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Greed Turning Losers to Leaders in Russell 1000 Index

February 24, 2014

Greed Turns Russell 1000 Losers to Leaders

Unprofitable companies such as Zynga Inc. and FireEye Inc. are leading gains in the Russell 1000 Index. Photographer: David Paul Morris/Bloomberg

Two things explain why the biggest gains in the U.S. stock market this year are coming from companies without profits, according to Jeff Mortimer of BNY Mellon Wealth Management: Greed, and fear of missing out.

Neither dooms the bull market, even as they signal to some investors a potential top after five years, said Mortimer, the Boston-based director of investment strategy for BNY Mellon Wealth Management, which oversees about $185 billion. More than $14 trillion has been added to American equity values since March 2009 and the Standard & Poor’s 500 Index is within 1 percent of a record.

Related: Buffett Warns of Liquidity Curse, Celebrates Property Bet

Unprofitable companies such as Zynga Inc. (ZNGA:US) and FireEye Inc. (FEYE:US) are leading gains in the Russell 1000 (RIY) Index. The Nasdaq Biotechnology Index is up 25 percent in the past 10 weeks, the most since February 2012, data compiled by Bloomberg show. Less than a third of its 122 companies earned any money in the last 12 months. Marijuana shares, which trade on venues with less stringent reporting requirements, are among the most active.

“In this backdrop of human emotions, which begins to take over, it’s one of greed, it’s one of willing to pay for something that will happen in the future and being afraid that one might be left behind,” Mortimer said by phone on Feb. 19. “It benefits the whole market. Whether or not they’re overpaying, only time will tell.”

Candy Crush

Investors are embracing riskier stocks after declines this month proved fleeting amid rising corporate earnings and improving economic data. Takeovers from Actavis Plc’s $25 billion bid last week to buy Forest Laboratories Inc. to Facebook Inc.’s $19 billion purchase of WhatsApp Inc. are fueling speculative bets as companies such as King Digital Entertainment Plc, the maker of the “Candy Crush Saga” game, sell shares for the first time.

Not everyone agrees with Mortimer’s assessment. Wayne Wilbanks of Wilbanks, Smith & Thomas Asset Management LLC has been watching a basket of stocks including Tesla (TSLA:US) Motors Inc. for signs of a market peak after the S&P 500 went 28 months without a 10 percent decline. The gauge climbed 0.6 percent to 1,847.61 today.

“I would associate wild speculation in this type of companies with a near-term top of the market,” Wilbanks, based in Norfolk, Virginia, said in a Feb. 19 phone interview. “People bid these things up like crazy. The fact they’re so strong right now means we’re probably not quite there yet as far as the market rolling over.”

Rally Interrupted

The bull market was interrupted in January as Argentina’s currency devaluation and slowing economic growth in China sent the S&P 500 down as much as 5.8 percent through Feb. 3. Stocks have since restored about $1.2 trillion in market value as companies from Walt Disney Co. to Applied Materials Inc. beat estimates and the Federal Reserve reassured investors about the strength of the economy.

Global money managers have increased holdings in U.S. equities and retreated from emerging markets. About 11 percent of investors are overweight American shares, meaning they own more compared with the weighting in global benchmarks, double the level from a month ago, according to a Bank of America Corp. survey of fund managers this month. The report, based on replies from 175 money managers overseeing $456 billion, showed a record 29 percent of respondents were underweight developing nations.

‘Bull Psychology’

Investors are returning to U.S. stocks after withdrawing $35.8 billion from equity exchange-traded funds in the first six weeks of the year, data compiled by Bloomberg show. The ETFs have since taken in almost $18 billion. Deposits reached a record $139 billion in 2013 as the S&P 500 jumped 30 percent for the best annual gain since 1997.

“We’re definitely in a bull market and a bull psychology,” Terry Morris, a senior equity manager who helps oversee about $2.8 billion at Wyomissing, Pennsylvania-based National Penn Investors Trust Co., said by phone on Feb. 20. “Investors are inclined to buy and you don’t want to get in the way.”

The Nasdaq Biotechnology Index reached a record last week as Actavis announced its bid to buy Forest Labs (FRX:US), the maker of the Alzheimer’s drug Namenda. Almost half of the stocks in the gauge have risen more than 20 percent this year.

NewLink Genetics (NLNK:US) Corp., a developer of cancer treatments with less than $2 million in annual revenue, has surged 111 percent this year. Stephen Willey, an analyst with Stifel Nicolaus & Co. in New York, said in a Jan. 22 report that cancer treatments from the Ames, Iowa-based company may fetch about $2 billion in sales in 2025.

Marijuana Stocks

Investors have flocked to pot stocks after Colorado became the first state to legalize sales to anyone 21 and older. Tranzbyte and nine other marijuana-related companies have seen combined trading average 543 million shares a day in 2014, triple the amount from a year ago, data compiled by Bloomberg show.

Tranzbyte Corp., which sells the drug in Colorado, and Hemp Inc. (HEMP:US) have been unprofitable for at least the past three years, according to filings with OTC Markets Group Inc., which hosts trading in over-the-counter securities. Most of the 10 marijuana stocks are priced below $1 and all have risen at least 50 percent this year.

Tesla closed above $200 for the first time on Feb. 18 amid speculation that the electric automaker may be an acquisition target for Apple Inc. The stock trades for 119 times projected earnings for this year, compared with a multiple of 9.5 for General Motors Co., the largest U.S. car manufacturer.

500 Percent

While Palo Alto, California-based Tesla is projected to double earnings (TSLA:US) this year and is planning to raise Model S sedan production by 56 percent, the shares have soared almost 500 percent in the past 12 months.

Matt McCormick, who helps manage about $11 billion at Bahl & Gaynor Inc. in Cincinnati, said his firm is sticking to companies with consistent earnings and dividends, even if it means smaller stock returns. While the bull market will continue, valuations (SPX) in these speculative industries are unsustainable because the Fed is withdrawing stimulus, he said.

“We all know the music is going to stop and when it does stop, it’s going to end badly for these companies with questionable fundamentals,” McCormick said in a Feb. 20 phone interview.

Investors are giving higher prices to companies that have less stable profits. The S&P 500 Low Quality Rankings index has climbed 3.4 percent this year, compared with a 1.4 percent drop for firms judged to be higher quality.

Stock Valuations

Valuations in the overall stock market aren’t excessive, even with the S&P 500’s price-estimated earnings ratio near a four-year high, according to Chad Morganlander, a Florham Park, New Jersey-based fund manager at Stifel Nicolaus, which oversees about $150 billion.

The S&P 500’s multiple of 15.6 is below levels from the market’s two previous peaks, when the ratio reached 16.7 in October 2007 and 26.4 in March 2000, according to data compiled by Bloomberg.

“We’re not at the edge of a cliff,” Morganlander said by phone on Fed. 20. “Valuations on certain slices of the market are becoming frothy. Investors should note that, and look toward the past as a cautionary tale for the future in certain seams of the market.”

S&P 500 software stocks traded at more than 70 times earnings in 2000 before the technology bubble burst. While the industry’s performance in the past three months is second only to biotechnology companies, the group has a price-earnings multiple of 19, according to data compiled by Bloomberg.

Zynga, FireEye

Zynga, known for its “FarmVille” and casino-style games, has rallied 32 percent in 2014 even as the San Francisco-based company forecast its loss (ZNGA:US) this quarter will be wider than analysts estimated because of costs related to job cuts.

FireEye, which specializes in detecting computer network threats, has soared as companies including Target Corp. faced hacker attacks on consumer data. While analysts say the Milipitas, California-based company will stay unprofitable until 2016, the stock has jumped 67 percent this year.

“This is a period where investors are drawn to the fastest growth opportunities possible,” David Pearl, co-chief investment officer who helps oversee $40 billion at Epoch Investment Partners Inc. in New York, said by phone on Feb. 20. “The market realizes it’s in a sustainable recovery in the U.S. and you’d rather own companies that are more economically sensitive.”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net


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Companies Mentioned

  • ZNGA
    (Zynga Inc)
    • $3.12 USD
    • 0.11
    • 3.53%
  • FEYE
    (FireEye Inc)
    • $33.27 USD
    • -0.93
    • -2.8%
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