Over the years we’ve all seen events that indicate the high in the stock markets – blockbuster deals by private equity that have absolutely no chance of ever making a return (at least positive) for their investors, commercials that imply a tow truck driver owns an island/country, or the wave of “bubble funds” that seem to crop up every time during a market peak.
I bring these up because I recently saw a commercial that certainly meets the criterion of hinting at a market high. In this case the hands down winner is the recent Super Bowl commercial for a company called SoFi. Its commercial model believes the yawing gap between have and have-nots is filled with those who are “great” and those who are “not great”. Frankly you are far more likely to be with the “not great” than the “great” according to their marketing.
So what does SoFi do? At it’s most basic it has taken the unicorn model (pumping an organization full of venture capital and private equity and delaying a public offering) writ large – providing loans for people who don’t need money (the great) and not providing loans for those who have a need (the not great). One of my favorite writers Felix Salmon has a great discussion about the commercial here. He cogently lays out the absurdity of the company’s message, its ridiculous valuation, and the improbability of spending a large percentage of its revenue on insulting marketing campaigns.
My take on SoFi is from a different angle. Much like Ambassador Kennedy’s feelings on getting a stock tip from the shoe shine boy, I think SoFi’s commercial is a warning signal for a potential market top. Combined with other news such as this and this, I recommend keeping your eye out for three clear markers of a market peak.
- Absurd/Extreme Financial Product Claims: Running a commercial that insults the vast majority of Americans is unlikely to provide a company with a lot of positive PR. More importantly, claiming that nearly everyone you meet on the street is “not great” is one of those absurd claims that seem to pop up when markets get frothy. Much like the tow truck driver owning an island, this is a commercial absurd in its claims and not worthy of investors’ time.
- Poor Capital Allocation: In general, the markets should be the means of allocating capital where it can best achieve adequate returns for investors. The operative words here are “in general”. During periods such as 1999-2000 or 2006-2007 the markets can dramatically fail in this core function. Sometimes capital can follow trends and - much like the pack of proverbial lemmings - fall right off the sanity cliff. A great metric to keep your eyes on is private equity acquisitions. When you see a string of the largest PE deals ever made, it’s time to take a close look at your holdings.
- Cheap Debt Floods the Market: Many winners in a frothy market are funded by cheap debt. Whether it’s a large private equity firm doing a $10B deal for a green nanotechnology technology firm or Valeant running up $30B in acquisitions, cheap debt is a great growth tool until it isn’t available anymore. With the Fed raising rates late last year it won’t take much more before we see cheap debt go the way of the dodo.
Why This Matters
It's a rather unfortunate - if not predictable - cycle where markets peak and irrational behavior suddenly takes hold. When you begin to see marketing such as the SoFi ‘s Super Bowl commercial, then you know there is far too much capital sloshing around the markets. It is remarkably easy to fall into Wall Street’s thinking about these types of investments. It is even more important to reject it in your investing strategy and capital allocation. At times like these I advise investors to bear in mind three thoughts.
You Are Not A Lemming….So Don't Act Like One
When Valeant Pharmaceuticals was reaching its peak valuation of roughly $250/share in the summer of 2015, it seemed nearly every successful hedge fund (and even a few mutual funds) had extraordinarily large positions in the company. Accordingly, you began to see individual investors bid up the shares wanting to be the next Bill Ackman. When a company bases its strategy on raising cheap debt, acquiring new holdings, slashing internal staff, and jacking up prices, it generally isn’t a real long-term winner. Ask Al Dunlap how that worked out for him. Just because every hedge fund is piling in doesn’t mean you should do so as well. Stick to your circle of competence, focus with value, and let compounding be your friend.
Keep a Keen Eye on Your Valuations
As the markets – and corporate valuations – get stretched, don't hesitate to take profits. Last year, the Nintai Charitable Trust saw nearly 60% turnover as we sold winners held since the early 2000s. If a fellow investor is willing to pay a 40% premium to your valuation, don’t hesitate to let them have it. Anchoring on a stock simply because it’s been very profitable is a fine way to see those gains dissipate.
This is the Worst Time to Get Intellectually Lazy
At market tops, it’s frequently believed that focusing on valuation is a sucker’s game. A great economist once said, “After one year of market gains most investors think they are lucky. After 5 years of market gains most investors think they are geniuses”. We’ve reached the stage where many investors believe they have greater than normal investment skills. They do not. As you see markets near their all-time highs its even more important to double check your assumptions and rerun your valuations.
It seems like just yesterday we were all writing about the perils of a bear market. The past month has seen the markets recover much of their losses with the S&P 500 roughly at the same levels as one year ago. At the Nintai Charitable Trust we find our purchases made in the last six months (Paychex, Linear Technology, SEI Investments) are up substantially and offer little to no discount to our estimated intrinsic value. It seems appropriate the shoeshine boy’s advice to Ambassador Kennedy was to buy Hindenburg. Much like the Zeppelin with the same name, markets (and stocks) that get grossly overinflated have a tendency to go up in flames with little to no warning. I suggest investors lock in profits from holdings that look grossly overvalued. Otherwise your long-term returns might be - in SoFi’s words - not so great.
 Such examples include commitments made during the height of the 2007 bubble including KKR/GS Capital’s acquisition of Harman and Cerberus’ acquisition of ACS busted deals.
 The full commercial can still be found here. It’s a nostalgic look back at a time of true market madness.
 Just ask the shareholders of the Merrill Lynch Internet Strategies Fund or the Chicken Little Growth Fund (I’m not making these up).
 The commercial can be seen here.