Recently, Business Telegraph ran an op-ed titled, ‘Is ‘hysterical’ market speculation pushing us towards another crash?’ with a focus on overvalued stocks. One of the challenges facing the US financial markets in particular is the bullishness of the stock markets like the NASDAQ, the S&P 500, and the DJIA.
True to form, the NASDAQ is up 39.85% over 1 year, the S&P 500 index is up 14.07%, and the Dow Jones Industrial Average is up 5.69% up [January 19, 2021]. These figures defy expectations, given that the global economy has stalled, demand has dropped off, and supply has been reduced accordingly.
Proof of the slowdown is evident everywhere, including the demand for crude oil. According to the US Energy Information Administration (EIA), the world liquid fuels production consumption balance reveals a slow and steady return to normal, but the lag effect does not justify the overinflated pricing on US equities.
The companies that ship their products and services abroad, scaled back manufacturing, production, and distribution in 2020, leading to a massive surplus of crude oil production. This was highlighted in Q2 2020, and throughout Q3 2020, only returning to normal in Q4 2020 and Q1 2021.
Pre-2020 global petroleum production and consumption levels have still not been reached, by OPEC and non-OPEC countries alike. The drawdown in 2020 was 3.9% in terms of world real gross domestic GDP, although growth of 5.4% is projected for 2021, that remains a speculative assessment. The concept of artificial inflation has been written about ad nauseam; companies cannot justify their stock price valuations.
One of the strongest drivers of speculative sentiment is the Fed itself. When the Federal Reserve Bank pumps trillions of dollars back into the economy, essentially giving ‘Free Money’ to anyone and everyone, that money has to get soaked up somewhere. People are loath to save; they would much rather spend.
According to Census.gov, a percentage of respondents is using their stimulus funds to pay for food, 77.9% for rent, mortgage, utilities, 58.2% on household supplies and personal care products, and 20.5% on clothing. 8.1% of respondents are spending their money on recreational goods, appliances, furniture, electronics, televisions, games, toys, and fitness equipment. Even if all the other components are ignored, that 8.1% is significant.
Newly elected president, Joe Biden has proposed additional stimulus valued at $1.9 trillion, including $1400 checks for Americans. If 8.1% of every check (assuming the census is reflective of the average) is spent, that means every eligible taxpayer could be spending $113 on the aforementioned products. Multiply that figure by 153 million payments, and you get a pretty good idea of how much money is finding its way into companies, many of which are listed on the stock markets.
From an earnings perspective, listed companies are certainly generating income, but it is not earned income per se. The funds are being disbursed by the federal government, and what we are seeing is a sharp increase in the Debt/GDP ratio. In other words, we are borrowing trillions of dollars to prop up an economy, albeit at ultralow interest rates. The only foreseeable consequence of such unprecedented expenditure (greater than annual US GDP) is inflation. This occurs when too much money is chasing too few goods.
A country flush with cash, and high unemployment levels presents economists with a dilemma. The markets are liquid now, but what happens when the money is spent and the jobs aren’t there? Or if means tests are abolished and people simply collect unemployment because it’s easier to do so? These are the types of hard questions that the federal government has to answer if it hopes to foment a lasting economic recovery.
Speculative Sentiment Is Driving up the Stock Markets
Speculation is nothing new. It has been going on since the inception of markets. We hear about speculative sentiment causing a run on NASDAQ stocks, only to result in spectacular selloffs as profit takers moved in. It is true, bullish momentum cannot continue unabated. Companies will have to perform in order to justify their market capitalizations.
Stocks like Tesla ((NASDAQ: TSLA), Apple (NASDAQ: AAPL), Under Armour (NYSE: UA), and scores of others present as value propositions, but they may not be. The problem with highflying stocks is that they have a long way to fall.
Speculators can play the market in both directions – bullish or bearish. Right now, everyone is feeling amped about the stimuli, but the global economy is aware that this is an injection of adrenaline into an already bullish market. At the risk of sounding the alarm, one doesn’t inject adrenaline into a raging bull – the consequences will be catastrophic.
Right now, 401(k)s are looking healthy, but without protections in place such as trailing stop loss orders (percentages or dollar values), portfolios could collapse to their Q1 2020 values. Tesla presents differently. It is heavily overvalued, but the company is a green energy giant and the Biden administration is determined to redefine American energy for the 21st-century.
Tesla stands at the forefront of this revolution, with tremendous tax benefits, incentives, and government backing guaranteed to come Tesla’s way. From that perspective, it is unlikely that Tesla will suffer too much with a market correction.
Penny Stocks Now Comprise A Growing Proportion of Financial Portfolios
For traders seeking value propositions, it’s best to start off a low base with penny stocks trading. Listed companies with low stock prices have less further to fall than heavily overvalued blue-chip stocks. An investor with £10,000 in the markets could opt for fewer blue-chip stocks with stable pricing and slow growth, or volatile penny stocks (equities under £1) with strong upside potential. In nominal terms, investors stand to lose the same amount – £10,000 – but the upside potential with a strongly performing penny stock outpaces that of a mature company stock by a long margin.
As a case in point, consider an investment comprising 10,000 stocks at £1 each. If they move from £1 to £3, that’s a 300% ROI, or £30,000 return on £10,000. The same £10,000 could be spent on £100 blue-chip stocks, but a 300% return is highly unlikely at the heavily overinflated prices we are seeing. Recently Warren Buffet’s ‘indicator’ of market valuations revealed that the global stock market capitalization is 120% of global GDP. This indicates a reversal is on the cards.
Effective Ways of Mitigating Risk
For these reasons, many traders and investors are taking a long, hard look at their portfolios and allocating an increasing percentage of their budgets towards alternative stock options, such as penny stocks with their higher growth potential. The volatility and liquidity concerns with penny stocks are precisely the reasons why they stand to generate outsized returns. Speculators with an eye on penny stocks can run the prices up rapidly, or dump stocks en masse and cause prices to tumble. The savvy investor is able to spot these opportunities in time, and act decisively.
With pre-set take profit orders in place for top performing penny stocks, it is possible to mitigate risk, and play the markets, but not get played by the markets. Investors can take control of the direction of their financial portfolios by being attentive to market mechanisms. In a sense, well-traded penny stocks can provide a cushion against the volatility that is coming.
By incrementally taking profit from multiple individual trades, it is possible to protect 401(k)s from corrections, or reversals that may result. In all cases, risk mitigation measures must be implemented with traditional stocks and penny stocks alike, because this raging bull is going to run out of steam at some point.