The frothy markets of the last few years have led many analysts and commentators to wonder whether investors in 2020 are looking down the barrel of a repeat of the dotcom bubble of the early 2000s. Founder of Greenlight Capital and famed shortseller David Einhorn (Trades, Portfolio) has long been among this group of individuals, arguing that parts of the tech sector have been driven way beyond fair value. In particular, he has been a vocal critic of Tesla (TSLA, Financial) and its CEO and founder, Elon Musk, a position that thus far has not been particularly lucrative for Einhorn. In his latest letter to investors of Greenlight, Einhorn reiterated his concern that the market is in a bubble.
Reasons to be worried
Over the course of the third quarter, Greenlight generated returns of 5.9%, compared with 8.9% for the benchmark S&P 500 Index. This is reflective of the defensive position that Einhorn has maintained as a result of his market-skeptic convictions. He listed a number of reasons why investors might consider adopting a similar approach:
"All the signs of a bubble are there, including: an IPO mania, extraordinary valuations and new metrics for valuation, a huge market concentration in a single sector and a few stocks, a second tier of stocks that most people haven't heard of at S&P 500-type market capitalizations, outperformance of companies suspected of fraud based on the consensus belief that there is no enforcement risk, outsized reaction to economically irrelevant stock splits, increased participation of retail investors, who appear focused on the best-performing names."
The increased participation by novice amateur investors is a particularly famous hallmark of bubble behavior. Recently, there has been an explosion in the volume of short-dated call and put options traded as small investors try to make quick profits off of the upward movement of some of the more volatile stocks.
It's impossible to know exactly when a bubble will pop - it is only in hindsight that investors can look back on history and assert that "it was obvious all along." In general, bubbles tend to run out of steam before they begin to properly deflate. For what it's worth, Greenlight's prediction is that the Sept. 2 S&P 500 all-time high will prove to be the high water point of this particular bubble.
Of course, this is just a prediction, and by no means should be assumed to be accurate (as Einhorn himself agrees). But if the guru is right that we are approaching the point where even the most optimistic buyer has begun to have doubts, and all the shorts have been squeezed out of their positions, then it may be time to adopt some of his skepticism.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Joel Greenblatt: Think About Buying a Business Like Buying a House
- The Value Investor's Handbook: The Broader Impact of Oil Prices​
- Joel Greenblatt: There Will Always Be Opportunities for Investors
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