Two “Disruption” topics today:
#1: How does Tesla’s +$1 trillion valuation affect commonly used measures of US large cap equity valuation and other commonly used market metrics? Three points on this:
First, Tesla’s rally is making the S&P 500 even more of a concentrated bet on disruptive technology. When it was 1.X percent of the S&P, one could exclude TSLA as an interesting but not mathematically important piece of the index. No one ever talks about Berkshire Hathaway (1.4 pct of the S&P 500) or Johnson & Johnson (1.1 pct) as systematically important, after all.
But with its recent ramp TSLA is now solidly in “must watch” territory along with the rest of US Big Tech for its potential impact on day to day moves in the S&P 500:
- Apple: 6.0 pct of the S&P 500
- Microsoft: 6.0 pct
- Google: 4.1 pct
- Amazon: 3.7 pct
- Tesla: 2.1 pct
- Facebook: 2.0 pct
- Total: 24 percent of the S&P 500
It’s worth noting that no other broad market index around the world has a 24 percent weight to its top 6 names. MSCI Emerging Markets is close, at 21 percent, and as you know we don’t like that index exactly because names like Tencent (4.5 pct) and Alibaba (4.1 pct) feature so prominently. MSCI EAFE (non-US developed markets) is only 9 percent weighted to its top 6 names.
Takeaway: take the S&P 500 Technology sector and add Google plus Facebook (nominally in Communication Services), and Amazon plus Tesla (Consumer Discretionary), and you get 40 percent of the S&P 500. We’ve halfway joked since starting DataTrek that “Tech” would eventually be 50 percent of the S&P 500 but thought that was maybe a 2030 event. The way things are going, it will come long before that.
Second, Tesla’s recent move pushes the S&P 500’s aggregate forward PE ratio valuation even higher:
- Tesla trades for 127x its 2022 earnings expectations ($1,018 stock, $8/share EPS estimate).
- That is meaningfully higher than the 30.9x multiple average for the rest of US Big Tech. The others: Apple: 26.2x 2022 estimates, Microsoft: 30.6x, Google: 26.6x, Amazon: 51.4x, and Facebook: 19.8x.
Takeaway: while the S&P 500 may trade for a nominal 20.7x next year’s earnings estimate, the reality is that its valuation is 20x – 127x for 6 companies and about 17x for the rest. Health Care, Materials, Financials and Energy – 30 percent of the S&P in total – all trade for 13x-17x, for example.
Third, you can’t use the S&P 500 Consumer Discretionary sector (ETF symbol XLY) as a proxy for US consumer spending anymore. That’s because Amazon and Tesla are 20 percent and 19 percent of the index each, or 39 percent together. The names you associate with this group, like Home Depot (9 percent weight) and McDonald’s (4 pct), don’t have much influence.
Final thought: one can argue about how much disruptive innovation “should” be in a stock index, to be sure, but it’s harder to take issue with the results. The S&P 500 is far ahead of any other global equity index over 1-10 years precisely because it has so much Big Tech exposure. Does that leave the S&P 500 at risk of a sizeable correction? Of course it does. But we’d far rather own the S&P 500 than Europe or Japan or even China for the long term, simply because you need to own as much disruptive technology as you can bear to earn a decent return on investment capital. That’s the central lesson of the last decade, as Tesla’s stock shows, and we don’t think that dynamic is changing any time soon.
#2: You don’t often see academic work on virtual currencies from top institutions, but there is a new paper out from researchers at the London School of Economics and MIT Sloan titled “Block chain analysis of the “B” market”. (Because email systems think the popular virtual currency whose name begins with “B” is spam, we refer to it simply by its first letter).
The paper’s 3 key findings (link to the complete work below):
- Regulating “B” in terms of anti-money laundering (AML) and know-your-customer (KYC) requirements is and will continue to be extremely difficult. There are many jurisdictions where such regulations are lax or non-existent. As long as these host “B” technology it will be possible – even easy – for illicit activity to continue.
- “B” mining has been highly concentrated, with 10 percent of miners controlling 90 percent of total capacity and just 0.1 percent controlling 50 percent. The authors used data from 2015 – 2020, so this does not include the recent exodus of Chinese miners. Still, the authors noted that “B” mining concentration rises when prices fall, making it more susceptible to a 51 percent attack (when 2 parties collude to fraudulently alter the transaction record) during periods of falling prices.
- By the authors’ estimates, the top 1,000 investors own 3 million “B” and the top 10,000 own about 5 million. There are 19 million “B” outstanding right now.
The paper’s summary sentences wrap things up succinctly:
“Our results suggest that despite the significant attention that [B] has received over the last few years, the [B] eco-system is still dominated by large and concentrated players, be it large miners, [B] holders or exchanges. This inherent concentration makes [B] susceptible to systemic risk and also implies that the majority of the gains from further adoption are likely to fall disproportionately to a small set of participants.
Takeaway: if you own virtual currencies like “B”, this paper is well worth a read.
LSE/MIT Sloan paper (Makarov and Schoar, free to download): https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3942181