First-quarter earnings season kicked off last week. With 23% of the U.S. vaccinated, businesses steadily re-opening, and trillions of dollars of monetary fizz getting pumped into the market, it’s no surprise that investor confidence is at an all-time high. Risk-taking is the new normal. And that makes the tug-of-war between Wall Street and Main Street even grittier. Recent bubble stocks like Gamestop (NYSE:GME), AMC Theaters (NYSE:AMC), and Discovery (NASDAQ: DISCA, NASDAQ:DISCB) prove that even smart money can get squeezed.
While no one knows which market sectors will come out on top this quarter, one thing is clear: when stocks are priced for perfection, some bullish bets will fail spectacularly. And that applies not just to speculative sectors of the market, like special purpose acquisition companies, or SPACs, where tensions run highest. Overoptimistic investors in many steady blue-chips and cyclicals could also see their investments implode.
Expect a bumpy ride this earnings season. Here are some of the market ingredients that suggest we’re in bubble territory — and three stocks across very different sectors that could be targets.
The first ingredient for a making a bubble: screaming technical indicators. After all, Wall Street’s favorite time to make big bets is when valuations look stretched. While NO ONE can accurately call the top of a bubble, the eagle’s-eye view includes at least some of the ingredients that make a “frothy” cocktail.
Exhibit A: Stock prices. The S&P 500, which is at its second most expensive point in history. The first time was during the peak of the dot-com bubble in 2000, and we know how that ended.
Exhibit B: Investor sentiment. The CBOE VIX, popularly known as the beat fear-gauge of Wall Street, has dropped 26% year-to-date. On April 12, the index closed at 16.91, its lowest level since Feb 20, 2020.
But the first ingredient alone doesn’t make a bubble. You also need ingredient No. 2: momentum — the case where investors are buying stocks for purely speculative gains, rather than fundamentals. Despite growth-y earnings projections for 2021 and 2022, stock prices appear to have detached from the fundamentals that normally drive them. Just ask Elon Musk, whose Tesla (NASDAQ:TSLA) stock is up 465% since January of 2020. Or Brian Armstrong, whose Coinbase (NASDAQ:COIN) crypto IPO (initial public offering) this week fetched a valuation of $85 billion.
In fact, stocks have also been expensive for six years now, and that hasn’t stopped one of the strongest bull markets in history. But when momentum is tied to the story, and not the stock, it’s a signal that a bubble can burst.
Now that we have a mix of froth market and momentum, it’s time for the final ingredient: more difficult quarterly comparisons. Right now, the market is priced as if quarter-on-quarter growth will last forever. But it won’t.
While almost EVERY company reporting this quarter is going to beat its Q1 2020 results, this “beat-and-raise” performance is already baked into consensus estimates. The Street is modeling S&P 500 earnings growth of over 22% this quarter. That’s a recovery OVER 2019 levels. Same for revenue, which is expected to be the highest year-over-year revenue growth in the S&P since Q4 2018. The result? Forward price-earnings ratios have risen to 21.9x — a multi-decade high — even as the pace of earnings growth looks set to slow.
Already, year-over-year comparisons are starting to get more difficult– and that bar could get even higher is the pace of stimulus slows in an improving economy. The result? It will be tougher for the Street to justify continued upward bumps to forward estimates. And when momentum slows, investors “sell the news,” which means stocks with fantastic runs may be headed for a short-term correction.
So now, let’s look at three potential bubble stocks and what red flags they’re flying.
- Social Capital Hedosophia Holdings Corp. V (NYSE:IPOE)
- United Foods (NASDAQ:UNFI)
- The Children’s Place (NASDAQ:PLCE)
Bubble Stocks in SPACs: Social Capital Hedosophia Holdings Corp. V (IPOE)
The most obvious place to find the three ingredients for bubble stocks is IPOE, the latest Chamath Palihapitiya SPAC to merge. The entity, which plans to merge with lending startup Social Finance, has pushed its shares 60% higher than its fair value using its well-crafted message.
Social Finance, which recently agreed to acquire Golden Pacific Bancorp (OTCMKTS:GPBI), a California-based community bank, is moving closer to getting approval for a national bank charter. The vision: a digital-only bank projecting a bull case of over 50% EBITDA growth this year. But tensions are starting to rise, as the deal hasn’t yet been finalized (it was expected to close by Q1). With 30% of shares now sold short, the stock has traded down to around $16.
SPAC IPOs have dominated the market over the past eight months and have collectively raised almost $90 billion since the start of the year. Because this non-traditional IPO route requires fewer financial disclosures, stocks are trading on long-term stories and very distant future projections. We’ve seen more than 10 electric-vehicle or battery companies without revenue that have come public this way.
With over 300 SPACs in the market enjoying a rising tide, there are likely some bubbles to be found in this space. Chamath’s portfolio, which includes Virgin Galactic (NYSE:SPCE) and OpenDoor Technologies (NASDAQ:OPEN), is showing some evidence of weakening. While SPCE still trades at 2x its IPO price, OPEN is down over 40% from February highs. With the tension so high, IPOE’s performance will have a ripple effect on Chamath’s other SPACs and on the perception of the group as a whole.
Consumer Defensive: United Foods (UNFI)
Blue-chip investors haven’t escaped bubble warnings either. With almost a quarter of its float sold short, this hallowed consumer defensive stock has only recently entered the limelight as a fast trade on consumer recovery.
UNFI is North America’s leading natural, organic, and specialty food distributor. The company is the top grocery supplier to Whole Foods, owned by Amazon (NASDAQ:AMZN). And it clearly benefited from consumer stockpiling and shifting home eating habits during the pandemic. The stock is up 200% over year-ago levels, and has more than doubled since the start of the year. Now, the shorts are betting that the good outlook for Q2 and Q3 will be muted.
The theory is that mass vaccinations and a surge in dining out will result in less grocery buying. With the Street already modeling a healthy outlook — with gradual earnings improvement and a return to profitability not far away– it’s hard to make the case for another round of upward revisions to estimates and targets. If the momentum slows, investors will sell the news, and the shorts will have their day.
Consumer Cyclical: The Children’s Place (PLCE)
Finally, expect some bubble stocks among the cyclical retail stocks — low-growth companies bid up by retail investors trying to play the “reopening trade.”
There’s just one problem: if your overall business is still in decline, no amount of pent-up-demand can save your firm from extinction.
Chief among these is The Children’s Place. The firm’s overall store count is declining 10%-15% annually as the firm has struggled to maintain its in-person shopping relevance. Its share price, meanwhile, lives in an alternate universe. Shares are priced at 20x price-to-earnings — a 16% premium to their five-year average — on expectations that the firm will accelerate its online strategy.
Few professional investors believe the hype. Short interest in PLCE stands at a record 26%. They realize that low-quality firms like this face growing competition from off-price retailers and stores like Gap (NYSE:GPS), Walmart (NYSE:WMT) and Target (NYSE:TGT). What’s more, demand has slowed for PLCE’s merchandise. In 2020, birth registration declined 9% from pre-pandemic levels. Not good news for a retailer focused on toddlers and young children. Whether PLCE comes out on top this quarter will depend on the success of its digital channel and the pace of recovery.
On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.