Overhyped growth stocks in markets across the world are heading for a reversal akin to the ‘dotcom’ market crash of the early 2000s, according to one investment manager.
Eugene Barbaneagra, portfolio manager at SEI Investments Co’s Traditional Strategies Group, told Proactive that since the Global Financial Crisis in the late 2000s, markets have experienced “an unprecedented era of new money creation, which inevitably found its way into asset bubbles”, adding that the dynamic further accelerated in 2020.
“Much of the trillions of stimuli found its way into speculative investments, including into unprofitable hype stocks which populate a good portion of growth indices today. As the world returns to normal, stimuli will be pared back and the energy supporting this bubble will be cut off,” Barbaneagra said.
“All bubbles burst. When investors, or, in this case, speculators, cease to discount future cash flows, hype is their last hope: attract new money and bid the prices up. For a while it works and reinforces itself, until it doesn’t,” he added.
In terms of hype stocks that could be vulnerable to sharp reversals in value when the bubble finally pops, Barbaneagra pointed to “non-earners with big promises” as those most at risk.
“These stocks always carry significant chances of never being able to turn their business into profitability… excitement attracts competition, which, in turn, drives margins down, or altogether delivers a better solution, rendering growth-generating technology obsolete. Paying up for the future is a loser’s game, because the future is uncertain and the high price we pay for it even more so. At different times, many of the preeminent growth stocks are actually profitable and have a seemingly unbreakable grip over their markets – until they don’t,” the portfolio manager said.
Regulation was also flagged as a key risk for these sorts of firms, with Barbaneagra saying that while these entities may be slow to take action, “eventually and inevitably they act” as “no government wants to be governed by corporate monopolies”.
Headwinds ahead in post-pandemic world
Looking towards the second half of 2021 and beyond, Barbaneagra said developments such as the addressing of inflation by central banks, increased consumer activity and regulatory developments will all serve as “headwinds for overpriced hype stocks”.
“As much as we are convinced of truisms like in the long run buying cheap is better than buying expensive, buying earnings is better than buying losses, and diversifying is better than concentrating, sentiment is all that matters in the short term and rationally predicting irrational sentiment is near impossible,” he said.
Barbaneagra’s comments, if accurate, could spell trouble for a number of stocks that have seen strong surges in market value despite not yet managing to turn a profit.
Notable names among the unprofitable growth stocks include social media firm Snap Inc (NYSE:SNAP), workplace chat platform Slack Technologies Inc (NYSE:WORK) and ride-hailing app Lyft Inc (NASDAQ:LYFT).