Articles - I knew you were a bubble when you walked in

Over the past couple of years, a lot of market commentary has focused on US tech stocks. Developed Market performance during the Covid-19 pandemic has largely been driven by a handful of tech giants (think acronyms like FAMTANG), which explains both the large returns and the apparent dissociation between the booming stock market and the less booming economy. Apple and Microsoft have market caps roughly equal to the GDP of the UK or India – is this a legitimate development in the market or a bubble waiting to burst?

 By Alex White, Head of ALM Research, Redington

 Historically, this type of market dominance is not unprecedented. However valuable companies like the Dutch East India Company (or the VOC), British East India Company and Mississippi Company were in today’s terms (and Googling it reveals a lot of interesting rabbit-holes around how difficult this sort of comparison is), it seems almost certain that they made up a far greater proportion of the investible universe than any of today’s firms. Similarly, the Credit Suisse Global Investment Returns Yearbook suggests that in 1900, Railways accounted for half of the UK market and around two thirds of the US market, much larger than the c.25% of the MSCI World accounted for by tech firms today.

 On top of this, Covid-19 has dramatically changed how we work, and valuations have shifted accordingly. Tech has become an even more critical pillar of society, which explains why current valuations are so high. To the extent that we all return to offices, this may partially reverse. But it seems likely that at least some of this change is permanent. And given the structural dependence (and large cash reserves) of these firms, it’s hard to argue there’s not a large body of core value in them.

 If there is a bubble, a better candidate than tech firms is perhaps non-fungible tokens (or NFTs). These are surely unprecedented in that owning one confers no rights other than the right to sell. If I own a painting, I can put it in my house, append it to my metaphorical peacock tail and impress my guests. If I own the copyright to digital artwork, I can restrict who uses it and charge them for it. But an NFT doesn’t actually let the owner do anything.

 Of course, having no tangible value is arguably missing the point. The values of crypto, gold and fiat currency are also based on shared convention rather than anything physical. And while you can look at a piece of art, how many of us would pay millions to own one without an expectation that someone else might do the same? NFTs offer scarcity as a form of value, and are almost certainly harder to forge than most artworks. NFTs may also be better for patronage than buying physical art, because an artist can sell their art directly to a wider possible market and keep more of the profits.

 The fact that the scarcity is artificial is also not necessarily a problem. Fiat currency works on an implicit promise that the government won’t print so much as to devalue it all. In that sense, cryptocurrencies, which are based on maths, might turn out to be more reliable. Crypto is an attempt to solve a variety of related problems, such as anonymising digital trades, and by being provably limited and fungible, it may achieve some of those aims.

 But currency, whether traditional, digital, or crypto, is fungible. The market for bitcoin is for one product, whereas the market for NFTs is really a fractal smorgasbord of different sub-markets. Collectors of Star Wars memorabilia may have no interest in Pokémon cards, and the same may be true of collectors of NFTs related to either. At the same time, they do share a common vulnerability to interest and confidence in NFTs more broadly. Every NFT trade is unique. The power of currency comes from replacing barter with a single conversion tool. In this sense, NFTs are arguably a step back towards a barter industry, only in things which don’t exist.

 The NFT market could easily continue to soar, and there are many possible uses for the technology (such as authentication certificates). NFTs could be the future of patronage, and could enable bets on the future success of artists. However, they could also just be a bubble.

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