After a glorious two years of broad gains, the bond and equity sell-off is hitting investor confidence. Our own assessment of investor risk aversion shows the once-in-a-generation levels of speculation have morphed to caution.
Companies are finding it more difficult to raise capital on terms that favour them – though, for long-term investors with savings to invest, this is good news.
Lower prices reflect lower expectations and better value. In fact, investors still remain ahead relative to 12 or 18 months ago and we have yet to see signs of panic or ‘closed’ markets, which are typical when speculative manias end.
This leaves us to look at historical comparisons and how investors can prepare themselves to deal with challenging conditions.
The most comparable period of recent investor behaviour is the late 1990s and early 2000s – though the mid-to-late 1920s also has many similarities.
I was working as an equity strategist at the time – in the former instance – and it was exceptionally difficult to distance yourself from what was going on and not get drawn into the fervour about companies changing the world (which many did).
Highly successful businesses of that era are still major players today: Microsoft, Cisco and Apple being obvious examples.
Others, such as media and telecoms companies, have very much faded as disastrous acquisitions, fast-changing technologies or oversupply torched their profitability and growth.
Disruptive innovation
Many investors today have no memory of this so it is worth dwelling on the parallels to today.
A fascination for disruptive innovation is common to both periods – back then it was focused on media, telecoms and e-commerce, now it is broader-based and includes blockchain, gene therapy, energy transformation and information technology.
New cheaper and easier ways to invest also emerged – this time digital free trading platforms supported by social media socialising and, back then, online share trading accounts.
In both cases, these ushered in a new generation of investors unfamiliar with investing, who had only ever experienced unusually large gains, as markets rebounded from the 1998 and 2020 market sell-offs.
Another notable feature is what Charles Kindleberger, in his excellent financial markets history Manias, Panics and Crashes, calls a “displacement”.
This is an outside event or shock that shifts expectations and seems to make history less relevant as a guide.
In the 1920s, it was the electricity, automobiles, telephones and radios; in the 1990s it was the information technology and the internet. This time round, blockchain technology was breaking through and, with it, cryptocurrencies attracted huge interest, despite no associated income stream or clear way of assessing fair value.
Early investors made up to 30 times their money in cryptocurrencies and up to five times their money in more speculative innovation-themed companies, putting to shame the gains in legendary speculative manias, such as the Dutch Tulip craze of 1637 and the British South Seas Bubble of 1720.
A new generation of retail investors led the charge with little focus on traditional fundamental analysis, such as valuation; influenced by social media cheerleaders; and empowered by free and widely available trading platforms.
Enthusiasm breeds overconfidence
Enthusiasm led investors to have confidence that loss-making companies would eventually turn a profit.
This spurred waves of IPOs to soak up this demand, aided and abetted by ‘special purpose acquisition companies’ or ‘Spacs’, for which investors paid a hefty price for the potential to acquire an unknown company. The use of debt and single stock options to magnify returns ballooned.
Major successful companies during the Covid pandemic were also re-rated so that share prices rose much faster than profits.
On average, share prices doubled for the ‘Faang’ group of tech giants from the end of 2019 to their peak. This is all the more remarkable given the already huge size of these companies and global government moves to increase regulation to reduce market power and increase taxation.
As at 8 June 2022, the average Faang share price is down 35%, while bitcoin and high flying stocks such as Peloton are down 50% and 90% from their peak, according to Morningstar data.
See also: How the Faangs lost their bite
In the early 2000s sell-off, the average fall in share prices from peak to trough was 76% for the successful survivors, such as Cisco, Apple and Microsoft, while the Nasdaq fell by a similar amount.
These losses occurred against a backdrop of the US Federal Reserve raising interest rates by 1.75% from 4.75% to 6.50% between June 1999 and May 2000.
We are starting to see more value emerge and the valuation gap is narrowing with sectors and countries that did not get caught up in this era’s innovation-led mania.
If there is a re-run of the early 2000s, there may be some bargains to be had – assuming investors can bring themselves to buy something that may previously have lost them a lot of money.
Mike Coop is CIO of Morningstar Investment Management, Emea
