This work was inspired by UCLA Professor Michael Brennan’s efficient autopsy of the dot.com bubble. Published in 2004, the piece broke down the mania that led to the historic bubble in 2000. A misplaced belief in Efficient Markets, agency problems on Wall Street, and weak accounting rules figured large in his work.
This paper will do the following:
- Update the simple yet powerful evidence he provided that equities had been in a bubble
- Provide compelling evidence that the problems that drove the mania in 1999 are present again today
- Offer a list of stocks where today’s accounting rules are most severely misrepresenting economic reality
Asset Allocation Gone Wrong: The Cult of Equity
The most basic evidence can often also be the most compelling. In his first sentence, Dr. Brennan explains that price appreciation outstripped earnings growth by a huge margin between 1980 and the peak of the dot.com bubble. Figure 1 below shows this effect in raw form.
The navy blue line is the total return of the S&P 500 between 1980 and August of 2000. The light blue line is the growth in those stocks’ earnings. Stocks rose 2,526% while earnings only grew 327%.
Rarely have we seen a more compelling image of a bubble. With hindsight, the evolution of price and earnings made it painfully clear. Capital markets and fundamental valuations had totally detached.
Think that’s crazy? Look at the next chart…
Democratizing Investing Gone Wrong
The chart below merely updates the one above. Just another way of visualizing extreme overvaluation. Warren Buffett’s valuation metric and its long term predictive accuracy all indicate many investors may not understand the risks they are taking
KCR’s research team finds itself writing the phrase “this isn’t complicated” a lot lately. Look at our chart about zombie firms that can’t pay their interest expense. The value of stocks priced for disaster. Or our research on the soaring exposure of index investors to loss-making firms.
These charts conspire to tell one simple story: don’t buy stocks that fail the basics of common sense.
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February 16, 2022 |
| Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin
February 16, 2022
Authors: Matthew Malgari, Nathan Przybylo, Dr. Sanjeev Bhojraj and John Durkin