by Sean Kelly
When we think about Wall Street and the sudden rise and fall of the financial markets — words like parabolic, feverish, and frantic often describe periods of rapid speculation. These are commonly known as bubbles. Stock bubbles are anything but normal events. They reflect extreme market psychology including greed, herd instinct, and the infamous ‘fear of missing out.’ A market bubble is a surge in share prices that is not backed by fundamentals or critical corporate markers like cash flow, ROI, profit, and future growth prospects. And, it tends to feed itself.
Tesla’s current rally may well be the perfect 2020 illustration of ‘irrational exuberance,’ a term coined by former Fed Chair Alan Greenspan during the tech stock boom of the late 1990’s. Greenspan used the phrase to suggest that the market was overvalued and that animal spirits had replaced critical financial metrics such as income statements, accounting ratios, and balance sheets. He also used it to warn that a massive bubble was forming.
Last week, Tesla’s stock shares jumped almost $130 on Monday, another $107 on Tuesday, and then dropped over $150 on Wednesday. Overall, the electric car maker’s share price has more than tripled since late September despite experts deeming the company’s valuation as ‘stretched’ and most analysts listing the stock as a solid ‘sell.’ And as share prices continue to climb — there’s no doubt that euphoria is in play.
This begs the question — is Tesla’s market mania a typical ‘high-risk/high-reward’ gambit or could it be a cautionary tale about the underlying fragility of world markets?
Tesla’s wild ride is reminiscent of several other famous bubbles that started small and rapidly spread across various funds and equity classes triggering a broad-based sell-off. In this sense, bubbles function as market disrupters. After all, they have triggered some of the most notorious recessions in history. The Great Depression was sparked by an unsustainable asset bubble. The recession of the early 2000’s was powered by the dot.com bubble, and more recently, the Great Recession was fueled by a real estate bubble.
When bubbles burst, prices plummet, paper wealth evaporates and panic ensues. What follows is typically a contraction, correction, or a full-blown crash.
Hyman P. Minsky, an American Economist and scholar at the Levy Economics Institute — was among the first to outline the key elements of a market bubble. The first is Displacement which is the disruption caused by a new technology or extraordinary financial condition like historically low interest rates. The second is a Boom where prices gain momentum and attract a rising throng of investors. Next comes Euphoria where market shares are driven to new highs that are well beyond sound data or reason. This is followed by Profit Taking, where traders sell securities to lock in their gains. The last phase is Panic where prices quickly reverse course and correct — causing a rush for the exits where investors invariably get crushed and trampled in the mad dash to avert additional losses.
Bubbles are punishing pain points and Tesla, which is being driven by the lure of renewable energy, sexy cars and the appeal of Elon Musk himself — could be the high-tech canary in the clean energy coal mine. The electric car maker’s ‘Peak Musk’ valuation has doubled in a month and risen almost 380% since May. Its market capitalization, according to NASDAQ, makes it more valuable than GM, Ford, Fiat, Chrysler and Honda combined. It is now the second largest automaker behind Toyota, and within striking distance of iconic corporate giants like Nike and McDonald’s.
It’s an extraordinary feat for a company that has had major struggles with delivery, profitability, and consumer demand. So, is the Tesla rally sustainable — or is the auto-maker the latest poster child for over-priced, over-hyped and over-pumped markets around the world?
A rising consortium of experts say it’s time to diversify and not with asset classes that rise and fall together. Holding gold is one of the oldest forms of wealth protection in existence and one of the most powerful hedges against rising bubble talk, improbable bull-runs, and single stock rallies that foreshadow massive sell-offs.