Amazing things are happening in technology, and everyday investors are being invited to be a part of them.
With SpaceX’s market debut on Friday, Anthropic and OpenAI’s IPOs in the pipeline, and red-hot tech stocks already on the market, there’s no shortage of betting opportunities.
Elon Musk caused a stir with his SpaceX roadshow, promising a future of interstellar wealth through artificial intelligence that combines space travel, satellites and orbiting AI data centers. I watched his presentation at JPMorgan and was fascinated.
Who am I to say that cheap, virtually limitless AI generated from Earth orbit won’t happen the way Mr. Musk says it will? Intellectually, I am ready to consider the possibility that he may actually lead the world into a vibrant future, on this planet, on the Moon, and eventually on Mars.
But from a pure investment perspective, I remain firmly grounded.
As I mentioned earlier, the asking price for SpaceX shares was exorbitant and rose even further on the first day of trading. Still, the company’s stock could very well rise further in the coming weeks, driven by pure market enthusiasm. Mr. Musk reserved a double-digit percentage of IPO shares for “retail investors,” or ordinary investors — as opposed to large institutions. A retail allocation of 5 percent or less has been common in recent public offerings, according to Jay Ritter, an economist and IPO expert at the University of Florida.
However, SpaceX’s price is so high that the likelihood of a solid return in the next few years is slim for investors who are late to the party. The historical data provided by Mr. Ritter confirms this.
SpaceX has set its own valuation well above a key threshold, a price-to-sales ratio of 40 to one, meaning it would take 40 years of sales to reach market value at that share price. Stocks valued above this level rarely made money over the next three years. Because Anthropic and OpenAI’s public offerings are still in their early stages, there is less information about them. But their valuations also suggest highly valued stocks.
Accepting these prices, as well as those of many other big tech stocks, is inherently worrisome for investors. This suggests that the stock market has entered dangerous territory. If this isn’t already a full-blown blister, it could easily become one.
Still, I won’t quit the stock market entirely because stocks have performed well over the long term and because I can’t accurately predict market movements. But some times are riskier than others for stock market investors – and this could be one of those times.
The bubbling market
For now, I’m not too worried about the direct impact of mega IPOs on retirement investments. Either they will not be represented in broad, diversified index funds – for example, the S&P 500 – for a long time, or they will only represent a tiny part of the assets held by investors.
The CRSP market indexes, now managed by Morningstar, will conduct the IPOs soon, meaning Vanguard Target-Date Retirement Funds based on one of the indexes will have small stakes in the newly listed companies within a few weeks. However, they are only included in the indices in proportion to the shares actually available for sale on the market. This is called a “float” and will be tiny. Even if stocks fall sharply after inclusion, they will do little to change the overall index, and anyone’s retirement funds (including mine in the New York Times retirement accounts) will be little affected.
The Nasdaq-100 is a different matter. This tech-heavy index will hold SpaceX and the other two major IPOs quickly, perhaps within 15 trading days. Funds based on this index typically serve as proxies for bets on the technology market rather than core retirement investments. Nasdaq 100 funds, like the Invesco QQQ, allow traders to quickly enter and exit the tech market as the waves of frenzy ebb and flow. That’s not my thing.
The trillion dollar IPOs worry me, but for a different reason. I worry that stock offerings of this remarkable size are only coming to market because AI stock prices have already skyrocketed. The IPOs are not only generous in terms of price. They represent a dangerous moment for the stock market.
There have been some declines in the stock market recently, but the information technology sector of the S&P 500 traded at a price-to-earnings ratio of over 39 this week, according to FactSet. This is a very high level.
Tech companies’ profits are growing quickly, but the sector is still overly expensive. The entire stock market benefits from the momentum of AI companies, which makes the entire market vulnerable. Rising bond yields, geopolitical turmoil and rising inflation threaten the market, and further declines would hardly be surprising.
In an unusual warning on June 5, Bank of America equity strategists led by Savita Subramanian warned that the S&P 500, and technology stocks in particular, were overvalued and suggested investors should “take profits.” According to strategists, the S&P 500 is likely to fall slightly for the rest of this year. Such a decline could seem painful. But in my opinion, after the market rally of the last few years, a small decline could be healthy if it would prevent a huge bubble from forming.
History lessons
How much irrational exuberance will be unleashed in the excitement surrounding SpaceX and the upcoming IPOs of Anthropic and OpenAI can only be known once the new shares have expired and have been trading on the market for a while.
But there are signs of a bubble starting. The most important financial questions may be how far the current market excesses will go and which companies will survive and thrive as new technologies are unleashed on the world.
The story provides some context. After the dot-com bubble reached unsustainable levels, the market crash lasted 30.5 months, from March 24, 2000 to October 9, 2002. The S&P 500 fell 49.1 percent from top to bottom during that time. Investors who stuck with the S&P 500 index were still doing poorly a decade later. But companies like Amazon, eBay, Google and Salesforce survived that crash, and the infrastructure foundations created back then made the current technology boom possible.
Whatever happens in the markets in the next year or two, some companies will thrive in the coming decades because of AI technology. It’s just difficult now to know which companies will be involved.
Parallels to previous periods of extreme stock market enthusiasm can be exaggerated. It’s true that by some measures the market has reached 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. Professor Shiller, a Nobel Prize winner, designed it as an inflation-adjusted benchmark for comparing stock prices with the average of corporate profits over the last ten years.
The rate is currently higher than it has been since the dot-com bubble burst. But it has been high – although not quite this high – for years and that hasn’t led to sharp market declines. Timing the market is difficult. I certainly can’t do it.
But high stock market prices combined with the current period’s relatively high interest rates still matter. They don’t tell us what will happen next week, but they suggest that stock market returns will be muted in the coming years. Vanguard, which uses a methodology derived from Professor Shiller’s work, predicts limited stock market returns for these reasons.
Over the next decade, U.S. stock prices are expected to rise 4.9 percent to 6.9 percent on an annual basis, compared with a return of about 13 percent for the Vanguard Total Stock Market Index fund over the last decade, the firm said in its latest estimates in April. Small, beaten-down value stocks are likely to outperform large-cap stocks in the United States, including technology stocks, and stocks in foreign markets are expected to outperform those in the United States, Vanguard said.
Perhaps the most notable prediction is that bonds will underperform the stock market by only about a percentage point and the risk of major declines is far lower. In short, bonds seem to be a relatively good value at the moment. That’s not the case with tech stocks. And the mega IPOs look particularly expensive.
So instead of jumping on the IPO bandwagon at this point, it might be wiser to consider whether you already have excessive exposure to AI through funds that hold big tech stocks. Perhaps this is a good time to rebalance by reducing your allocations to US megacap stocks, shifting some holdings to bonds and cash, and diversifying globally using low-cost index funds.
SpaceX, OpenAI and Anthropic could be as great as their founders claim. If so, I expect it will be possible to buy them at bargain prices later when the hype has died down.
For now, as I noted last week, the only sure thing that SpaceX’s IPO will bring is that it will enrich Mr. Musk, just as he did at Tesla.
For the rest of the investing public, it may be better to just watch the market spectacle and hold enough bonds and cash to ensure a few restful summer nights.