Same Old Dance Moves

Every decade or two financial markets enter a state of what Alan Greenspan called “irrational exuberance.” These periods are characterized by markets that defy logic and reason. The time changes but the narrative repeats.

  • “We’ve entered a new paradigm.”
  • “Old investing rules no longer apply.”
  • And of course, “Things are different this time.”

In the 1990s internet stocks were valued on “eyeballs” instead of earnings. In the 2000s financial engineering transformed speculative credits into investment grade. And in every case “prices only go up.

Each iteration produces a fresh crop of wide-eyed, newly-minted investors seduced by the promise of fast money. Investing is “easy” and anyone who criticizes the exuberance is a fear-monger stuck in the past.

In case you’re wondering, yes, we’re seeing signs of irrational exuberance. If you’re in denial consider the rationality of recent market action.

Last May after filing for bankruptcy Hertz stock jumped +896% in two weeks. Stocks of other bankrupt companies like JC Penney and Chesapeake also joined the party.

This January the stock of near-defunct GameStop catapulted almost +1,800%, collapsed and then surged again. The stock is still up over +800% year to date. It was just one of many “meme stocks” that have flourished from the fervor of day-trading self-proclaimed Reddit “degenerates” and”Robinhoodies.”

Right now anyone can be an oracle and it’s hard to know what’s real or fake. Just look at Dave Portnoy’s viral “DDTG” clips of the past year (heads up on his explicit language). Some dismiss Portnoy as a joke, many others seriously follow his lead.

And then there is the original poster child of this decade’s-long run in stocks, Tesla, which has gone near parabolic since 2020.

Tesla deserves special mention due to its sheer size. At year-end 2020 Tesla had a market cap of over $795 billion. For perspective, that was more than the market cap of Toyota, Volkswagon, Daimler, General Motors, BMW, Honda, and Hyundai COMBINED (they totalled 596 billion)!

As of 12/31/2020
Sources: VisualCapitalist, Statista, BCM

That extraordinary premium existed even though Telsa only sold about 1% of the number of cars its competitors did in 2020 (Tesla’s highest sales year ever). Bulls might argue that reflects enormous growth potential. Sure, Tesla will gain market share in the future, but it’s ALREADY valued like the other automakers don’t exist today.

Is it reasonable to assume Tesla will be the world’s only automaker? Is it rational to pick stocks out of a scrabble bag, or for bankrupt companies to jump 1,000%? No, it doesn’t make sense, but it doesn’t have to with irrational exuberance.

To the credit of Portnoy, Robinhoodies, and Tesla faithfuls their approaches have worked well. It’s hard to find any strategy that beat long “YOLO” calls on meme stocks over the past year. Well, except for crypto on margin maybe (but that’s another post).

What’s more, the same momentum that led for the past year could certainly keep going. For how long, nobody knows. Like Archegos, Melvin Capital, or John Keynes would tell you, “the market can stay irrational longer than you can stay solvent.”

The important takeaway from all this is to remember that in the end things will not be different this time. We’ve played this game before and we know how it ends. Whether its tulips, eyeballs, or meme stocks we’re all playing musical chairs (h/t Chuck Prince). Everybody may be wild’n-out on the dance floor, but just remember the music stops, and keep an eye on your seat.

Victor K Lai, CFA

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