By Randall W. Forsyth
The world has gone bananas. As you've no doubt heard by now, a so-called artwork consisting of a banana affixed to the wall with a piece of silver duct tape sold this past week for $6.2 million. The buyer, appropriately enough, was a cryptocurrency operator, who can safely be assumed to be rolling in dough as Bitcoin approached the magic price of $100,000.
If this is exuberance of the most irrational sort, MicroStrategy once again made the most of it. Nominally a software outfit, MicroStrategy's main claim to fame and riches has been the steadfast accumulation of Bitcoin, which has sent its shares up 16-fold in a little over two years. Using its stock as currency, it has bought still more Bitcoin, but with a twist.
MicroStrategy has employed some clever financial engineering that further leverages its crypto strategy. This past week, the company issued $3 billion of five-year convertible notes paying 0% (as in nil, zilch, nada) interest, which are convertible into its stock at $672 a share, some 55% above where it traded at the time of the deal's pricing. To break it down, MicroStrategy sold high-priced (that is, low-yielding) notes, to which it attached richly priced call options to buy its high-priced common shares, which will be invested in Bitcoin, whose price keeps rising in no small part because of the momentum of its move. Brilliant.
By comparison, the S&P 500 index, trading at 22 times expected earnings, doesn't seem outrageous. That's a hefty 31% over the average price/earnings multiple from 2015 to 2019, writes BCA Research's chief strategist, Peter Berezin. And while he doesn't mention it, back in those days, the 10-year Treasury yield was generally in the 2% to 3% range, a much lower hurdle for risky assets than the current benchmark yield of 4.4%.
Sharply rising yields can cause problems in a high-P/E environment, such as now, according to Société Générale's Albert Edwards. "This is a case of an elastic band stretching to break point -- the 1987 equity crash being a good example," he writes in a client note (in which he admits to his perennially bearish mien). Those of us with long memories recall the 30-year Treasury bond hitting a 10% yield then, which led to Black Monday's 22.6% single-day crash in the Dow Jones industrials on Oct. 19, 1987.
Equities also initially shook off rising bond yields in 2018, he notes. Then a rising P/E multiple resisted climbing bond yields, until it didn't. The S&P 500 came within a hair of a 20% drawdown that qualifies as a bear market when it bottomed on Christmas Eve that year.
"High profits justify high P/Es, or so I am told, but expectations have now run far ahead of trailing [earnings per share] reality. But as with all bubbly episodes I have witnessed during my 42 years in the industry, there is always a seemingly plausible and compelling narrative to explain away investor exuberance," Edwards observes.
The promise of artificial intelligence provides that narrative, notably in the form of Nvidia, which has become the world's most valuable company (even with a late-week dip following merely great earnings), eclipsing the total value of the entire United Kingdom stock market.
And since the election, many market strategists have begun to refer to a "Trump put." In the president-elect's first term, he touted the stock market's performance as the indicator of his success. Bulls expect policies in the coming administration to keep stocks on an upward track. (President Joe Biden probably didn't tout new highs in the market while folks were more focused on soaring prices of groceries and rent than on stocks.)
"Capital markets are arguably the strongest guardrail against destructive or irrational policies," write Macquarie global strategists Viktor Shvets and Kyle Liu in client note. "If there is any meaningful rise in risk premia, mortgage rates, or a meaningful decline in U.S. equities, it is highly likely that the U.S. administration will beat a hasty retreat. The same is true for commercial and corporate interests and their lobbying power in respect of immigration."
Soc Gen's Edwards further points to ample liquidity as a reason for inflated valuations. That's not confined to equities but also to credit, with spreads (the extra yield on corporate bonds over risk-free government securities) around record lows -- plus the exalted prices for crypto and "art" such as pieces of fruit taped to the wall.
BCA's Berezin points out that the firm's clients claim the trend is their friend. And as Citigroup's former CEO, Chuck Prince, famously declared, "As long as the music is playing, you've got to get up and dance." That was in 2007, just before the financial crisis took hold. "How did that work out?" Berezin rhetorically asks.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
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November 22, 2024 19:11 ET (00:11 GMT)
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