Speculative High Flyers are Rapidly Losing Altitude

By John Banks

On Friday of last week we said:

“There is a formidable bearish case for overvalued technology stocks moving forward, and it is only getting stronger by the day.

“The bear case has to do with interest rates at the long end of the curve, and the willingness of the Federal Reserve to sit back as long-end yields (the 10-year and the 30-year) start to rise.”

On Monday, Feb. 22, the markets took heed, with various high flyers falling hard.

Perhaps most notable was Tesla (TSLA), which dropped nearly 9% in a single day. Other single-day decliners included Peloton (PTON), down nearly 10%, and DoorDash (DASH), down nearly 14%.

So was Monday, Feb. 22, a rough day for markets overall? No, it depended on how you were positioned.

Energy stocks surged, with XLE, the bellwether energy stocks ETF, up nearly 3.5%; and financial stocks surged too, with KRE, the bellwether regional banking ETF, up more than 2%.

Energy stocks and financial stocks went up, on the same day high flyers got hammered, because the long end of the curve is doing its work. Also on Monday, the U.S. 10-year and 30-year yields touched pre-pandemic highs of 1.37% and 2.19% respectively.

As we have explained repeatedly in these pages, the case for Buzz Lightyear valuations — “To infinity and beyond!” — is predicated on perpetually low interest rates. If you change that equation, the valuations are no longer sustainable.

On Feb. 22, legendary hedge fund manager Ray Dalio published a think piece to ask and answer the question, “Are We in a Stock Market Bubble?”

His answer: It depends on which names you are talking about. “There is a very big divergence in the readings across stocks,” Dalio said. “Some stocks are… in extreme bubbles (particularly emerging technology companies), while some stocks are not in bubbles.”

Dalio then noted the extreme bubble stocks represented about 5% of the top 1,000 U.S. companies by market cap, making them a kind of “Nifty Fifty” for the new era.

(The original Nifty Fifty comprised a group of stocks deemed “no-brainer” or “one-decision” investments in the 1960s and ’70s, known for wildly high price-to-earnings ratios prior to crashing and burning.)

For TSLA, a psychologically critical support level is $650 per share. Why $650? Because TSLA closed at roughly that level on Dec. 21, the day the company joined the S&P 500.

In December 1999, a company called Yahoo! — the exclamation point was part of the name — joined the S&P 500 index, and a few months later reached an all-time high valuation of $140 billion. (Seventeen years later, Yahoo! would be scooped up in a fire sale at less than 5% of that amount.)

The December 1999 inclusion of Yahoo! into the S&P 500 also marked the top for the whole bubble, or something very close. It was roughly three months later, on March 10, 2000, when the Nasdaq 100 peaked above 5,000.

We mention Yahoo! — not for the first time in these pages — because the S&P 500 parallel feels uncanny. If Tesla follows the Yahoo script, the all-time high could be in; and if the Nasdaq follows the 1999-2000 script, the high for the 2020-vintage “Nifty Fifty” complex could be on the books too, with a fudge factor of weeks relative to the March 2000 top.

It is very hard, if not definitively impossible, to know when a raging bull market will end. But there is a difference between making the call in advance, as based on assumption or conjecture, and observing a breakdown in price action alongside a series of bearish events.

As we finish this note, CNBC is reporting that December home prices rose 10.4% — the largest jump in seven years, according to Case-Shiller Home Price Indices.

At the same time, a Bloomberg economist survey foresees 4.9% U.S. GDP growth in 2021 — a pace more normally associated with emerging markets — and Morgan Stanley is forecasting $70 Brent crude (another 8 to 10% price rise from current levels) by the third quarter. 

Then, too, in the past week or so, we have seen headlines like this:

  • “U.S. is Poised to Beat China’s V-Shaped Recovery, JPMorgan Says (Bloomberg)”
  • “Blue-Collar Jobs Boom as Covid-19 Boosts Housing, E-Commerce Demand” (WSJ)
  • “Midwest Labor Markets Shake Off Covid-19 Downturn” (WSJ)
  • “U.S. economy may have its best chance in years to break from era of subpar growth” (Washington Post)

“Midwest cities such as Columbus, Ohio, have had some of the most resilient job markets during the pandemic,” the Wall Street Journal adds. “Indianapolis, Minneapolis, and Cincinnati joined Columbus as having among the lowest unemployment rates of 51 major metro areas at the end of last year…”

We should also note that, for some observers, the U.S. GDP estimate of nearly 5% is on the low side; Goldman Sachs expects 7% growth, which would be the biggest U.S. expansion year since 1984.

The point of revisiting this growth litany is that economic growth can sustain higher yields at the long end — particularly if the short end is held at zero — and the Federal Reserve is likely to allow an ongoing rise in 10-year and 30-year treasury yields.

If Columbus, Indianapolis, and Minneapolis are looking good, that further steepening of the yield curve — which, by the way, is like manna from heaven for bank stocks — can continue until something breaks.

And as investors rotate heavily back into reflation plays — energy stocks, financials, industrials, construction plays, airlines, travel and leisure, and so on — the prospect of further carnage looks strongest in the “Nifty Fifty” group Ray Dalio referenced.

Then, too, the electric vehicle (EV) and special-purpose acquisition company (SPAC) niches may warrant close attention.

EV companies are (or were) a white-hot center of speculation, with the SPAC structure serving as the perfect grifter spaceship vehicle: When putting, say, an EV and a SPAC together, you get a combination that is pure nitroglycerine.

Perhaps it is no surprise, then, that Churchill Capital Corp IV (CCIV) — a blank-check SPAC that just confirmed a much-anticipated EV acquisition, and had previously sported a $15 billion market cap — is down nearly 50% in early morning trading as we finish this note, and TSLA is sub-$650, too.

As a final note, the really unsettling thing about the EV exodus (and the move away from tech stocks generally) is the possibility for a new “market structure” event to quickly unfold, over the course of the coming days or even by the time you read this. Short sellers provide an under-appreciated service to markets by covering their positions on the way down, which means buying when everyone else is selling. When short sellers are mostly absent, as they are for most of the high-flyer names, there is a greater risk of air pockets (via no one left to buy) as longs head for the exits.