Amazing things are happening in tech, and everyday investors are invited to get in on the action.
With SpaceX’s market debut Friday, Anthropic and OpenAI IPOs underway, and hot tech stocks already hitting the market, there’s no shortage of betting opportunities.
Elon Musk sparked a frenzy with his roadshow for SpaceX, promising a future of interstellar riches from artificial intelligence combining spaceflight, satellites and orbiting AI data centers. I watched his presentation at JPMorgan and was fascinated.
Who am I to say that cheap and virtually unlimited AI generated from Earth’s orbit won’t happen exactly as Mr. Musk claims? Intellectually, I am ready to entertain the possibility that he will truly lead the world into a dynamic future, on this planet, on the Moon, and eventually on Mars.
But from a purely investment point of view, I keep my feet on the ground.
As I pointed out, the asking price for SpaceX stock was exorbitant and it increased further on the first day of trading. That said, the company’s stock could well rise further in the coming weeks, driven by market enthusiasm. Mr. Musk has reserved a double-digit percentage of IPO shares for “retail” or ordinary investors, as opposed to large institutions. A retail allocation of 5 percent or less has been typical in most recent public offerings, according to Jay Ritter, an economist and IPO expert at the University of Florida.
But SpaceX’s price is so high that, for late investors, the likelihood of a solid return over the next few years is low. The historical data provided by Mr. Ritter confirms this.
SpaceX has set its own valuation well above an important threshold, a price-to-sales ratio of 40 to one, meaning it would take 40 years of sales to equal the market value at that stock price. Stocks valued above this level rarely made money over the next three years. With the Anthropic and OpenAI public offerings still at an early stage, there is less information about them. But their valuations also imply high-priced stocks.
That investors accept these prices – as well as those of many other big tech stocks – is, in itself, troubling. This suggests that the stock market has entered perilous territory. If it’s not already a bubble in its own right, it could easily become one.
Still, I’m not getting out of the stock market completely, because stocks have been great over the long term and because I can’t predict market movements accurately. But some times are riskier than others for stock market investors – and this may be one of those times.
The sparkling market
I’m not too worried, at this point, about the direct effects of mega IPOs on retirement investing. Either they will not be represented for a long time in broad and diversified index funds – the S&P 500, for example – or they will represent only a tiny proportion of the assets held by investors.
The CRSP stock indexes, now managed by Morningstar, will soon host IPOs, meaning Vanguard’s target-date retirement funds based on one of the indexes will have small dollops of the new public companies within a few weeks. But the indices will only include them in proportion to the shares actually for sale on the market. This is called their “float”, and it will be tiny. Even if stocks fall sharply after inclusion, they will barely move the overall index, and anyone’s retirement funds (including mine, in the New York Times Retirement Accounts) will barely be affected.
The Nasdaq-100 is another matter. This tech-heavy index will hold SpaceX and the other two big IPOs quickly, perhaps within 15 trading days. Funds based on this index typically serve as a proxy for tech market bets and not as core retirement investments. Nasdaq-100 funds, like the Invesco QQQ, allow traders to quickly enter and exit the technology market as the frenzy moves. It’s not my thing.
Trillion-dollar IPOs worry me, but for another reason. What concerns me is that stock offerings of this remarkable size are hitting the market only because AI stock prices have already skyrocketed. There’s more to IPOs than lavish pricing. They represent a dangerous moment for the stock market.
There have been some stock market declines lately, but the S&P 500 information technology sector this week traded at a price-to-earnings ratio above 39, according to FactSet. This is a very high level.
Profits for technology companies are growing rapidly, but despite this, the sector is overvalued. The stock market as a whole has benefited from the momentum of AI companies, making the entire market vulnerable. Rising bond yields, geopolitical unrest and soaring inflation threaten the market, and further falls would hardly be surprising.
In an unusual warning on June 5, Bank of America stock strategists, led by Savita Subramanian, warned that the S&P 500, and technology stocks in particular, were overvalued and suggested investors “take profits.” For the rest of the year, strategists say, the S&P 500 index is expected to fall slightly. Such a decline may seem painful. But in my opinion, after the market recovery of recent years, a slight decline could be beneficial if it prevented the creation of a gigantic bubble.
History lessons
One cannot know how much irrational exuberance is unleashed in the furor around SpaceX and the potential IPOs of Anthropic and OpenAI until the new stocks have been tested and have been trading in the market for some time.
But the signs of a budding bubble are there. The most important financial questions may be how far current market excesses will go, as well as which companies will survive and thrive as new technologies spread around the world.
History provides some context. After the dotcom bubble inflated to unsustainable proportions, the stock market crash lasted 30.5 months, from March 24, 2000 to October 9, 2002. The S&P 500 fell 49.1% from top to bottom during this period. Investors who stuck to the S&P 500 index were still suffering a decade later. But companies like Amazon, eBay, Google, and Salesforce survived that crash, and the infrastructure foundations that were abandoned then made today’s tech boom possible.
Whatever happens in the markets over the next two years, some companies will thrive on AI technology for decades. It’s just that it’s difficult to know now which companies it will be.
The parallels with previous periods of extreme enthusiasm in the stock markets may be outdated. It is true that using certain measures, the market has approached levels of overvaluation not seen in decades.
Take economist Robert Shiller’s CAPE ratio, which measures the valuation of the S&P 500 over long periods of time. Nobel Prize winner Professor Shiller designed it as an inflation-adjusted yardstick for comparing stock prices with the average of corporate profits over the past ten years.
Right now, the ratio is as high as it has been since the dot-com bubble burst. But it’s been high for years – if not this high – and it hasn’t triggered big market declines. It is difficult to time the market. I certainly can’t do it.
But high stock prices, combined with the relatively high interest rates of the current period, remain significant. They don’t tell us what will happen next week, but they suggest that stock market returns will be moderate in the years to come. Vanguard, which uses a methodology derived from Professor Shiller’s work, projects limited stock returns for these reasons.
Over the next decade, U.S. stock prices will likely rise in a range of 4.9 to 6.9 percent, annualized, compared with a return of about 13 percent for the Vanguard Total Stock Market Index fund over the past decade, the company said in its latest estimates, produced in April. Small, lagging value stocks will likely outperform large-cap stocks, including technology stocks, in the United States, and stocks in foreign markets will likely outperform those in the United States, Vanguard said.
Perhaps the most notable prediction is that bonds will lag the stock market by only about a percentage point, and with much less risk of significant declines. In short, bonds currently appear to represent relatively attractive value. This is not the case for technology stocks. And mega IPOs seem particularly expensive.
So instead of jumping on the IPO bandwagon at this point, it might be wiser to evaluate whether you already have excessive exposure to AI through funds holding large tech stocks. Now may be a good time to rebalance, reducing your allocations to large-cap U.S. stocks, shifting some holdings to bonds and cash, and diversifying globally, using low-cost index funds.
SpaceX, OpenAI and Anthropic could be as awesome as their founders claim. If so, I hope it will be possible to buy them at great prices later, once the buzz has died down.
Right now, as I noted last week, the only certain thing that comes out of the SpaceX IPO is that Mr. Musk will be enriched by it, just as he was at Tesla.
For the rest of the investing public, it might be best to just watch the market show and hold enough bonds and cash to ensure restful summer nights.
