Phil D'Iorio / January 15th, 2021

Is The Stock Market in a Bubble?

Phil D’Iorio

The stock market has been volatile as 2021 gets underway. After a negative start on January 4th, the market strengthened but it has given back most of the gains in the last few days. This leaves the market up marginally since the beginning of the year. The key issues for investors remain the same and are centered around a global economic recovery. One of the key factors that will drive the recovery is the success of the vaccines that are now being rolled out around the world, which will allow businesses and economies around the world to re-open and resume normal activity.

As we all know, global stock markets have surged since late March primarily on the back of government stimulus. This has provided massive amounts of liquidity, a large portion of which has found its way into stock market. This begs the question, is the stock market in a bubble?

From our perspective, we do see some areas within the market that are concerning. Tesla is a good example with the stock up approximately 1,000% since the March lows! During my career I have seen a few 10-baggers but typically they unfold over several years and sometimes over a decade. I do not recall seeing too many large-cap 10-baggers happen in less than 1 year. As seen in the chart below, Tesla’s 12- month return is well above some of the largest returns that were generated during the Tech Boom in the late 1990’s. This includes Amazon, Microsoft and Cisco.

Source: Boomberg

Another example of a potential bubble is Bitcoin. As seen in the chart below, Bitcoin’s return has been well in excess of other bubbles that occurred in the past. This includes the Tech bubble, the US housing bubble, and the gold bubble.

Finally, we also see a potential bubble within unprofitable Technology companies. Many of these companies are up by 200-300% over the last year despite a lack of profitability.

So Tesla, Bitcoin, and non-profitable Tech are good examples of potential bubbles but does that mean there are bubbles everywhere? We believe it is an exaggeration to say that the entire market is in a bubble. A number of stock market indices generated negative returns during 2020 including the FTSE 100 Index in the United Kingdom (-14.3%), the CAC 40 in France (-7.1%), and the Borsa Italiana in Italy (-5.4%). The S&P 500 was up 16.1% in 2020 but some industry sectors were down during the year including Energy (-37.3%) and Financial Services (-4.1%). These types of returns are not indicative of a widespread bubble formation. We are finding opportunities in various parts of the market, especially in the Financial Services and Healthcare industries. Within those sectors, we see several stocks trading at a 50% discount to the stock market multiple with many companies trading at price-to-earnings ratios of 10-12x on 2021 consensus estimates.

So back to Tesla, Bitcoin, and non-profitable Tech. Why do we say they are in a potential bubble? The interesting thing about bubbles is that you will only know it was a bubble with the benefit of hindsight. Bubbles can go on for years before they pop. Nobody knows how long they will go on for and sometimes what is perceived to be a bubble doesn’t always materialize. Amazon is a good example. And it’s possible that Tesla could keep going up. Having said that, just because a popular stock doesn’t implode and become worthless, it doesn’t necessarily mean that it will be a good investment. Cisco is a good example. If you had bought Cisco Systems during the peak of the Tech boom in 1999-2000, you would still be in a loss position today, 20 years after the fact! The reality in the world of investing is that the price you pay dictates the return you receive. Buying a great company does not always guarantee a great return.

Our clients can rest assured that we are staying away from the areas of the market where we see the risk of a potential bubble and we are spending our time looking for opportunities in areas of the market that have been neglected.

*Cumberland and Cumberland Private Wealth refer to Cumberland Private Wealth Management Inc. (CPWM) and Cumberland Investment Counsel Inc. (CIC). NCM Asset Management Ltd. (NCM) is the Investment Fund Manager and CIC is the sub-advisor to the Kipling and NCM Funds. CIC is also the sub-advisor to certain CPWM investment mandates. This communication is for informational purposes only and is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. Reasonable efforts have been made to ensure that the information contained herein is accurate, complete and up to date, however, the information is subject to change without notice. Information obtained from third parties is believed to be reliable but no representation or warranty, express or implied, is made by the author, CPWM or CIC as to its accuracy or completeness. The communication may contain forward-looking statements which are not guarantees of future performance. Forward-looking statements involved inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. All opinions in forward-looking statements are subject to change without notice and are provided in good faith but without legal responsibility. Past performance does not guarantee future results. CPWM and CIC may engage in trading strategies or hold long or short positions in any of the securities discussed in this communication and may alter such trading strategies or unwind such positions at any time without notice or liability. CPWM, CIC and NCM are under the common ownership of Cumberland Partners Ltd.