In March, Arrival, a British startup that produces zero-emission public transit vehicles, listed on the Nasdaq at a valuation of $13bn, making it one of the largest-ever listings of a UK tech company. The company completed its IPO through a SPAC merger with CIIC Merger Corp, which is led by Peter Cuneo, the former chief executive officer of Marvel Entertainment.
It sounds like a great British tech success, and on some levels it is. But on other levels, it’s quite strange. One of the largest-ever listings of a UK tech company involves a company that hasn’t sold a single product.
The colossal valuation, Arrival (£9.36 billion) was worth a lot more than the Royal Mail (£5 billion), Sainsbury’s (£5.43 billion) or British ecommerce success stories Asos (£5.35 billion) Boohoo (£4.33 billion) or The Hut Group (£6.28 billion), is based on a combination of its intellectual property and a large pre-order commitment from the courier firm UPS – an active investor.
The deal with UPS, signed in October last year, is significant. It is for 10,000 vehicles with an option to buy 10,000 more. It could potentially be worth $1.2 billion. The company is said to have a lot of valuable IP. But a $13 billion valuation for a pre-production vehicles company with some nice looking IP and one firm commitment for a large order, made by a major investor in the company with a clear vested interest is, well, a bit strange.
At least, under normal circumstances. But a lot of the recent goings on in financial markets would be considered strange under normal circumstances. Strange enough to spark alarm. As it is, these events are seemingly being largely ignored by large segments of the market.
#1 Hometown International – the $100 million deli that made $14,000 in a year
One somewhat startling example of the market’s current euphoria is the story of Hometown International – a single location deli in New Jersey. The company that owns the deli was until earlier this month listed on New York’s over-the-counter market.
The deli isn’t especially thriving and last year generated annual revenues of $13,976. In February it was valued by the market at $113 million. As one commentator pithily remarked, “the pastrami must be amazing”.
Hometown International was delisted from the over-the-counter market earlier in April “for not complying with the rules”. But what does the fact that o-t-c liquidity markets could value a business with absolutely no IP, scalability, or even viability as a running concern ($14,000 annual income wouldn’t pay even one full-time minimum income salary before tax) at over $100 million tell us about the forces currently driving stock markets? Especially Wall Street?
#2 The stock market is booming
Despite the end hopefully now being in sight for much of the developed world, with the USA and UK out in front with their Covid-19 vaccination programs, we’re still in the grip of a pandemic. One that cost the global economy over 5% of GDP in 2020 and a figure that could quite conceivably increase in 2021. The developed western economies of the UK, EU, USA and Canada have been hit harder than most so far.
Of the impact of the coronavirus pandemic on the U.S. economy, the World Economic Forum’s bullet points read:
- The COVID-19 pandemic has caused the biggest blow to the US economy since the Great Depression.
- GDP fell at a 32.9% annualized rate, the deepest decline since records began back in 1947.
- 30.2 million Americans were receiving unemployment checks in the week ending July 11.
And yet, stock markets have never been healthier. The major Wall Street indices of the S&P 500, Dow Jones industrial average and, most of all, the Nasdaq are on an absolute tear. All three have set multiple record highs in 2021 – 21 for the DJIA by late April.
Trump never ceased to boast about his administration’s positive impact on Wall Street. But the Dow Jones’ gains over the first 100 days of the Biden administration that succeeded him are the highest since after Roosevelt ascended to the office in 1933.
#3 A new generation of online daytraders and retail investors a new animal spirit driving markets to unprecedented highs
One of the most significant developments in financial markets over recent months has been the increasing influence of small retail investors. Low and no commission trading apps and easy access to information, social media groups, and other online communities have all influenced a growing interest in trading and investing among younger demographics.
Like many other trends involving digital technology and business models, it is one that has noticeably accelerated throughout the Covid-19 pandemic. To such an extent that a greatly reinforced army of retail investors is having a real impact on trading volumes and levels of volatility in equities and other financial instruments.
Large numbers of retail investors, often intentionally, skewing prices has been most notably apparent in the Gamestop saga, where a group coordinated via the Reddit subforum #WallStreetBets started attacking the short positions of hedge funds.
In early 2021, the army of retail investors started piling into the stock of struggling U.S. video games retailer Gamestop with a clear strategy of driving its valuation higher. Not because they felt the company’s financial fundamentals or future prospects justified a share price that reached several multiples of where it started the year. But to force hedge funds shorting the stock, and several others, to close positions betting on its valuation falling, crystalising losses.
It’s a strategy known as a ‘short squeeze’. And while many of the army of retail investors also clearly hoped to profit from the unprecedented volatility that resulted from the tactic, the movement has been positioned as an idealistic attack on the perceived opportunism of hedge funds and the damage their short attacks can cause to companies.
The result has been ‘off the chart’ record equity trading volumes over the first part of 2021, both for standard ‘cash’ equities and leveraged derivatives trading. Just January saw 7 of the 10 days with the highest volumes of call options in history. About 25% of these trades, say Goldman Sachs, are made up of small orders, compared to just 10% in 2019, demonstrating the presence of large numbers of retail investors driving record volumes.
These higher volumes are translating into higher levels of market volatility and some particular anomalies such as Gamestop’s share price gaining over 700% in a day in late January.
Another symptom is just how forward-looking the valuations of some companies have become. Especially the stocks most popular with retail investors, for example the electric car maker Tesla and other high profile tech stocks like Amazon and Apple, seem to be ignoring current conditions. Huge valuations are being assigned on perceived future prospects of companies rather than their actual performance.
Stock prices have always priced in optimism on future performance but in a way that also priced in the risk things may not turn out as positively. Right now valuations seem to more reflect the best-case scenario for companies over future years and ignore the risk of that not actually coming to pass.
The resurgence of interest in cryptocurrencies and the huge gains bitcoin has seen over the past year, from around $8000 to $60,000, is also seen by many as a warning sign financial markets may be in meltup.
Again, the cryptocurrencies market is one predominantly driven by the trading activity of retail investors. Believers are convinced the huge surge in the dollar exchange rate of bitcoin and other cryptocurrencies simply reflects a reality that digital assets are reaching a tipping point and will soon become part of mainstream finance.
The counter argument is that regardless of whether digital currencies become part of financial markets or not in future years, and most accept they probably will in one form or another, they are not there yet. Right now, investing in bitcoin is speculative.
Nobody really knows what the future holds for the original cryptocurrency. But despite the still significant uncertainty, a single bitcoin, a digital currency that can’t be used as a currency in any mainstream financial transaction and only exists as a line of computer code, costs around $60,000. A further example of retail investor-driven markets arguably completely ignoring risk and possible downside and placing all the emphasis on the most optimistic outcome.
#5 Schiller calls crash
The economist Robert Schiller first made his name as someone to listen to when he called the timing of the end of the dotcom boom. Sure enough, as Schiller had foretold, it came to a spectacular halt in early 2000 with the onset of the dotcom crash in March. Schiller also subsequently warned the USA’s housing market was dangerously overvalued ahead of the sub-prime collapse that triggered the International Financial Crisis of 2008-09.
While those calls obviously don’t mean Mr Schiller will always be right about everything, they do lend weight to his warnings. Schiller now sees parallels between the stock market boom over the last decade and that of the 1920s, when surging prices and technological innovations also tempted in large numbers of small investors with little to no experience of stock market investing. Worryingly, the eventual collapse of the roaring ‘20s on Wall Street ushered in the Great Depression.
The good news is while Schiller is worried about an impending market collapse from current prices, he thinks it is unlikely to be as severe as that of a century ago. He recently wrote in the New York Times:
“There is no particular reason to expect a market collapse that would be as bad as the 1929 crash, and the government and the Fed have shown themselves to be far more adept in staving off prolonged recessions than their predecessors. But we shouldn’t be surprised if uncomfortable feelings about the market grow to unmanageable proportions, leading eventually to a major stock market decline.”
The psychology of melt-ups
One thing all financial market melt-ups are seen as having in common is that they are symptomatic of ‘lazy investors’ making money for an extended period of time without having to put in the volume of work usually needed to make correct choices – because everything is going up. That ultimately leads to the valuations of financial instruments becoming detached from economic realities.
Aswath Damodaran, professor of finance at the Stern School of Business at New York University, is convinced that’s what we are seeing now and that the eventual outcome is inevitable:
“The longer a bull market rally lasts, and the easier it is to make money without doing any work, the lazier investors get,” he said. “I think that the laziness that traders and investors are bringing to the market is going to create blow-ups and pain.”
Are we in a melt-up?
Time will tell if we are currently in a melt-up phase or not. There are those who argue there are differences between what is happening now and ahead of past crashes. For one, most of the large technology companies do also generate significant revenues, even if not all are profitable. And their potential is on a scale not possible in the pre-digital economy we currently live in.
Also, as Schiller says, governments and central banks have recently shown themselves to be far more interventionist than in the past, and have largely prevented particularly bad or extended market downturns. But there’s also no guarantee that will continue to the same extent. There are competing concerns that the level of intervention seen over the past decade and a half will have to be wound down at some point – even if that results in some pain for companies and investors over-exposed to the bull market.
I personally do think we are in the midst of a classic melt-up period for financial markets and the big question is how painful its end will prove. Many analysts agree with me. Others don’t.