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Crypto craze: Why retail investors shouldn't put all their eggs in one basket

Michael Darda, MKM Partners Chief Economist, joins Yahoo Finance Live to break down the outlook for economic recovery and the state of cryptocurrency amid the pandemic.

Video transcript

JULIE HYMAN: I want to take it to Michael Darda, MKM Partners Chief Economist because, Michael, I think long story short, we don't envy you, trying to make sense of all of these numbers right now. And so how are you trying to sort of cut through the noise and figure out what the actual narrative is right now?

MICHAEL DARDA: No doubt about it. So we certainly have had some confusing data points. And you all did a great job, I think, of describing the challenges out there. And then also, unfortunately, with the confusion, strange and unsupported narratives end up starting to take flight. So we have a little bit of that going on.

But I like to look at the data and try to just figure out what the data is telling me. And what we had with the last jobs report was a pretty good bump in wages month over month but weak job growth. And so that does speak to some of these supply side shocks maybe hitting the economy. And I think a lot of those are going to self-resolve over the course of the months and quarters ahead.

We also shouldn't go crazy on one jobs report. One thing that we've been talking about with our clients is jobless claims are now making new post-pandemic lows pretty much weekly. And weekly confidence readings have been making post-pandemic highs. And it's really the ratio of confidence to jobless claims that's served as a really good high-frequency barometer for the labor market.

And there was a huge lift in April, even with those weak jobs numbers. And we're continuing to lift going into May. So I think we're going to see better job gains ahead.

There is some inflationary pressure. But that also followed deflationary pressure in the CPI about a year ago. So one way to cut through the noise is just to look at where the data points are, whether it's jobs, GDP, or inflation, relative to the pre-COVID trend growth path, right? Because you had a huge collapse. And now we've had a violent recovery in a lot of statistics. And so you want to take both into consideration.

And when we do that, we see the economy is in a V-shaped recovery. But we still have a lot of jobs to make up. Inflation is moving up now. But it's a little less than 1% above it's pre-COVID trend growth path.

So we'll see how the rest of the year plays out. We're pretty optimistic on the economy. We're a little more cautious on risk markets, particularly the NASDAQ and what would be represented by high valuation growth stocks. I think in this environment with the valuations up where they are, there's some real risk there. So it's a bit of a nuanced picture for investors, I'm afraid.

BRIAN SOZZI: Michael, if you still see a V-shaped recovery, why wouldn't tech be the stocks to own?

MICHAEL DARDA: Yeah. I think it just comes down to valuation. So there are parts of tech, I think, that can certainly work here that maybe are not commanding the valuations that are too steep and that would benefit from a V rebound and reopening. And there are other parts, I think, where, not only are the valuations high, but reopening could actually be a threat to business models that thrived with the lockdowns and the shutdowns and the shelter in place activities.

And so I think it's a really nuanced question. And it just depends on the valuations. And it depends on the outlook for earnings.

But just taking the NASDAQ as a whole, the forward valuations are 40% above the last two years of the last cycle. And the last cycle, as all of you know, we had a 10-plus-year bull market with growth totally dominating. And so the configuration here, from a valuation perspective, is quite different than what we were looking at at the dawn of the last bull market.

And so I think that would be suggestive of some caution on the part of investors for some of the areas that were really high flyers last year. And keep in mind, these discussions of inflation and potential overheating in a V-shaped recovery, any upward pressure on market interest rates, inflation rates, tax rates on capital, all other things equal, those will tend to be valuation headwinds.

So the areas of the marketplace we need to be concerned about is those carrying the steepest valuations. Those have the least room to maneuver in an environment where we're debating the trajectory of these variables. And so definitely, a cause for concern here on what would be represented by the NASDAQ index in particular.

40% of that index is trading at a double digit price-to-sales ratio. To me, that is quite concerning in an environment where we're V-shaped rebounding. And we're probably going to see some additional upward pressure on market interest rates and in core inflation rates.

MYLES UDLAND: You know, Mike, speaking about the NASDAQ specifically and some of the dynamics there, let's call it underneath the surface and sort of the techs mid-cap space where we saw 10, 20, 30 times sales as the going rate for some of these SaaS names. Are you pleased or encouraged by the fact that the overall index has actually held up OK, while underneath the surface, I mean, you could go down any kind of screener and you are going to find dozens of stocks that are down 40%, 50% from their recent highs? There's been a lot of pain underneath the surface. But the major averages have held in pretty well, the NASDAQ in particular.

MICHAEL DARDA: No doubt about it. That's a great point, actually. And that's exactly what you would expect in the context of a recovering business cycle. So what we see here mostly is just a churn and a reorientation in terms of leadership.

There's about 13% of the NASDAQ index that's trading at a negative equity risk premium, meaning the earnings yield, the inverse of the P/E, is below the 10-year Treasury yield. And if you look at those 13 names, they're down 25-plus percent from the highs of the year. That's a bear market by almost anyone's definition.

But as you mentioned, the broad indices are not down in that fashion. Why? Because other areas of leadership have come into vogue. And that's exactly what you'd expect with a rotation, a reorientation in a positive-growth environment, not a recessionary environment. So that's actually an excellent point.

JULIE HYMAN: Mike, finally, I want to ask you about crypto because in your note to us, you sort put them in the same category with some of these other high-flyers. But you were just a moment ago talking about valuations of some of those. And I don't know how one really values crypto. Certainly, you don't value it in the same way that you value some of this other stuff. So how are you thinking about that trade right now in contrast to the others?

MICHAEL DARDA: So what we've been warning clients about basically all year is areas of the marketplace that are highly liquidity-dependent or trading at extremely high valuations that would tend to come under pressure or increased volatility as inflation or market interest rates or tax rates on capital move up.

So you're exactly right. I don't think anyone really knows how to value crypto. You're either bullish, or you're bearish. But you can be bullish on the underlying technology in the asset class but simply acknowledge that this is a super-volatile, very risky asset class subject to repeated crashes and then booms.

So if we're in an environment here-- and we think we are-- where a V rebound is going to add some pressure on inflation and market interest rates, where we probably have some increases in tax rates on corporations and capital coming up in the years ahead, we need to think about these areas of the marketplace that have been swept up into a speculative frenzy or are super-liquidity-dependent or are trading at extremely high valuations on a price-to-sales basis.

So what would fit into that matrix would be crypto, the so-called Reddit trades, the 40% of the NASDAQ 100 trading at a two-digit price-to-sales ratio, a dangerous place to be. So I would just warn retail investors to be careful and not be dedicating too much of your portfolio to those areas if you do want to speculate.

JULIE HYMAN: Good old-fashioned asset allocation and being wise about it. Michael Darda, MKM Partners Chief Economist and Market Strategist, great to get time with you and with your weimaraner there on the couch as well. Thanks so much, Mike.