If it looks like a bubble, smells like a bubble and walks like a bubble, it is a bubble.
What we have in the certain stocks today is a bubble every bit as epic as the one that took the NASDAQ Composite Index (INDEX:.IXIC) to its previous record of 5048 back in 2000.
There are few certainties in this world, but one of them is that bubbles pop.
And like all previous bubbles, this bubble will pop too.
One of the key signs of a bubble is when investors and the analysts that cheer them over the cliff refuse to acknowledge facts that contradict their bullishness.
The Evidence Is Irrefutable
Exhibit "A" is Tesla Motors, Inc. (NASDAQ: TSLA). At the beginning of the year, analysts were forecasting that the company would earn $2.78 per share and had an average price target on the company's stock of $269 per share – $49 per share higher than where it was trading at the time. Since then, a series of setbacks have led analysts to radically lower their earnings estimates to a mere $0.53 per share – a reduction of 80%.
But instead of lowering their price target on the stock by a commensurate amount, analysts have only lowered it by $19 per share to $251 – a reduction of a mere 7.1%.
That is bubble thinking. The psychological term for that is denial. The Wall Street term for that is careerism.
Exhibit "B" is Amazon.com Inc. (NASDAQ: AMZN). In the first quarter of the year, the company once again managed to spend every penny it took in – and it took in a lot of pennies.
Revenues for the quarter increased 15.1% from a year earlier to $21.7 billion, but the company managed to spend every penny and more, leaving it with a $57 million net loss.
The big news, however, was that the company disclosed for the first time some financial details about its secretive cloud computing business, Amazon Web Services (AWS). AWS's revenue for the first quarter was $1.57 billion and its operating income was $265 million; analysts had been projecting annual revenue of $6 to $9 billion, so this met expectations.
Amazon has been competing fiercely with Google, Inc. (NASDAQ: GOOG), Microsoft Corp. (NASDAQ: MSFT) and International Business Machines Corp. (NYSE: IBM) to provide cloud computing services to startups and other companies such as Netflix, Inc. (NASDAQ: NFLX).
Investors are now fantasizing about an Amazon Web Services spin-off and the possibility that AWS could someday be larger than the Mother Ship at Amazon.
For its part, Amazon promised further losses of between $50 million and $500 million in the second quarter. The result – investors bid up the company's stock by $55.11 per share (14.13%) to $445.10 per share, where it is trading at an even more infinite multiple of its non-existent earnings.
That is bubble thinking.
Investors were so enamored with AWS, in fact, that they bid up cloud competitor Microsoft's stock by 10.45% – the biggest move in that behemoth in years.
Microsoft saw its stock rise by $4.53 per share to $47.87 just a couple of days after announcing earnings that failed to inspire the market (in fact it inspired Goldman Sachs Group Inc.'s (NYSE: GS) analyst to reiterate his "Sell" recommendation on the company).
What happened, of course, was that investors extrapolated Amazon's success at AWS to Microsoft's growing cloud business to add $37 billion to the software giant's market cap.
Once again, bubble thinking.
Bubble thinking also requires a total lack of memory. Investors seem to think that cloud storage is something that has never existed before, but it is merely a new version of the Internet hosting business that crashed and burned 15 years ago.
"Creative Destruction" May Not Be Enough This Time
Amazon and its competitors are already engaged in a vicious price war that is driving down the cost of cloud storage and obliterating margins and profits in this business.
The history of technology is filled with case studies of creative destruction, which is why even with its current success Microsoft's current market cap of $393 billion is 31.6% lower than what it was in 2000.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.