The Market Is Overvalued -- These Two Stocks Prove It - Motley Fool

The last few weeks have been some of the best in market history.

The S&P 500 has rallied 31% since it hit a bottom on March 23, even as the global economy is experiencing an unprecedented crash.

In the U.S., more than 26 million Americans have filed for unemployment in the last five weeks, a trend that shows no signs of abating. Retail sales plunged in March, falling 8.7%, and April is expected to be even worse, as stores across the country have been closed for much of the month.

Image source: Getty Images.

There's no shortage of industries struggling during the pandemic; retail, restaurant, travel, entertainment, real estate, energy, and manufacturing sectors are all seeing their financial health rapidly deteriorate during the crisis. Investors, however, seem to be ignoring those consequences, confident that the economy will return to full health.

Not surprisingly, a number of investors are baffled by the market's sudden surge, skeptical that it will hold up. Indeed, some high-growth stocks have recovered nearly all of their losses during the crisis and are now trading near all-time highs once again. Among those that stand out here are Chipotle Mexican Grill (NYSE:CMG) and Tesla (NASDAQ:TSLA), as both stocks are getting hit in multiple ways by COVID-19. However, as the chart below shows, they have nearly recouped all of their earlier losses.

CMG data by YCharts.

What's especially puzzling here is that these aren't companies like Amazon or Zoom Video Communications that are benefiting from the pandemic. Both are experiencing very real headwinds from the virus. Let's take a closer look below.

Image source: Chipotle.

The burrito roller keeps rolling

The restaurant industry has been among the hardest hit by the pandemic. Eateries have been forced to close dining rooms across the country, limiting them to takeout and delivery, which has taken a big bite out of sales.

Even Chipotle, a fast-casual chain that has a strong digital and delivery business, saw a precipitous drop in sales once the shutdown orders began. Comparable sales jumped 14% in January and February but then plunged by 16% in March. Management said weekly comps hit a nadir of negative 35% in the week ended March 29 and then recovered a bit to being down in the high teens by the week before April 21.

The stock actually surged on the earnings report, as the headline numbers were solid enough to please Wall Street, and management convinced investors it could weather the crisis. However, Chipotle's profits are clearly taking a hit. Though adjusted earnings per share only fell 9% in the quarter thanks to the help of a tax benefit, operating income sank 35%. Analysts now expect a slight loss in the second quarter and have sharply dialed back expectations for the rest of 2020 and for 2021. That makes sense given that spiking unemployment and social distancing mean that Chipotle is unlikely to recover all of its lost sales until fears of contracting the virus are eliminated and the economy returns to full health.

Considering those new expectations, it seems hard to justify Chipotle's trading back near an all-time high.

Image source: Tesla.

The electric-car maker soars again

Tesla has long been a battleground stock, giving bulls and bears plenty of fodder for debate. Bulls argue that the company is revolutionizing both automobiles and renewable energy and has built a collection of competitive advantages that will drive its growth for the next generation. Bears, on the other hand, see a slow-growing, often unprofitable, overvalued company that will eventually lose its head start in electric vehicles to legacy automakers.

Whatever your opinion on Tesla, what is clear is that the company is not escaping the coronavirus crisis unscathed. It's been forced to close its factories in both Shanghai and California, though its Shanghai plant reopened after about a two-week stoppage. Its Fremont, California, plant is expected to open in May after shutting down in late March.

However, the supply side is just one area in which the automaker is being challenged. Car sales in the U.S. collapsed in March, falling 25.6% from February as consumers stayed home to stop the spread of the virus. April sales are likely to be down sharply as well, and even once stay-at-home orders are lifted, Tesla will have to contend with a much weaker economy, which will likely weigh on demand, and with rivals who are offering steep discounts on inventory that has piled up during the pandemic. Additionally, the crash in the oil market has led to unusually low gas prices, making the argument for paying up for a Tesla more difficult, especially for consumers who might be minding their bank balance during a recession.

Nonetheless, Tesla stock is back up to the sky-high prices it was trading at early in the year. From a year ago, shares of the EV maker have more than tripled even as estimates for 2020 earnings have fallen substantially. Again, as with Chipotle, investors seem to be ignoring the downside risk here and effectively choosing to look past the crisis to a better future.

What it means for investors

With risky, high-growth stocks back near all-time highs, the market seems to have moved the goalposts past the coronavirus. The assumption in the valuations for Chipotle and Tesla is that while the virus will be a headwind, these companies can overcome it and will be in even stronger positions, relative to their competitors, once the crisis is over.

That might be true, but the soaring recovery in both of these stocks seems to be evidence that the market is overvalued and ignoring the risks facing the economy right now, which include the threat of a second wave of infections, a sustained unemployment crisis, declining consumer spending, rising foreclosures, geopolitical risk from the global spread of the disease, and other factors like the ominous warning from Tyson Foods earlier this week that the "food supply chain is breaking."

This is a time when business is anything but usual, yet these stocks and the broader market are now priced for perfection. Both Chipotle and Tesla still look like long-term winners and have the same competitive advantages they did just a few months ago, yet it seems like a mistake for their prices to be similar when profits are tumbling and the global economy is experiencing an unprecedented shock.

If the economic recovery turns out to be "perfect," these two stocks will be able to hold their gains, but any of a number of potential threats could send them, along with the rest of the market, spiraling again.

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The Market Is Overvalued -- These Two Stocks Prove It - Motley Fool
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