Macro: Sandcastle economics
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Bubble stocks go into ‘hyperdrive’ mode
Peter Garnry
Chief Investment Strategist
Summary: With several 'bubble stocks' moving significantly higher this year on aggressive speculative fever in technology and green stocks we take a look again at stocks with a high EV/Sales ratio as these stocks are most at danger if we get a correction or a huge value rotation in 2021 due to reflation and higher interest rates. We encourage investors to start reduce exposure to the 'bubble stock' segment and consider reflation stocks.
Last year we wrote about ‘bubble stocks’ where we highlighted many high EV/Sales were experiencing a bull market defying historical patterns in equities and not seen since the years during the dot-com bubble. The high priced equites have continued to do well since our analysis, but with Tesla shares rising 16% this year already and up another 4% again today in US pre-market session we have to ring the alarm again on ‘bubble stocks’ as history suggests an ugly end to such a speculative rally. While we have no idea about the timing of this, we guess that the correction will be linked to higher US interest rates and we encourage every investor to monitor the development in rates.
In case of Tesla the recent rally is fuelled by speculative sentiment in ‘green stocks’ as investors are betting that the new Biden administration will provide a significant tailwind for these companies through new subsidies and regulation. In our Q1 Outlook, which will soon be released, we touch on the ‘green transformation’ trade and highlight the various speculative aspects of this theme. We still think that the ‘green transformation’ will be one of the biggest trends in financial markets over the next 10 years, but this year we will most likely see a split of the ‘green trade’ into that of ‘green quality’ vs ‘green speculative’. The speculative green stocks will also be found in the high EV/Sales bucket, so the phenomenon of ‘bubble stocks’ has spilled over into other parts of the economy than that of Silicon Valley companies.
High EV/Sales stocks have severe drawdowns during corrections
As the backtesting on Russell 1000 shows, low EV/Sales stocks (value stock) normally do better than high EV/Sales stocks (growth stocks) but since 2014 value stocks have underperformed massively as investors have increasingly been bidding up valuation multiples on high growth stocks as interest rates have plunged. The last time we saw value vs growth plunge to this degree was during the dot-com bubble years, but we all know how it ended. The high EV/Sales stocks as group experienced an 80% drawdown compared to around 53% for the other quintiles in the Russell 1000. The spread between the two groups (long value stocks and short growth stocks) rose during the drawdown years after 2000 and again during the great financial crisis. Our bet is that the same will happen again, we just do not know the timing. It can be difficult to see in the chart but the spread bottomed in August 2020 and has since gone up (value stocks outperforming again) which is related to rising interest rates and the reflation trade.
The table below shows the US and European companies with market value above $10bn that have the highest EV/Sales ratio but sorted on market cap. The list highlights many well-known stocks mostly in the technology industry but a few green stocks have also entered the list, a big change from May 2020 when first wrote about ‘bubble stocks’. Many retail investors have very concentrated portfolios and as such many retail investors will have got significant wealth accumulation from holding a few concentrated positions in some of the stocks in the table. Prudent risk management principles include diversifying across many holdings that are not too correlated and avoid obvious risk sources. We identify high EV/Sales stocks right now as one of the most dangerous risk sources out there in the equity market and we encourage investors to think hard about how much risk they are willing to take a few speculative names.
| Name | Market Cap (USD mn,) | EV/Sales T12M | Total Return 5Y | Price | P/E |
| Microsoft Corp | 1,650,381 | 10.85 | 358.49 | 218.29 | 35.0 |
| Tesla Inc | 773,525 | 27.52 | 1792.05 | 816.04 | 1,292.9 |
| Visa Inc | 515,171 | 24.25 | 199.68 | 213.81 | 40.6 |
| Mastercard Inc | 348,784 | 22.50 | 293.78 | 349.86 | 51.9 |
| NVIDIA Corp | 330,397 | 22.19 | 1701.46 | 533.76 | 75.2 |
| PayPal Holdings Inc | 275,394 | 13.35 | 609.45 | 235.04 | 103.1 |
| Adobe Inc | 229,181 | 17.71 | 436.12 | 477.74 | 44.0 |
| Pinduoduo Inc | 221,661 | 31.99 | 180.12 | ||
| ASML Holding NV | 206,982 | 12.33 | 454.70 | 403.90 | 52.1 |
| Prosus NV | 166,596 | 40.01 | 83.76 | 40.0 | |
| McDonald's Corp | 157,949 | 10.68 | 108.58 | 211.98 | 32.7 |
| NextEra Energy Inc | 155,335 | 11.36 | 244.27 | 79.29 | 35.5 |
| Texas Instruments Inc | 154,159 | 11.32 | 271.42 | 167.94 | 32.0 |
| Shopify Inc | 142,032 | 55.64 | 4126.72 | 1470.90 | 1,553.5 |
| Advanced Micro Devices Inc | 114,450 | 13.10 | 4082.86 | 95.16 | 106.7 |
| Hermes International | 112,895 | 14.82 | 206.45 | 875.40 | 83.2 |
| Square Inc | 107,990 | 14.02 | 2045.88 | 239.48 | |
| Sea Ltd | 104,249 | 28.69 | 203.94 | ||
| ServiceNow Inc | 99,776 | 23.46 | 542.15 | 511.41 | 137.5 |
| Zoom Video Communications Inc | 97,957 | 49.13 | 342.50 | 234.9 | |
| Intuit Inc | 96,856 | 11.96 | 307.79 | 368.63 | 49.5 |
| American Tower Corp | 96,616 | 16.28 | 150.37 | 217.50 | 49.5 |
| Intuitive Surgical Inc | 95,010 | 20.97 | 351.60 | 808.21 | 99.7 |
| Orsted AS | 93,559 | 10.45 | 1355.00 | 37.8 | |
| Booking Holdings Inc | 91,733 | 10.01 | 91.90 | 2239.85 | 91.2 |
| Airbnb Inc | 91,132 | 25.41 | 151.27 | ||
| Snowflake Inc | 86,119 | 166.72 | 304.20 | ||
| NIO Inc | 85,374 | 43.87 | 54.28 | ||
| MercadoLibre Inc | 79,542 | 23.39 | 1462.56 | 1597.97 | |
| Zoetis Inc | 79,370 | 12.78 | 270.89 | 167.00 | 43.6 |
| S&P Global Inc | 79,174 | 11.40 | 280.85 | 329.07 | 29.6 |
| Snap Inc | 78,135 | 35.89 | 52.44 | ||
| Blackstone Group Inc/The | 75,498 | 18.23 | 219.35 | 63.23 | 55.7 |
| CME Group Inc | 71,371 | 15.04 | 171.90 | 198.81 | 32.3 |
| Prologis Inc | 70,402 | 21.76 | 166.08 | 95.32 | 79.9 |
| Autodesk Inc | 69,309 | 19.12 | 463.06 | 315.20 | 162.6 |
| Crown Castle International Corp | 65,751 | 15.73 | 117.46 | 152.45 | 81.5 |
| Intercontinental Exchange Inc | 65,002 | 14.51 | 142.77 | 115.81 | 29.8 |
| Adyen NV | 63,562 | 16.28 | 1714.50 | 273.7 | |
| Equinix Inc | 60,497 | 12.23 | 146.73 | 678.97 | 103.4 |
Source: Bloomberg and Saxo Group
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