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Stock market stories sometimes lead us to the wrong conclusion

25th January, 2021

Published in the Sunday Times on 24th January 2021

If you are a market enthusiast, it’s unlikely to have escaped your attention, that Tesla was added to the S&P 500 Index last month. Exxon’s deletion from the Dow Jones Industrial Average (DJIA) in August may well have flown below your radar. 

Markets run on narratives. Afterall, it is easier to think in terms of stories. And the stories that these two events are being used to support are worth scrutinising. 

Tesla, now the fifth-largest stock in the U.S., has catapulted Elon Musk up the world’s richest table, briefly eclipsing Jeff Bezos as the world’s wealthiest person. Its stock price has risen eight-fold since the lows of March last year. Predictably given such a meteoric run, it’s the poster boy for evidence of a market bubble with comparisons to the tech mania of 2000.

At the other end of the spectrum is Exxon Mobil. To the injury of a share price that has cratered in the last five years was the insult of news that after 92 years of membership, the index committee of the DJIA would be replacing it with It is seen as a relic of bygone era, with little or no future in a carbon free world. 

Market narratives can shift quickly

The markets have a remarkable ability to shift from one narrative to another at the drop of a hat. So I wouldn’t read too much into either. But there are some historical precedents worth exploring.   

According to a paper from Research Affiliates, in the case of companies that get deleted from an Index the average deletion beats the market by an average of 20% over the next year (based upon the S&P 500 discretionary deletions between October 1989 and December 2017). Market capitalisation weighted indices are designed to buy high and sell low in Rob Arnott’s view. 

Exxon & the Dow

The Dow Jones bizarrely is a price weighted index, not market cap weighted, and rules for inclusion/exclusion are more subjective. As observed by my colleague Killian Buckley, in 1939, IBM was removed from the DJIA and replaced by AT&T. 40 years later IBM was restored to the index after its share price had increased 220 fold, compared with AT&T which only increased 149% over the same period.  At that time, the DJIA stood at 841. Had it not made that switch forty years prior, it would have reached a level of 23,582. That’s a stunning destruction in value for a so-called passive Index.

It’s hard to imagine a similar path for the once mighty Exxon, but bears beware.

Is Tesla more like Cisco or Amazon from 2000?

The outlook for Tesla is a much thornier issue. Comparisons with the mania of 1999/2000, I think are wide of the mark. John Authers of Bloomberg makes a more valid comparison between Tesla and three companies that were at the centre of that boom in 1999 and 2000; Cisco Systems Inc., Microsoft Corp., and Inc. All three were priced for perfection at the market peak in 2000, though none of them experienced a parabolic share price rise to match Tesla over the last 12 months. All three were, and are still great companies. Nevertheless it’s instructive to look at how investors fared in buying these at their respective tops at the turn of the millenium.

Twenty years on, in price terms, Cisco’s investors are still under water. Amazon shareholders had to wait out a decline of more than 90%, and didn’t show a profit on their investment for a decade. Buyers of Microsoft at the top in 1999 had to wait 15 years to make a profit.  Investors in both have been spectacularly rewarded, particularly so in Amazon, but you’d have required Buffett-like patience and fortitude.

Pockets of madness doesn’t mean the market is a bubble 

If searching for examples of stocks to back up a thesis that the market is a bubble, you’ll never have to look far. Stocks, or even whole sectors, trading on wild valuations are necessary conditions of a bubble, but not sufficient. Excessive behaviour in pockets of the market can play out whilst all else remains relatively calm.

There are plenty of valid arguments for why the entire market isn’t a bubble. To a diversified equity investor, the lesson of Tesla is not that it’s a canary in a coalmine. It’s that brilliant companies don’t always make for brilliant investments – price matters. Tesla may well turn out to be as magnificent as its valuation currently implies. I simply have no idea - the most I can say is that risks seem to outweigh the potential rewards. 

Tesla is worth about $1.4m for every car the company is expected to produce this year. The bullish might say investors are paying to come along for the ride. A cynic might say they are being taken for one. 

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