(Bloomberg) — For years, stock traders have been getting so rich that they’ve forgotten what a bubble looks like as big companies get bigger. Thanks to Nvidia Corp.
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So says Rob Arnott, a designer of passive products to warn about the dangers of bloated megacaps – and to silence their threats. In the year Up 228% by 2023, Nvidia may be riding a computer science revolution, but the stock is “a textbook story of big market manipulation,” wrote the founder of Research Associates LLC.
“Overconfident markets paradoxically translate future business prospects into brighter current stock price levels,” Arnott wrote in a new research note, citing stocks trading at about 110 times earnings. “Nvidia is today’s exemplar of that genre: a great company that values excellence over perfection.”
Will the emergence of Nvidia bring down the entire market? “It’s very possible,” Arnott said in an interview.
Shares of Nvidia fell 1.1% on Tuesday.
Strong opinions about alleged bubbles are nothing new to Arnott, whose so-called smart-beta system of reinventing traditional indexes limits the influence of giant companies. In December 2020, Tesla Inc. It was forecast after becoming the largest company added to the benchmark S&P 500. Since he made that case, the stock and the index are both up about 20%.
Before Apple Inc. became the first trillion-dollar U.S. company five years ago, warnings about valuations rained down on the Nasdaq 100. The index has returned nearly 15% since 2008. And efforts to track a major exchange-traded fund index have been unsuccessful.
Only one actively managed stock mutual fund in the U.S. has outperformed the Nasdaq Invesco QQQ Trust Series 1 (Register QQQ) over the past five, 10 and 15 years, according to a Bloomberg Intelligence analysis by David Cone. Thanks to the intense focus in Tesla.
“You don’t want to be at this point where you’re betting against continued U.S. innovation and the potential impact on the economy,” said Steve Chiavarone, senior portfolio manager and head of multi-asset solutions at the Fed. Hermes. “These companies, they’ve got more money than God. So there’s a recovery, there are completely different balance sheets than you had two generations ago.
Arnott said he would not oppose a capitalization-weighted index if a company’s representation in an index is based on market value. “If you want to own the market, sure, it’s good to have a cap weight. But there are issues — and the most obvious issue is that anything that’s overvalued today relative to its future potential is overweight in your portfolio, he said.
Following the peak of the tech bubble in March 2000, the average stock in the S&P 500 rose 25% over the next two years, while the cap-weighted index held by tech stocks fell 21%. Arnott points out a list of the 10 most valuable tech companies at the peak of the dot-com bubble. None of them beat the market when the next bull run peaked in 2007, and only Microsoft Corp. and Oracle Corp. are ahead today, two decades later.
The tech behemoths that powered the Nasdaq 100 rally have stood out for years, benefiting from scalable business models that allow them to generate strong earnings and large cash-flow balance sheets. They look “spectacular” at certain times, including when they really started to take off in 2014. “If you cherry pick these days, you can’t beat QS.”
But the sentiment for Nivea – which leads the market in artificial intelligence processors – reflects a strong confidence that its products will not be displaced by competitors, he said.
Many investors are buying in on the assumption that its size – around $1.2 trillion – makes it a “safe play”. But “not too big to fail,” according to Arnott, “too big to fail.”
“The risk of being wrong is that Nvidia is going to do amazing things and grow another 10-fold in the next 10 years,” he said. “I say it’s irrational, and so I call it a bubble.”
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–With help from Subrat Patnaik, David Watkins and Ryan Vlastelika.
(Market updates are open.)
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