Fund managers have long since learned to live with the accusation of short-termism. Yet in the current cycle they could equally be accused of being excessively patient in managing their beneficiaries’ capital. The reason for this counter-intuitive assertion is an outbreak of long-termism in the market for initial public offerings.
In 2018, no less than 81 per cent of companies that undertook IPOs in the US had negative earnings, according to data compiled by Jay Ritter of the University of Florida. This is the highest level since 2000 when the great technology bubble burst. The trend has continued in 2019 with the likes of ride-hailing pioneer Uber coming to market on the back of multibillion-dollar losses.
Back in 2000, 68 per cent of all US IPOs were tech stocks, whereas in 2018 tech stocks accounted for only 29 per cent of IPOs. In both cases investors’ tolerance of loss makers rested on the hope that there would be a crock of gold at the end of a very long rainbow. Today more of these companies are revenue generating than in 2000, which is healthy. The tolerance of loss is nonetheless a wider phenomenon that extends beyond the primary market. Adam Berger, a strategist at Wellington Management, said that about a quarter of all small-cap US stocks had negative earnings at the end of last year.
What seems clear is that many of these profitless companies have business models based on the greater fool theory. They are hoping to be bought out before it becomes obvious that their visionary aspirations are so much pie in the sky. While some investors have bought into the long-term vision, others are probably conniving in the greater fool theory.
When investment becomes speculative, it is often a sign of a bubble. Yet while equity valuations are relatively full, we are not seeing the kind of frenzied hysteria in equities that marked the peak years of 1999 and 2000. The pumping and dumping is less frenetic too.
That said, there are other markets beset by foolery that do fit the bubble description. A clear case in point is bitcoin. This masquerades as money although it satisfies none of the main criteria to qualify for that description and generates no revenue stream. It is thus purely speculative. Whether consciously or unconsciously pursuing a greater fool, many investors have discovered the risks inherent in buying a volatile will-o’-the-wisp devoid of fundamental support.
A much bigger area where the greater fool theory is at work is the bond market, in which both sovereign and corporate borrowers are raising money at negative rates of interest. Some investors are buying such IOUs for regulatory reasons, others because they are so anxious for the protection of a safe asset that they are willing to give up income and incur a capital loss regardless. But then there are still more who buy on the assumption that the central banks will play the role of the greater fool through their asset purchasing programmes, thereby providing a profitable exit from a profoundly unattractive investment.
This is the very opposite of the search for yield, in which income-starved investors feel obliged to take on more risk in an exceptionally low interest rate environment. It is a short-term strategy that entails the risk that the central banks will not come through. Given the growing consensus that monetary policy has been accepting too much of the burden of driving the global economy, combined with increasing calls for fiscal activism, the risk is not negligible.
Note, too, that expansionary fiscal policy holds part of the key to escaping from the abnormally low or negative interest rates that prevail in this bond market bubble. It may take some time before the market and the central banks revert to rate levels close to the historic mean. But even a very modest move in that direction could wreak havoc with bond portfolios.
The silver lining is that a rise in rates means that the discount factor applied to pension fund liabilities will help shrink them. Even so, when government bond markets are out of kilter to the extent they now are, the risk of systemic trouble as the consequences of unconventional central banking are unwound is real. When markets have been driven to historical extremes, the road back is invariably painful.
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