DNY59/E+ via Getty Images
The great pandemic pull forward is pushing back.
Shares in the high-flying “pandemic winners” are dropping like flies. The first wave of selling started months ago, with names like Zoom (ZM) and Peloton (PTON), each down 70% or more from the highs. Now, the pain is rippling through the rapid-growth “disruptor” cohort across the board.
Cloud software companies DocuSign (DOCU) and Asana (ASAN) recently became the latest high-profile blow-ups, with each company giving up over 50% of its value in a matter of weeks. DOCU’s 45% single-day decline last week was enough to spark some initial bargain-hunting interest. But to my dismay, even despite the half-off sale, shares remain wildly overpriced at >13x trailing sales.
The fundamental problem is one of the initial conditions. Investors became so enamored with the growth prospects of the “disruptive innovators” in today’s market, that they’ve priced these companies at impossible-to-justify valuations.
In many cases, much of the growth came from the temporary impact of pandemic lockdowns, amplified by record fiscal and monetary stimulus. It turns out, much of the so-called “disruption” premium-priced into these businesses was merely a giant pull forward of 5-10 years of growth into the last 18 months.
The problem with pricing business for perfection is that perfection often remains elusive. That’s the story in countless of the disruptor business models today, with growth slowing as consumer spending patterns mean revert in the wake of the waning pandemic. Investors can no longer justify price/sales multiples of 30x, 40x or higher in the absence of 50% compounded sales growth rates.
That’s how we find ourselves in a situation where stocks can drop 50% overnight, and yet remain overpriced and fraught with risk.
So, what’s it all mean for investors and the broader stock market?
Disruptor Destruction a Preview for Blue Chips and Broader Stock Market
For now, the broad market indices remain only a few points off all-time highs. However, the breadth and magnitude of share price destruction across the more speculative areas of the market reflect major damage from the “confidence termites” eating away at the foundation of today’s bull market.
Jeremy Grantham coined this term to describe the historical boom/bust pattern where the speculative stocks that led the boom transition into laggards, just before the bust reaches the broader stock market.
This phenomenon is best captured in the chart below of the ARK Innovation ETF (ARKK), which outperformed during the bull market thanks to its concentrated holdings in some of the most speculative story stocks in today’s market. Now, ARKK is telegraphing an imminent bust, with the ETF down more than 40%, as the indices levitate near all-time highs:
If we look under the hood at ARKK’s individual portfolio holdings, we can see the scope of carnage taking place, with many stocks down 70% or more from their former highs:
Chart from @PensionCraft on Twitter
Make no mistake, this ain’t your garden variety “healthy correction”. This is the stuff of an imploding asset bubble. We’re feeling the first tremors now. But if history is any guide, this is a prelude to the “big one” coming for the blue chips and the broader stock market.
I’m not the only one making that bet.
The Smart Money Cashes Out
It’s no big secret that the FAANNG cohort (including NVIDIA (NASDAQ:NVDA)) has driven the vast majority of market gains in 2021. But these blue chip tech companies are not immune from the same macroeconomic forces dragging down their smaller upstart peers.
At least that’s the message being telegraphed from the smart money – corporate insiders across the FAANNG cohort, who are dumping stock at record volumes. This includes Microsoft CEO Satya Nadella, who recently sold nearly $300 million of his stake in the company – or over 50% of his holdings. Insiders at Amazon (AMZN), Facebook (FB), Alphabet (GOOG) (GOOGL) and Tesla (TSLA) have likewise dumped billions in stock so far this year, as shown below:
Sure, they say insiders can sell for any variety of liquidity, tax or estate planning purposes. But when insiders liquidate record volumes of stock across the board, that’s a sign that they’re all thinking the same thing: these prices can’t last.
Take Elon Musk for example. He claims he’s merely selling stock based on the potential for a future tax increase, which hasn’t yet been implemented. But the following Tweet suggests another potential motivation for selling billions in Tesla stock: his view that today’s mania is even crazier than the peak of the DotCom bubble in 1999:
Elon Musk @elonmusk
@sama I thought nothing could be nuttier than ’99
December 2nd 2021
240 Retweets6,117 Likes
With insiders cashing out across the board in the big tech names, I don’t think we should be surprised if the same slowdown hitting the likes of ZM, PTON, DOCU and ASAN eventually ripples into the FAANG complex. As one example, Apple (NASDAQ:AAPL) just warned about lackluster demand for the new iPhone 13.
Fundamentally speaking, we have every reason to expect headwinds in the broad economy and stock market going forward. This includes the unwind of the greatest monetary and fiscal stimulus of all time.
Record Monetary and Fiscal Tailwinds Shift to Headwinds
Just last week, Jerome Powell signaled a more hawkish stance on monetary policy by capitulating on the “transitory” nature of today’s inflation. Few will argue that the Fed’s cheap money policies weren’t a primary driver of asset price inflation over the last decade. Will anyone be surprised to see asset price compression as the Fed removes the monetary punch bowl?
On the fiscal side of the ledger, even assuming the White House passes an infrastructure bill, the economy faces a serious fiscal drag into 2022 and beyond. The proposed infrastructure package won’t offset the previous economic support from record unemployment benefits, stimulus checks and debt deferrals – all of which are now in the rearview. Or, at least until after the next crisis hits.
Meanwhile, the bond and currency markets have been telegraphing an economic slowdown for months – with long-duration Treasuries and the U.S. Dollar making new highs, despite the hottest inflation in over 30 years. This is the exact opposite of the price action you’d expect from an “early cycle” expansion.
Finally, just as the tide begins to recede on the greatest mania of all time, we’ve suckered in a record volume of passive fund flows into the stock market, record flows into cryptocurrencies, and record volumes of speculators trading options.
My favorite chart showing the scope of mania is margin debt approaching a record $1 trillion. This is your future source of forced panic selling during the next market downdraft:
So, to sum it all up, we’ve got a long list of checkmarks signaling a shift from boom to bust looming on the horizon, including:
The good news: with the broader market indices only a few points off record highs, there’s still plenty of time to prepare your portfolio to play defense.
This article was originally published at the Ross Report.