Be careful of bubble stocks and updating bubble methodology

Following our introduction of the reflation theme which we expect to dominate financial markets over the next 12-18 months, we talked about bubble stocks and introduced 40 stocks that had bubble like characteristics. While all 40 stocks are aggressively valued, some of them have high valuations due to industry specific characteristics (exchange and certain software companies). We have been thinking about the bubble stocks basket since and have chosen to update the methodology. Some of the stocks are the same, but many new stocks are on the list, but we think this list is much better.

Our selection universe is still stocks listed on the exchanges in North America, Western Europe, Japan, Hong Kong, Singapore, and Australia. We filter on market cap (above $ 2bn) and require that stocks have a negative 12-month forward expected earnings per share, and that the 12-month forward EV/Sales (enterprise value to sales) ratio is above 8. Our of an initial universe of 3,776 stocks (those with market cap above $2bn), 194 stocks have negative earnings expectations and a high equity valuation on their expected revenue. Of these stocks, we select the top 40 stocks on market cap (see list below).

Source: Bloomberg and Saxo Grop

The red thread is that the list is dominated by US and Chinese stocks with the majority within biotechnology, software, media, and gaming. The combined market value for this group is stunningly $1.6trn but even more usual, the average price target is 6.5% below the current price which is something that rarely happens in equity markets as equity analysts typically have a positive bias in their recommendations and price targets. The average forward EV/Sales ratio is 30.7x which is around 10 times higher than the S&P 500 which is one of the most expensive equity indices in the world.

While January performance in equities was driven green transformation and biotechnology stocks, this month so far has been about e-commerce and bubble stocks with the latter segment up 11.2% month-to-date. In our team, we have tried the past couple of days to strike a tone of caution with financial conditions maxing out to the positive side and thus we think reality could begin to disappoint a bit against expectations. If interest rates continue higher, which we expect due to reflation, then the bubble stocks presented here pose a significant downside risk.