Saying that the stock market is showing signs of excess is an understatement.
Exhibit 1: This chart via Jim Bianco is the Goldman Non-Profitable Technology Index.
Blank Check Companies
Probably the largest sign of excess is the rise of the SPAC, Special Purpose Acquisition Corp. These are blank check companies. As John Hempton pointed out in his Jolly Swagman Podcast interview, a recurring theme in bubbles is the rise of the blank check company. Probably none bolder than this solicitation during the South Sea Bubble.
But the most absurd and preposterous of all, and which showed, more completely than any other, the utter madness of the people, was one, started by an unknown adventurer, entitled “company for carrying on an undertaking of great advantage, but nobody to know what it is.”
Next morning, at nine o’clock, this great man opened an office in Cornhill. Crowds of people beset his door, and when he shut up at three o’clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid. He was thus, in five hours, the winner of 2,000 pounds. He was philosopher enough to be contented with his venture, and set off the same evening for the Continent. He was never heard of again.
– From Charles McKay’s Extraordinary Popular Delusions and the Madness of Crowds.
Timing the Market is Hard
Identifying excess is easy but using it to make market timing calls is hard.
In 1996 then Fed Chairman Alan Greenspan gave his irrational exuberance speech pointing out the excess and extreme valuations in the TMT stocks. The tech bubble didn’t burst until 2000.
GMO, a firm with probably the best public track record of identifying bubbles, sold down their US Equity positions in late 1997 as valuations exceeded 1929 levels. Only to watch clients withdraw money as they “missed” 3 years of returns.
We know there is excess in the stock market, but we don’t have to invest in the over-valued and over-hyped stocks. As The Brooklyn Investor stated.
In some places, yes, valuations are silly, but who cares? If you owned, say, BRK in 1999, who cares what the market valued Pets.com at? Just don’t buy Pets.com!
We continue to follow our portfolio management rules. Trimming positions that have exceeded our maximum position size rules. Adding to positions that are below our target weight and estimate of fair value. And avoiding sectors and stocks that are trading at excessive values.
Value in the Defense Sector
One part of the market where we are finding high-quality companies at reasonable prices is the defense industry.