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Are equity bubbles forming – and how can we avoid them?

Potential bubble formation in parts of the equity market is a theme attracting increasing attention. Investment strategist Lars Skovgaard Andersen presents his assessment – and gives some good advice about investing in new trends and technologies without running unnecessarily high risks.

 

 

“Yes, we too believe a number of companies have recently experienced share price rises that are out of step with the earnings you could expect to see from these companies in the not-too-distant future – and that is not sustainable. Sooner or later reality always comes knocking,” he says.

But if these are companies in sectors that are expected to be the big winners of the future, is buying now not sensible, even if equity valuations are expensive?

“We can generally say that electric vehicles, e-commerce and the green transition are undoubtedly strong, long-term trends. The problem is you might risk being the last to buy just before a major price fall that could potentially take years to correct – if it ever does. Another challenge is that predicting which companies will be the winners in the slightly longer term can be very difficult, especially when it comes to new trends and technologies. This risk is further amplified if you invest in individual stocks,” says Lars Skovgaard Andersen.

Why have we seen these huge rises in equity prices?

“New technologies can attract a great deal of hype. Investors are often so afraid of missing the boat that they unquestioningly hop aboard much too early or when a stock is unduly expensive. We expect that new technologies will rapidly revolutionise the whole world, but that is seldom the way. And while the news value fades and disappointed investors get cold feet, the technology gradually matures and develops until it achieves a broad commercial breakthrough. During this process we often find that the companies originally creating much of the hype are ultimately not the industry’s long-term winners.”

Green equities are one of the areas currently experiencing enormous investor interest, and in Denmark we have seen the share prices of Vestas and Ørsted, for example, soar. Have they also risen too much?

“Here at Danske Bank we may not make pronouncements on individual equities, as that could be viewed as a buy or sell recommendation. Generally, however, I would say that if you as an investor have a large exposure to Vestas or Ørsted, is that because you believe these particular companies are extraordinarily attractive investments? Or is it really because you just want exposure to the green transition trend? If the latter is the case, you could consider reducing your holding in preference to a broader approach to the theme – for example, via a relevant fund – so you do not assume as much risk in terms of developments in a few individual equities. The same applies if you have invested in Tesla, for example, to gain exposure to the electric vehicles theme. Here again, you can achieve a less risky exposure to the theme via a fund.”

Why do funds provide less risky exposure?

“Because they can invest in a broad portfolio of companies within a particular theme, such as electric vehicles or the green transition. This can be a particularly sound approach to investing in new trends and technologies where, as we mentioned, picking the longer-term winners can be unusually difficult. This way you can share in the potential overall growth in the theme without risking having too much money bound up in a few individual equities that fail.”