The Narratives That Drive Bubbles

Tesla recently cut the price of its sport utility vehicle Model Y by $3,000, just four months after its launch, in an effort to maintain sales momentum during the COVID-19 pandemic. This reduction follows price cuts in May on Tesla’s Model 3, Model X and Model S.

Tesla has seen its value skyrocket in recent quarters, rising from a 52-week low share price of $211 to a high of $1,794.99 made on July 13, 2020. That figure, however, is low in the eyes of some. According to a recent report by Piper Sandler, they cite two key factors for their new Tesla price target of $2,322: The company’s edge in manufacturing and resulting unit volume, and the “possibility” that software will allow the company to “eventually” generate operating margins in the mid-20s, currently at 4.7%!

When valuations are so removed from the fundamental value of assets they are considered in a bubble. The hysteria and destruction created by asset bubbles should be something that people have come to be familiar with. In the past twenty years we have experienced the large boom bust bubble of the dot com era and then again in 2008 with the subprime mortgage crisis.

There are many possible causes of these bubbles such as; moral hazard, herding, greater fool theory, extrapolation, or liquidity, but once they expand they are driven by narratives because it is the narrative that infects and influences investors. Economist Robert Shiller once said that the stories investors tell themselves drive their investment thesis, which drives their reason for putting money to work in an economy. They are usually not making rational, cool-headed decisions based upon careful and cautious fundamental analysis. 

The larger theme narratives that seem to be prevailing and driving markets are the Federal Reserve, US/China relations and trade, the pandemic (with its alternating themes of lockdown and vaccines), and the coming US elections. You would think just one of those narratives to be highly influential but you get the full force of the four.

Sometimes a sector is a narrative. Think cannabis stocks or tech stocks in the 1990s — one of the most inflated and irrational bubbles the market has ever seen. Companies with no profits and high expenses were going public. Of course, the bubble burst spectacularly in 2000. The poster child of the promise of growth was pets.com, an online pet food and pet care product retailer. The company lasted about a year. The more product it sold, the more money it lost. We could equate that with today’s gig economy and stock sector. Do you know any stocks like this? (cough – UBER)

There are also individual stock narratives that are just as powerful. Fitbit jumped out to an early lead in the wearable fitness market, an area that many experts believe would see explosive growth in coming years. However, Fitbit’s share price dropped from its IPO price of $20 back in 2015, to shares that now trade at around $6.8. 

Like Fitbit, GoPro is another example of how the narrative drives a company’s stocks to heights that don’t reflect reality.  GoPro’s IPO priced at $24 back in 2014. Today, shares trade at around $4.83.

Sometimes, investors don’t even take the time to develop the full narrative. In 2016, Pokemon GO conquered the world and sent Nintendo’s stock surging. Their stock price rose by over 50 percent, gaining over a billion dollars a day. It totaled over $10 billion in less than a week. There was one problem, Nintendo didn’t actually make Pokemon GO. 

Once the Nintendo spokesperson publicly reminded everyone that the game is made by a different company, the stock price plummeted by more than 30 percent. This “discovery” could have been revealed by a simple Google search or a play-through of the first two seconds of the game. 

When valuations don’t make sense it is the narrative that drives the stock. Everyone loves a story that they can believe in. The fundamental problem with story stocks is their prices are typically bid up by investors who have gone ga-ga over the story. As a result, they often trade much higher than they should relative to their profits, given the financial fundamentals of these companies.

In 1999, Howard Marks of Oaktree Capital Management, wrote in his piece “bubble.com” that “tech stocks had benefited in 1999 from a boom of colossal proportions. They exhibited all of the elements of a market bubble, with an attractive story providing the foundation for a gravity-defying escalation of prices far beyond reason, and for manic behavior on the part of investors.” He urged readers to view the tech stocks skeptically, but also acknowledged that it’s possible for overpriced assets to remain so for a long time. However, at the time he said that he certainly had no idea that the excesses he saw in the market would be remedied as quickly as they did. He also  added that “analysts added little insight in terms of either fundamentals or valuation.”  

In 2019 Tesla sold 367,500 units. In comparison, Toyota sold 10.7 million units. Tesla now has a greater market value than Toyota. Fundamentals or Narrative driven? You be the judge.