Pop: Bubbles Are Bursting Everywhere

Bubbles in risk assets, including Bitcoin and a lot of other speculative nonsense, are finally bursting, showing why intrinsic value matters after all—and why the laws of economics, though recently suspended, have not been repealed. 

After a long period of time where a value strategy looked tortoise-like (losing ground to the broad market, tech stocks, and every other hare-like momentum strategy), things appear to be changing. Fast. 

Last year, value plodded along behind the broad market indices and international stocks (the greatest store of ignored value) did poorly. But since December, a sea change has taken place. Only time will tell if it’s a lasting turn, but historical context would say yes.

The alleged catalyst for the change has been the looming Fed rate hikes, the effect of which is to make absurdly overvalued speculative stocks appear even more overvalued in the context of rising costs of capital. Fed minutes released on Wednesday brought this point home. But the reality is that when a bubble bursts, the reasons are created after the fact. They burst because physics and economics can no longer support the valuation. No other reason is necessary.

A few of the bubbles bursting:

Crypto: Crypto assets are suffering crashes the likes of which would be considered cataclysmic in general markets. Bitcoin is down nearly 40% from its highs; Ethereum is down 34%. More colorful (yet less commanding) names like Polkadot are down 50%. Crypto has seen such crashes before and may well rise from the ashes in a nanosecond. But as I wrote recently, you can’t value crypto so there’s no logical basis to own it. It is a classic speculative gamble. And such things usually end badly. 

Momentum Growth Stocks with Negative Returns on Capital: Perhaps the biggest fad of the past two years has been buying stocks that have captured the public’s pandemic imagination. In aggregate these companies have negative returns on capital (earnings/shareholders equity), a sure sign they are destroying shareholder money. These stocks are exemplified by ETFs such as Ark Innovation (ARKK)

which owns everything from Teladoc

to Roku, both of which are down more than 40% over the past year. Buying a basket of such businesses is the height of speculation.

Meme Stocks: Yet even more absurd are meme stocks, garbage companies that shot to the moon on the back of a tweet. The leader of this madness, AMC (AMC), is down 39% over the past three months. Over $80 billion in market capitalization has been wiped out since the highs. Meme stocks are the ultimate exercise of what’s called the “greater fool theory,” the belief that you should buy a stock because it’s going up on the prayer that a greater fool than you will eventually take it off your hands for the same reason. Many of these stocks will go to zero.

Just as in 2002 there were hundreds of dotcoms that perished (like Pets.com) for every Amazon, so too will there be a massive culling in the vast array of speculative trash that currently taints many portfolios. Being tortoise-like is hardly rewarding when the hares are all sprinting. But the complacency of the hare takes its toll eventually. That time could be now. Slow and steady may again win the race, as it often does.