The 3 most dangerous investment bubbles waiting to burst

While market volatility is still present, this year has really been something else. We looked at the benchmark S&P 500 lose more than a third of its value in about a month, and recover whatever was lost in less than five months. That’s about a decade of price fluctuations crammed into six months.

But just as investors overreacted to the downside in March on concerns over the 2019 coronavirus disease pandemic (COVID-19), they now appear to be showing signs of overzealousness on the upside. Even though U.S. economic activity is nowhere near its pre-COVID-19 levels, the stock market is hitting new highs and stocks in some industries are racking up triple-digit gains since the start of the year.

No matter how well or poorly the stock market performs, there always seems to be at least one potential bubble waiting to burst. But with exuberance in full force following the positive data from the COVID-19 vaccine, I see three dangerous bubbles waiting to collapse.

Electric vehicles

One area of ​​the stock market that exhibits exceptionally high levels of irrational exuberance is electric vehicles, or EVs.

The thesis behind buying EV stocks is simple to understand and generally makes sense. With most developed countries focusing on reducing their carbon footprint, electric vehicles have become the future of the automotive industry. It’s not about whether electric vehicles will take over our highways, but just when it might happen. This is why we have seen auto stocks like You’re here (NASDAQ: TSLA) and NIO (NYSE: NIO) rocket in the stratosphere. Tesla shares have risen nearly 590% year-to-date, through November 26, while NIO has gained a not-too-shabby 1,240%.

I am convinced that Tesla and NIO will be able to expand their production and see their sales increase. But sports valuations of $ 544 billion for Tesla and $ 73 billion for NIO in China make little sense given that neither company has demonstrated the ability to generate a recurring profit, based on generally accepted accounting principles (GAAP). Tesla’s valuation is especially glaring when you realize that the only reason it has been able to make a profit in recent quarters is because it sells emission credits to other automakers.

At $ 544 billion, Tesla’s market cap is over General Motors (NYSE: GM), Ford, Toyota, Volkswagen, Honda engine, Nissan engine, Ferrari, and Fiat Chrysler combined, but it will only produce 500,000 electric vehicles this year! Meanwhile, NIO’s market capitalization is higher than that of General Motors, although NIO has only shipped around 22,500 premium SUVs in the past six months. None of this makes sense.

Just like any other major investment, electric vehicle makers are likely to face hurdles in expanding production and competition concerns as every automaker under the sun tries to get their foot in the door.

EV stocks can be long-term winners for investors, but not before reality kicks in and the bubble bursts on those absurd valuations.

SPAC

Another potentially dangerous bubble that is brewing is Special Purpose Acquisition Companies, or SPACs. A PSPC is essentially a blank check company. It takes the traditional route of the initial public offering (IPO) to raise capital, then seeks to make acquisitions that will increase in value. In other words, investors turn over their capital and trust that the management team of a PSPC will make a smart acquisition to increase the value of their investment.

In mid-October, the the Wall Street newspaper reported that 143 PSPC had been IPOed since the start of the year, with the average PSPC surpassing the broad-based S&P 500 by nearly a factor of four (35% vs. 9%). With historically low lending rates and the prospect of a divided Congress likely to propel the larger market with Joe Biden in the White House, investors have been more than willing to get on the SPAC train.

However, the euphoria surrounding PSPCs could be misplaced. As is often the case, PSPCs lack information. Investors often have no idea what the directors intend to invest in or when they will consider making an acquisition. When an acquisition is announced, short-term traders and emotional investors often push the valuation of a PSPC into the stratosphere.

In addition to blindly throwing money at the wall and hoping it stays, PSPC managers don’t always acquire quality businesses. While the acquisition of the manufacturer EV Nikola (NASDAQ: NKLA) By blank check company VectoIQ The acquisition can arguably be considered a success (shares have tripled since early March), it could just as easily be seen as a failure. After all, Nikola has failed to finalize a partnership with General Motors (as of this writing), is under investigation for fraud by the Securities and Exchange Commission, and has seen founder Trevor Milton step down as executive chairman. of the advice via a late-night tweet.

I suspect the PSPC euphoria is going to produce a lot more losers than winners.

Cryptocurrency

Finally, we have cryptocurrencies, which are once again jumping into nosebleed territory for no fundamental reason or purpose.

Since the start of the year, the big three in crypto – bitcoin, Ethereum and Ripple – have gained 152%, 321% and 216% respectively. While it is possible for digital payments to rise due to concerns over the use of physical money during a pandemic, the monster cryptocurrency rally is much more likely to be associated with short-focused traders. run and emotionally motivated.

One of the biggest problems with cryptocurrency is that it often lacks utility. Most digital tokens are attached to their underlying blockchain, and very few companies are willing to accept digital tokens as a method of payment.

Take bitcoin and its total market value of $ 337 billion. With around 40% of Bitcoin’s circulating supply held by investors who have no desire to put those tokens back into circulation, this means that there are only around $ 200 billion worth of Bitcoin tokens that can be used for daily transactions. That $ 200 billion may sound like a lot, but it isn’t even 0.25% of global gross domestic product. Based on utility, there is no path to large-scale adoption of crypto.

Another concern is that crypto investors are placing their hope in digital tokens when, in fact, the underlying blockchain technology holds the real potential. Branded companies are developing their own blockchain solutions, some of which can work without a token, or perhaps fiat currency.

The point is, it hasn’t been convincingly shown that the world even needs digital tokens like Bitcoin or Ripple. We’ve seen sentiment-based cryptocurrencies implode before, and we’ll almost certainly see it happening again.