Since the start of the pandemic, the stock market has been red hot. Stock prices have hit all-time highs, buoyed by low interest rates, the rise of retail trading, and government stimulus checks. Startups entering the stock market for the first time raised more money than ever in 2020—and then doubled that total in 2021. Some wonder whether we’re in a bubble akin to the dot-com boom of the late 1990s.
Cathie Wood, the rockstar stock picker known for making bold bets on disruptive tech companies, rejects the comparison. There might be a bubble in the market, she argued in a Dec. 17 blog post, but it has nothing to do with tech stocks. Instead, she wrote, it’s the investments we normally think of as “safe bets”—namely, index funds—which have seen their prices rise beyond their underlying value.
Usually, when market watchers fret about a stock bubble, they’re thinking about tech startups like Zoom and Peloton, which saw their share prices soar as high as 10 times their original value during the pandemic. Investors drove up the value of these stocks as the world locked down, betting that the companies that developed the tools for work, shopping, exercise, and connecting with loved ones from home would benefit from the pandemic.
But as soon as wealthy nations began rolling out vaccines and their citizens began spending time out of the house, these so-called “stay at home” stocks tanked.
Wood’s investment firm, ARK Invest, holds a lot of “stay at home” stock. In fact, Wood has bought even more shares of companies like Zoom, the telehealth platform Teladoc, and the electronic signature company DocuSign, while other investors sell. She argues that after 11 months of freefall, these stocks “have entered deep value territory” and are trading at a discount relative to their earnings and potential for growth.
She illustrated her point with a table comparing the nosedives these stocks have taken to the steady gains they’ve made on fundamental business measures like quarterly revenue at EBITDA, a rough measure of a company’s profitability. Here’s a condensed version of her chart:
Wood argues the solid financial performance these companies have reported is evidence that “stay at home” stocks are still relevant in a hybrid world, where people venture back outside but retain some of the habits they picked up during the pandemic. “The coronavirus crisis permanently changed the way the world works, catapulting consumers and businesses into the digital age much faster and deeper than otherwise would have been the case,” she wrote.
Meanwhile, Wood argues, investors have been overestimating the value of index funds, which aim to reduce risk by blindly buying a wide swath of stocks from the biggest companies on the market. Fearing inflation and the economic fallout from an omicron-fueled surge in covid-19 cases, more investors have been pulling out of risky funds like ARK in favor of the stability of index funds.
But Woods argues that funds benchmarked to stock market indexes like the S&P 500 have reached inflated valuations out of proportion to their underlying performance.
The price of an S&P 500 fund has reached record highs in recent weeks, and the stock index’s price-to-earnings ratio has hovered above typical levels during the pandemic. (The price-to-earnings ratio gives you a rough idea of how overpriced a stock is by comparing the price of a share of the company’s stock to the amount of revenue a company earns. The higher the ratio, the more expensive the stock is relative to its actual business performance.)
To be sure, the price-to-earnings ratio of the S&P 500 still pales in comparison to that of “stay at home” stocks like Zoom. Zoom’s ratio of roughly 54 is more than double the S&P’s ratio of about 24.
But, as Woods points out, those “stay at home” stocks have seen their valuations move closer to reality, while the price of index funds are starting to float above the underlying performance of the businesses they represent. A cautious investor could reject the volatility of ARK Invest’s portfolio in favor of the slower, steadier growth of an index fund. But a more aggressive investor might side with Wood, who believes index funds are overvalued and will bring disappointing returns over the next decade.
The bubble, in other words, is in the eye of the beholder.