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Jonathan Pinsler is senior vice-president, portfolio manager, of TD Wealth Private Investment Advice.

It’s official, the song of summer in my household, ‘Watermelon Sugar High’, has run its course as the cool weather sets in. The period we are in now makes me think of lingering stock market sweetness, especially in certain companies and sectors, that are not sustainable in their valuations.

A coolness which started this month is likely to continue to take place over time in areas of excessive valuation. We have reached a reflection point where investors have become dreamers and believers of stories to be buyers here without much thought on the consequences if growth rates do not live up to their hype.

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It is important to consider all angles when making a bold statement. The reality is we live in a period of deep and disruptive change which is propelling certain elements of the global economy to do extremely well despite overall economic weakness.

The eye-popping performance for 2020 has mostly been congregated in the technology sector and in many respects, this makes good sense, considering many of these companies which were doing exceedingly well before COVID-19, have businesses that have become turbo boosted on demand acceleration because of the crisis and future possibilities.

Reality check. Valuations at some point matter and things do tend to revert to a mean over time. Nothing new here. Great businesses with excessive valuations present a clear and present danger if estimates of growth are missed – even with interest rates at ground zero. Despite the Wall Street’s analysts and strategist’s lofty predictions, combined with the recent technology market sell-off, investors could suffer stiff losses if priced-to-perfection expectations don’t come to fruition. The probably of gaining meaningfully from here, in this group, is low. Timing the market is impossible to get correct in the best times and yes, this party can continue but it won’t last.

The cyclically adjusted price earnings index (commonly known as the Shiller Index) takes price divided by the average ten years of earnings (moving average), adjusted for inflation. There is good value in taking note of this in today’s context.  The Shiller index is at a similar level last seen around end of October in 2018 prior to the FAANG stocks dropping 20% in Q4.  

Let’s get to the crux of it by taking a few examples of great companies that have valuations that need questioning. Do the below facts make a rational and prudent person have serious questions?

As of Sept 8th, Tesla’s market capitalization was US$308 billion dollars. It is worth almost as much as Toyota, VW, and Daimler combined $325.7 billion dollars). For 12 months ending June 30th, VW sold more than 9.5 million cars versus Telsa’s 388,668. While profitability alone accounts for part of the equation, valuations this inflated relative to the competition is enough to give one pause.

The video conferencing platform Zoom as of September 8th, had a market capitalization of over US$100 billion after reporting explosive growth in their second quarter, making the video company more valuable than well-established companies in the auto and aviation industries. At that level, Zoom’s market value exceeded General Motors and Ford, combined, as well as the value of aviation giant Boeing and consumer favorite Starbucks. Though Zoom has had a spectacular growth rate in this transformative environment, they are not the only kid on the block with video conferencing technology. The majority of large enterprises still continue to use Microsoft Teams, Google Hangouts and Cisco Webex in this space and I believe they will only improve their offering over time.

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Is it prudent to believe that these valuations can continue to infinity? I think not.

As the song goes, ‘I just wanna taste it, I just wanna taste it, Watermelon sugar high.’ Well some investors tasted it and others less so. This is a time to either control one’s FOMO (fear of missing out) or lower some exposure if one holds too large a percentage in their overall portfolio of these high-flying stocks.

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