The US Federal Reserve “can’t save a stock market” from a “total nightmare” failure driven by millennials, according to Cole Smead, president and portfolio manager at Smead Capital Management.
“The buying that went on in August and September is a 10-year phenomenon the likes of which we have never seen among millennials, and in the risk-taking among people that don’t want to own bonds and want to own overpriced US quality businesses, it is of record proportions,” Smead told CNBC.
Currently investors are paying 22 times forward earnings to purchase stocks on the S&P 500 – 50 percent higher than the 10-year average valuations across the index. The forward price-to-earnings ratio divides the current share price of a company by its estimated future earnings per share.
Much of the market rally that took the US benchmark from correction territory in March to a record high in August was driven by tech megastocks and a bullish options market.
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“They are buying bullish call options that expire inside two weeks. There was ($500 billion) of bullish call options bought in a four-week stretch by small retail traders,” Smead said.
A call option is a contract between the buyer and seller of the call to exchange a security – that is, a stock – at an agreed price.
“In ’99, it was $100 billion. In ’07, it was $100 billion. That’s what young, dumb investors are doing and when the market makers see those [call buying] out there, they sell that call to that person and buy the stock,” he added.
The fund manager suggested the willingness of wealthy investors and the baby boomer generation to “ride the index to a fault” and overpay for stalwart American businesses such as Costco and Microsoft was also detrimental.
“Microsoft is a wonderful company, but at 40 times earnings, there is zero percent chance of that producing wealth for someone over the next 10 years that will meet their needs,” Smead said.
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