Disclosure: I am short biotech right now and long select technology stocks.
Let me start with a summary of my thinking on market valuations these days:
- Currently there are markets out there that are overvalued
- Biotech is one of them and I will share data on this from our valuation models
- Investors need to be careful to not get burned by these overvalued markets
This article in the FT is the best I have seen so far on bubbles.
This is one of my favorite images from the article:
What you can see in this image is how the biotech bubble is playing out relative to some of the biggest bubbles we have seen (Japan 1982-1989, Global TMT (technology media and telecom – also known as Internet bubble) 1992-2000, China 2003-2007 and India 2001-2008). To give some context these are the worst overvaluations of our time. Markets usually turn around way before this point is reached.
This FT article provides a nice analysis of past bubbles however this and other articles, while shedding light on some aspects of valuation are getting to conclusions that I don’t agree with. For example here is the last sentence of the article:
“Essentially the message seems to be, with biotech still 70 per cent away from matching the TMT bubble’s performance, who can afford to pull out of this particular bubble just yet?”
Biotech is overvalued. The TMT bubble in 1999 was even bigger. In my view the last thing we should want is to get close to that size.
Biotech valuation model
Using our growth stock valuation model what we have found is that biotechnology stocks at a 87% (the number sounds precise but is meant to be more of a guideline) premium to other high-growth technology stocks we track.
Our model is pretty simple – it looks at the price you are paying for a given amount of growth.
Takeaways for investors
-Investors should be very careful about going long on biotech stocks. You are playing with fire and yes the game can continue and at the same time yes it will end.
-Investors should be careful about other markets that may be similarly overvalued. Chinese stocks? European bonds? We have not analyzed these other markets with our model but there do seem to be other pockets of overvaluation out there at this time.
Takeaways for central bank policymakers
-Finally policy makers should be very careful. I took Janet Jellen’s comments recently very seriously when she said:
“I would highlight that equity market valuations at this point generally are quite high,” Yellen said. “There are potential dangers there.”
People like Janet need to be aware that most investors cannot or do not really calculate the intrinsic value of assets they invest in. And this means it is incumbent on policymakers to protect investors by preventing valuations from getting more silly.
If you believe as I do that valuations are “quite high” not only in US equities but in other markets as well then it follows that this is almost certainly a result of easy money policy practiced by central banks. My opinion is that this has already gone further that it should go and the US central bank should not consider policies now that would allow a further increase in valuations.
This article in the Wall Street Journal is also well written:
One key takeaway from the WSJ article is that:
“My research team’s composite valuation for the three major financial assets in America—stocks, bonds and houses—is currently well above levels reached during the bubbles of 2000 and 2007.”
This serves as confirmation for me that overvaluation at this time is happening in various markets. What is also fascinating here is that we may not have a single market overvaluation that beats the biggest of our time but we may have multiple market overvaluations that in aggregate are bigger than ever. This is what the WSJ article is saying!
And I agree with the conclusion in the WSJ article:
“The Fed now leads a culture of central bankers who see their job as reducing unemployment and stabilizing prices for consumer goods only, come what may in the markets. This needs to change. In a world in which high trade and money flows tend to restrain consumer prices but magnify asset prices, central banks need to take responsibility for both. After all, asset price inflation is as dangerous as consumer price inflation.”