non-existent. For many, speculating in all sorts of investments became their new pastime.
The speculation escalated as the first round of stimulus checks hit. The stock market was the first place speculation surfaced. As people were sheltered at home with little to do, and no sports to watch or wager on, investors “gambled” on the stocks of cheap airlines, cruise lines, and companies in bankruptcy. After these wagers became boring or individual investment bubbles (bubblettes) popped, investors moved on to the next speculative investment. This cycle has now repeated itself through a multitude of investments.
What is the likely outcome? A bubble is defined as a situation when the price of an asset exceeds its fundamental value by a large margin. Safe to say newly invented crypto coins with no purpose and $69 million NFTs fall under this category. The likely outcomes are always the same. Just as in the 1600s one tulip was not worth 1,000 pounds of cheese, or in the 1700s the Mississippi Company could not follow through on a promise to French investors for 120% returns, or an internet stock with no revenue in 2000 should not be valued at $10 billion, most of today’s “investment” bubblettes will end the same way.
Speculative bubbles typically have five phases. First, Displacement (cryptos will displace all currencies). Next is the Boom (see 2020), followed by Euphoria (see 2021). The tricky part is phase four, Profit Taking. This is when more of the older “greater fools” are selling than the newer “greater fools” are buying. The asset price falls slowly at first, but then the decline accelerates quickly. Phase five is the Panic phase, when the bubble fully pops, and the investment never sees anything remotely close to previous valuations.
Timelines are difficult to build with bubbles. Although we know most of these investments will end with a spectacular implosion, the timing is impossible to call. We are certainly in the euphoria phase. Now, as soon as the seasoned greater fools start to sell faster than the newly minted greater fools, phase four should begin. Will a lack of future stimulus checks help to hasten the timeline? Will individuals physically returning to work be an ingredient? Maybe a bit of both.
How are traditional asset classes acting through this bubblette speculation? While some subsegments of equities such as small-cap growth, software, and online retail could be construed as moderately overvalued, value equities as a whole (Russell 1000® Value) trade at a reasonable 18 P/E on improving earnings one-year out. Foreign equities trade at a 16 P/E – a substantial discount to the S&P 500’s 22 P/E. Additionally, economically sensitive companies will see earnings spike on easy comparisons.
Natural resources are seeing signs of inflation just as most investors are underweight the asset class, and the supply of many commodities is inadequate to cover ramping demand. In real estate, high quality REITs are becoming excellent fixed income alternatives, while the business environment for homebuilders (a 2020 overweight for us) has arguably never been better. Today, the investment environment can be characterized as having a wide spectrum of reasonably safe and fairly valued investments coupled with obscenely speculative bubblettes.
Most importantly, how does this environment of easy money and low interest rates derived speculation affect your portfolio at Osborne Partners? As opposed to avoiding conducting research on these bubblettes since we do not own them, the Investment Team chooses to be knowledgeable about them in order to carefully monitor the potential fallout from future bubbles popping. When the Internet Bubble popped, billions of dollars were lost on terrible speculative investments, but at the same time, many fairly valued industries, sectors, and asset classes fared well and outperformed. Since our investing style is extremely disciplined and style agnostic, we are able to manage around some of these surrounding risks, and own a diverse portfolio of multiple asset classes with both growth and value characteristics.
Avoiding personal financial damage via active risk management is our most important job. This comes in the form of helping you to avoid speculative investments or deviating from the customized financial plan we create for you. These bubbles of all sizes will come and go, but there is no substitute for deep fundamental research, valuation analysis, risk-management, and having a solid, active financial plan.