The Rise (and Fall) of 'Mindless Investing'

The biggest mega-bubble in all recorded history isn't over... The wild, three-week ride of VinFast Auto... 'What were you thinking?'... Reminded of 'meme stocks'... A market full of 'trading sardines'... The rise (and fall) of 'mindless investing'...

The evidence is all around us...

I (Dan Ferris) realize the stock market is thriving. The benchmark S&P 500 Index is up about 17% this year. And the tech-heavy Nasdaq Composite Index has gained around 34%.

But you're mistaken if you think the biggest mega-bubble in all recorded history is over.

Just look at special purpose acquisition companies ("SPACs")...

SPACs are "blank check" entities that raise money by going public on the promise that they'll use the money to acquire a business. When they find a target, shareholders can either take stock in the new company or redeem their SPAC shares and get their cash back.

SPACs make it easier for companies to go public.

But anything that makes it easier to go public is like an invitation to flood the market with garbage. And as we've learned recently, a lot of SPACs wind up buying pure garbage.

You can see that in the performance of the IPOX SPAC Index over the past three years...

The IPOX SPAC Index is exactly what it sounds like. This index is designed to track the top publicly traded SPACs. So it's a great way to "check the pulse" of this space.

This index started in the summer of 2020 at a value of 500. And if you know how these types of situations work, you won't be surprised that it appeared at that moment...

That's because 2020 was a huge year for SPACs. That year, 248 of these companies went public – which was more than the previous 10 years combined.

SPACs were on fire. New ones went public almost daily. And you'll likely recall the setup...

Investors were locked down in the middle of the COVID-19 pandemic. And they were loaded with freshly printed government stimulus money.

That put them in a gambling mood. So they bought SPACs and a lot of other garbage they fell in love with.

By February 2021, the IPOX SPAC Index had nearly doubled to as high as 940. That happened in less than a full year.

But as we now know, the fun was short-lived. Just after that peak, SPACs crashed along with the rest of the market...

The IPOX SPAC Index bottomed in January of this year at around 460.

In other words, the index plunged 51% from its early 2021 high. And a quick look at the chart shows that investors have fallen out of love with SPACs since that peak...

But that hasn't stopped SPACs from being a huge source of risk – and evidence that we're still in a mega-bubble...

Despite the skepticism that investors have about SPACs, some of these new public companies are still achieving absurd valuations by questionable means. Take the most recent example...

VinFast Auto (VFS) is a Vietnamese carmaker. The company sells both internal-combustion-engine and electric cars in Vietnam and the U.S. It was founded in 2017 – and has yet to be profitable.

The company went public a few weeks ago through a merger with a SPAC called Black Spade Acquisition (BSAQ). On August 15, it started trading on the Nasdaq as VinFast under its new ticker symbol.

That's when things got interesting...

VinFast's stock rose roughly 255% that day. The company's market cap hit $86 billion – roughly 135 times its 2022 sales (about $633 million).

Since the company went public, its market cap has been as high as $190 billion – or about 300 times sales. Today, the stock trades for around $30 per share. And it's valued at roughly 110 times sales.

Now, the basic pieces of this story aren't unusual...

VinFast is a newly public, unprofitable company that's trading at a crazy-high valuation.

A lot of unprofitable companies go public to fund growth. They hope to get enough money from investors to grow their business and eventually become profitable.

VinFast's management believes it can achieve profitability in the near and long term. It mentions that many times in its filings with the U.S. Securities and Exchange Commission.

As a carmaker, VinFast's business has operating leverage.

That just means it needs to be a certain size to be profitable. Relatedly, it will become more profitable as sales grow – and less profitable as they shrink.

A carmaker with less than $1 billion in sales isn't very big. So it's not too ridiculous for management to believe that growing sales a lot will help it become profitable.

A lot of companies achieve crazy-high valuations, too. We're living in the age of crazy-high valuations, after all...

Just look at AMC Entertainment (AMC). The movie-theater chain is as doomed as doomed can be. Its bonds are trading at distressed levels. Yet its equity is still worth billions.

I can't help but recall one of the most famous quotes from the dot-com era...

Sun Microsystems co-founder Scott McNealy said the following in a 2002 Bloomberg interview...

At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends.

That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero [research and development] for the next 10 years, I can maintain the current revenue run rate.

Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are?

You don't need any transparency. You don't need any footnotes. What were you thinking?

As McNealy noted, Sun Microsystems' stock traded at 10 times sales at the height of the dot-com era in 2000. When you realize that, it makes you wonder how anybody could buy VinFast's stock when it's 12 times more expensive than one of the most expensive stocks of the dot-com era – which is one of the most expensive moments for stocks in U.S. history.

The answer is simple...

VinFast soared out of sight on its first day of trading and still has a crazy-high valuation today because few of its outstanding shares trade publicly. Because of that, it doesn't take a lot of buying and selling to push them around.

You see, VinFast has around 2.3 billion shares outstanding. But only about 7 million of those shares trade publicly. That's less than 0.5% of the total.

(Pham Nhat Vuong, VinFast's billionaire founder and chairman, directly owns about 48% of the company's outstanding shares. And overall, when you factor in three different holding companies, he controls 99% of the shares.)

The company also has nearly 15 million warrants outstanding. When they're exercised, they'll become nearly 15 million more shares. But even at that point, less than 1% of the company's outstanding shares will trade publicly.

In other words, at its recent share price of about $30, the company's tradable market cap is about 99% lower than you'll see listed on Yahoo Finance or any other financial-data website.

So despite VinFast's giant 'official' market cap, it's more like an illiquid small-cap stock...

Obviously, I can't know what discussions happened behind closed doors. But to me, it looks like the folks behind Black Spade and VinFast knew what they were doing the whole time.

It seems to me that these folks purposely took the company public in a highly illiquid manner, hoping to garner an insane valuation... And it worked.

But the joke is likely on them...

The same thing has happened with other SPAC mergers. And the results have often been disastrous. Dozens of these companies' stocks have fallen 80% or more.

You can see it in the volatility of VinFast's stock since it switched to the new ticker...

The stock closed at $10.45 per share on its last trading day as Black Spade. Then, as I said, it soared roughly 255% to close at $37.06 per share on its first day as VinFast. Then, it crashed 58% down to $15.40 per share three days later. Then, it soared 435% up to $82.35 per share this past Monday. And now, it's down more than 50% to about $30 per share.

All that volatility has happened in less than three weeks as a public company. Take a look...

VinFast's crazy-high valuation and roller-coaster volatility remind me of the 'meme stocks'...

Meme stocks like GameStop (GME) and AMC Entertainment soared thousands of percent in as short as a few days because a large portion of their shares were sold short.

In other words, the people buying the stocks didn't care about the businesses themselves. They only cared about the short positions – the bets against the stocks. They bought shares to produce a "short squeeze," causing short sellers to exit quickly. (And they succeeded.)

Due to the large short positions in these stocks initially, few shares were available to buy. That's why a bunch of small-time individual investors posting on Reddit were able to get together and push the meme stocks up so much in such a short span.

Most SPACs trade around their IPO price (usually $10 per share) until they merge with a business. Then, after the merger, the shares trade based on what folks think of the new business.

But the market doesn't seem to care about VinFast's business. If the market action reflected the fundamentals, the stock's price wouldn't rise and fall 50% to 435% every few days.

I bet most people trading the stock today don't even know that so few of its shares trade publicly. They likely only know that it's a new public company with crazy price action.

In other words, VinFast is a "trading sardine." If you don't know that old fable, here's how value investor and author Seth Klarman described it in his book, Margin of Safety...

There is an old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, "You don't understand. These are not eating sardines, they are trading sardines."

VinFast, AMC Entertainment, and GameStop are all trading sardines.

They're all stocks with wild share-price action whose businesses are of questionable and possibly negative value. Their business prospects and share-price movements have little, if anything, to do with one another.

The problem with VinFast comes down to liquidity. The stock is too illiquid. And that overwhelms fundamental factors, leaving the company with a much higher market cap than could ever be justified by its sales, balance sheet, and other hallmarks of a business.

Maybe you think the sketchy price action in VinFast is no big deal...

You might be right. But what if I told you that the utter mindlessness of its price action reminds me of Apple (AAPL), Nvidia (NVDA), and all the market's biggest businesses?

Well, the thing is...

Nearly the whole market trades mindlessly today...

Much of the action in the market is done with zero regard for the fundamentals of the actual businesses whose shares are bought and sold every day on the big stock exchanges.

No kidding...

A recent JPMorgan Chase report said that more than 90% of all the transactions in the markets don't involve any participants doing any fundamental calculations of any kind.

In other words, most of the buying and selling in the market is mindless.

Maybe you know why...

It's because of the rise of so-called "passive investing." That's when people automatically buy mutual funds and exchange-traded funds in their 401(k) and other (usually tax-advantaged) retirement accounts.

I say "so-called" because there's no such thing as passive investing. No investor is passive because you can't be an investor in publicly traded stocks without buying. And if somebody is buying, then somebody else is selling.

The simple act of millions of Americans buying a few hundred bucks' worth of stocks every two weeks in their 401(k) accounts makes it impossible to call it passive investing.

Let's instead call it "mindless investing." And most investing today is mindless. A 2019 article in The Economist reported...

According to Deutsche Bank, 90% of equity-futures trades and 80% of cash-equity trades are executed by algorithms without any human input. Equity-derivative markets are also dominated by electronic execution according to Larry Tabb of the Tabb Group, a research firm.

An algorithm is just a recipe for taking a series of actions. And the simplest (and by far most widely used) investing algorithm of all is the one you participate in every time you add to your 401(k)...

The passive fund receives $1 of cash and buys $1 of equity.

Today, tens of trillions of dollars are invested all around the world through mindless investing...

Roughly 45% of all U.S. investable assets are in mindlessly managed funds. And about $28.6 trillion is invested in the most popular mindless-investing vehicles – mutual funds and exchange-traded funds.

So far, mindless investors are focused on the long term and rarely sell. During the pandemic panic of March 2020 – one of the scariest market moments of anyone alive today – a Vanguard report found that only 1% of U.S. households abandoned equities completely.

Wow.

During one of the worst months in market history, only 1% of investors sold all their stocks. That seems reassuring. It tells you that most folks are behaving exactly as they should. They're holding for the long term and not getting scared when the market takes a dive.

But that 1% is potentially a lot more troubling than you might think...

You might recall that the S&P 500 fell 34% from its February 2020 peak to its March 2020 pandemic bottom. That month featured several days when the index fell between 3% and 11% in a single day. And yet, that all happened as just 1% of investors sold all their stocks.

It makes you wonder...

What would happen if 2% of households sold all their stocks? Or 5%? Or 10%?

A crazy-high-valued, extremely illiquid stock like VinFast crashes when the buying ends and the selling begins...

The stock isn't even a month old. And yet, it has already seen two declines of more than 50%. Given that it's extremely overvalued, more of those declines are likely coming soon.

But what will happen when mindless buying of the entire stock market wanes and mindless selling of the entire stock market begins? What will happen if a massive crisis of some kind leads to 2%, 5%, or 10% of investors selling all their stocks?

And worse, what if the first 2%, 5%, or 10% causes such an avalanche of selling that it leads to a spiraling effect in which folks with no intention of selling when the market is down 20% or 30% are selling in a panic when they're down 40% or more in just a few days?

Nobody seems to understand this simple, horrifying fact of life in the markets...

What happened on the way up will reverse on the way down.

Most mindless investment strategies involve buying more of stocks with larger market caps and less of smaller ones.

For example, the S&P 500's largest component is Apple. That's because Apple has the biggest market cap of any stock in the market (around $2.9 trillion). It makes up about 7% of the S&P 500.

So in your 401(k), if you own shares of an exchange-traded fund that tracks the S&P 500, 7% of the money you put in goes into that one stock. And these days, that also means roughly 30% of your money goes into the top 10 stocks by market cap.

That will cause a huge problem when mindless buying becomes mindless selling in a crisis. As people start selling their mutual funds and exchange-traded funds, $0.07 of every dollar sold will come out of one stock. And $0.30 of every $1 sold will come out of the top 10.

So when the selling really gets going, the stocks that are propping up the big indexes today will weigh those indexes down like lead anchors in deep water...

I don't mean the mild type of selling that took the S&P 500 down as much as 25% and the Nasdaq down 36% from their all-time highs. Rather, I mean crazy-panicky action that takes the big indexes down by those amounts in a couple days.

Now, I realize that kind of selling would require a really horrible crisis of some kind – something like the dot-com bust, plus the 2008 financial crisis, plus what happened in March 2020 times 100. I also realize that such events are rare. But the three I just mentioned all happened within a span of about 20 years.

Let me say that more clearly...

THREE major crises happened in roughly 20 years.

I'm not predicting when a financially catastrophic event like that will happen. That's a fool's errand. But importantly, it's an inevitable outcome of the growth of mindless investing.

It's one of those things that absolutely nobody will even think about until the day it happens. Then, it's all anybody will be able to talk about.

How do you prepare for a crisis that big?

Start by holding cash, gold, and quality stocks. Other than that, I don't know if there's a reliable way to sidestep that kind of crisis. You can just employ those basic survival skills.

Fortunately, I'm confident that anybody who has cash and the guts to deploy it when blood is running thick in the streets will make a fortune in the recovery – whenever it arrives.

For now, I recommend you start preparing.

New 52-week highs (as of 8/31/23): Adobe (ADBE), Applied Materials (AMAT), Array Technologies (ARRY), SPDR Bloomberg 1-3 Month T-Bill Fund (BIL), Cameco (CCJ), CyberArk Software (CYBR), Comfort Systems USA (FIX), Alphabet (GOOGL), Intuit (INTU), Iron Mountain (IRM), Eli Lilly (LLY), MSA Safety (MSA), Rithm Capital (RITM), Sprouts Farmers Market (SFM), iShares 0-3 Month Treasury Bond Fund (SGOV), TFI International (TFII), Sprott Physical Uranium Trust (U-U.TO), United States Commodity Index Fund (USCI), VMware (VMW), Verisk Analytics (VRSK), and Walmart (WMT).

In today's mailbag, subscribers share their feedback about inflation and the Federal Reserve, which we covered this week. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Price increases are crazy here in the Badger state and much worse across the South after returning from a vacation there. It's certainly not 2% or 3% by any economic measurement." – Subscriber Gary B.

"Can't resist throwing some stuff against the wall to see if it will stick.

"1. Totally agree from listening to some [of her talks], I believe Janet Yellen's brain has turned to mush. Ph.D. in Economics! From the University of Sears Roebuck catalog?

"2. The Fed in addition to pumping rates has also over 12 months reduced its balance sheet [by] nearly a TRILLION dollars even with putting $400 million stimulus for recent banks unpleasantness back into stimulus. Believe they now are continuing to just roll off about $85 billion expiring Treasury debt per month.

"3. Talking to the clueless White House is a waste of time. Is Jerome [Powell] and his cadre essentially ignoring the White House? Fed is also watching the substitution of other currencies by OPEC members for payment thus threats to the dollar with that trend continuing. Powell has spoken out about Federal Budget Fiscal Disaster [that] neither Congress nor the White House is serious about addressing. Thus the Fed squeezing via higher rates is one way for the Fed to get their attention. Would be interesting to see how many billions per year each 1% increase impacts Treasury financing. I'm sure it's a large number." – Subscriber Dana G.

Good investing,

Dan Ferris
Eagle Point, Oregon
September 1, 2023