A combination of low interest rates and the emergence of new technology can cause bubbles to form, according to Morningstar IM. Is this what is happening in crypto and clean tech stocks?
If history is any guide, then the combination of low interest rates and the emergence of new technology can set the stage for asset price bubbles to form in markets.
Currently, such forces are in play and this has created the perfect conditions for inflated prices, especially in the cryptocurrency sector, according to Dan Kemp, Chief Investment Officer for Europe, Middle East and Africa at Morningstar Investment Management.
“When interest rates are low, people become disillusioned with the returns they can get on traditional investments and tend to look for alternatives,” Kemp said at a media briefing last week.
“That tends to be exacerbated when we go through a period of technological change, because that can endow those alternatives with the attraction of very high levels of potential growth.
“We recognise a technological change and we see investments that are linked to that change and, of course, we expect tremendous growth to follow and that sometimes detaches the way we think about the price of those investments.
“Investors tend to get very excited and in that excitement they tend to miscalculate the timing, the size and sometimes the certainty of those future cash flows and that can lead to these very strong upwards price movements,” he said.
we’ve had very low interest rates for a very long time now and people are pretty disillusioned with the returns they can get in traditional investments and so they see the opportunity in cryptocurrency that comes from technological change – Dan Kemp
Currently, cryptocurrencies are a key example of asset bubbles sparked by new technologies, high prices and low interest rates, he says.
“If you think about all of the essential characteristics of this type of event, then they are in place. So we’ve had very low interest rates for a very long time now and people are pretty disillusioned with the returns they can get in traditional investments and so they see the opportunity in cryptocurrency that comes from technological change,” he said.
It is not just that people are being fooled. Many look at the technology underlying cryptocurrencies, the blockchain, and understand that this technology will have an impact. But where the miscalculation takes place is in chasing an asset that has no intrinsic value.
This has happened all throughout history, Kemp said. He pointed to the Dotcom crisis, the frenzy in railway IPOs in the mid-19th Century and even as far back as the Tulip Mania, which was partly caused by the introduction of the futures market.
“It was one of the first financial bubbles in history, where people went crazy for the price of tulip bulbs. What is interesting was that interest rates were low, capital was freely available, but there was technological change, even though it was very long ago,” Kemp said.
“That technological change was the development of futures for the first time. So what drove tulip bulb prices was an active futures market in the winter, when tulips had to be in the ground. They couldn’t physically be exchanged. So you had this incredible futures market that drove the price forward,” he said.
With inflation ramping up, reaching a 39-year high in the United States, investors are expecting central banks to lift interest rates in the near future. This could be especially bad news for technology companies in general, which have been the key beneficiaries of the low interest rate environment.
“There will be volatility in rates markets. We’ve already seen that in the last month or so. That volatility will then lead to volatility in equity markets,” Jody Fitzgerald, Head of Institutional Portfolio Management at Morningstar Investment Management said at the briefing.
“During this period of repricing of the risk, growth stocks will reprice and we are seeing that at the moment in tech.
The extraordinary performance of technology companies over the last decade or so has been underpinned by low interest rates. The concern for the path of interest rates is now leading to a massive repricing – Jody Fitzgerald
“The extraordinary performance of technology companies over the last decade or so has been underpinned by low interest rates. The concern for the path of interest rates is now leading to a massive repricing and a fantastic example of that is what has happened to Netflix just last month.
“Just for the month of January, Netflix is down 37 per cent. Tesla is down 25 per cent, almost,” Fitzgerald said.
In this inflationary environment, cyclical companies tend to do better, she said.
“There are some equities that will actually perform well during an inflationary period. What will do well? Energy stocks. Exxon was up 25 per cent over January.
“Other companies that tend to do well during inflationary periods are financials. Banks tend to make a lot more money when there is a shape to the yield curve, because of their spread products. It is about the ability to borrow short term and lend long term at a higher rate,” Fitzgerald said.
Clean Tech & Bubbles
Crypto might be a clear example of a bubble, but it is not the only area of technological innovation. Arguably, the world is in the middle of an energy transition, away from fossil fuels and towards renewable sources of energy and this transition will come with many new technologies.
Kemp, who looks after several ESG portfolios for Morningstar, said that although there was definitely a premium attached to companies that score well on ESG metrics, he didn’t think there was a bubble forming in the clean tech sector.
“The danger is that when you start looking for bubbles, you start seeing them everywhere,” Kemp said. “But some clean tech, Jody mentioned Tesla, but there are other EV companies as well, are phenomenally overpriced.
clean tech is a very broad area, so I wouldn’t want to paint the whole sector with that single colour of being overpriced. But we are seeing a premium in companies with low ESG risk, where investors are perceiving companies as having less exposure to climate change or even benefitting from the way that people are trying to tackle climate change – Jody Fitzgerald
“[Yet] clean tech is a very broad area, so I wouldn’t want to paint the whole sector with that single colour of being overpriced. But we are seeing a premium in companies with low ESG risk, where investors are perceiving companies as having less exposure to climate change or even benefitting from the way that people are trying to tackle climate change.
“I run ESG portfolios in the UK and I would love to have some alternative energy companies in the portfolio, but I really struggle to find alternative energy companies at what I consider attractive prices,” he said.
The difference between clean tech companies and cryptocurrencies is that where crypto has no intrinsic value, many clean tech companies produce clear cash flows that can be analysed and forecasted.
“With crypto, there are really no cash flows and it is really impossible to describe a fair value, so there is a difference there,” he said.
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