Category: Macro Analysis

What World Changing Things Will Come From This Episode of Irrational Exuberance?

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I think pockets of this market are clearly showing signs of irrational exuberance. The valuations of companies with no revenue, or even products yet, is alarming. I don’t know much about Nikola, but despite a credible short report and the CEO stepping down, they have no product but a $7.6BN equity valuation. I talk about View windows later in this post because even though they have a product, they have $30MM in revenue and a $2.2BN valuation. It is laughable.

Buffett had a good point in one of his shareholder meetings in the 2000’s. He noted that some of these companies wouldn’t even be able to raise debt, but their stock valuations are huge. I see that today – that’s View, in my view.

The point of the post isn’t to argue about these names, it’s not even an argument about “market timing” because I don’t believe you can do that effectively. There are also still some cheap names out there. But I do want to lay some groundwork that there is excess.

But the main point I am wondering what infrastructure is being laid down today that we will benefit from in the future? For example, the tech bubble destroyed returns for any investor in any of the most exciting names. However, the exuberance also led to a lot of fiber cable being laid that we now benefit from today.

You could say there was a huge transfer of wealth. Investors got completely hosed, likely lost most of their money, but the infrastructure led to consumer surplus way down the road.  If you don’t want to hear me discuss the exuberance first, then skip to the end of this post.


We have a SPAC mania. SPAC’s are literally called “blank check companies.” I am giving you a check to just go out and do something — and demand has never been higher. That seems somewhat lost on people. I guess people also don’t realize this is a red hot contra-indicator. When SPACs are booming, that’s a clear sign there’s too much money chasing too few things and probably not a great time to be investing (i.e. “I don’t know what to do with this money… but YOU do… take my money!”).

The last SPAC boom was 2006-2007… was that a great time to be investing in hindsight?

We now dwarf that period. Sure, IPO’ing isn’t easy. But that doesn’t explain all of this.

I would call it desperation to “catch the next thing.” Even though SPACs have totally misaligned incentives, are paying extreme prices for “businesses” they still pop on the announcement, effectively making the deal even more expensive. With the market this wide open, do you really think the seller got the worse end of the deal in the SPAC transaction that it requires trading up?

I recently tweeted the following explanation:

We’ve all seen the huge bid ups in electric vehicle or battery SPACs.

As an aside, one of my favorite SPACs (and by favorite, I mean laughable), is View – which is being brought public by a Cantor Fitzgerald SPAC (ticker CFII). View makes “smart windows” for commercial buildings. By “smart” they mean that you can change the window tint and that helps save energy, allows people to work near windows without heat discomfort, and reduces glare. Despite being around since 2007, View only has $30MM in revenue… The valuation? Right now around $2.2BN… Given the commercial property market right now, its hard for me to imagine upgrading to these windows or choosing them outright…

I immediately thought, “so… they compete with blinds?” and yes they address that upfront. I mean, c’mon, this is kind of hilarious story. Glass is “magical material.”


Let’s look back at other speculative areas and the benefits that actually came from them:

  • The 1840s: Railway Mania. Railroads had emerged and were completely changing the transportation of goods and people. You could now bring freight across the country at a fraction of the cost. It was a clear pattern bubble in the stock market though, but all this capital flooding into the sector helped build more and more railroads.
  • The 1920s: Right before the Great Depression, there was a major stock market mania. I believe it took ~20 years (as we exited WWII and had an economic boom) for investors to break even. Why was there so much speculation? The world had seen the dawn of the automobile, aircraft, radio, and the electric power grid. It was an exciting time. It’s likely that some of this speculation lined the pockets of these manufacturers to create newer and better products.
  • Tech Bubble / Fiber Cable: “the demand seemed so obvious that scores of new telecom carriers sprung up and by 2001 had hung, buried and bored $90 billion worth of fiber-optic cable across the U.S. Optimists predicted Internet traffic would grow 10-fold every year.” That didn’t really pan out and there was a huge fiber glut. But demand for internet traffic caught up and if it wasn’t for all that cheap bubble money, who knows if our gains from the internet would have been as rapid.

So what will lead to consumer surplus in the future?

  • Is it the electric vehicle? With all the capital flowing into the sector, it seems like a self fulfilling prophecy (not that investors will make money in the next 10 years, just that the cars will proliferate at a fast pace).
  • Is it software that increases our productivity? SAAS valuations are pretty high. And I’ve seen many of them issuing equity. This too may be self-fulfilling in that we get better and better software in our lives.
  • Is it further E-Commerce? We’ve seen Amazon take over the US and with COVID 19, every company is investing in e-commerce. Will this get better and better for the consumer?
  • Is it democratization of finance? Big banks have huge barriers to entry… their competitive advantage is cost of capital. But capital is cheap right now, soooo

When should I buy stocks? Putting my buy-decision thoughts completely out there $SPY

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I did a post yesterday on some data points to consider before buying in this market.  I’ve been nibbling on the way down, but looking at some of the data points, I have to agree with what Gavin Baker has said in a recent post: this is a tremendous demand shock that we have not seen the likes of before. It will be very difficult to navigate it this time because its almost like a 9/11 and a 2008 demand shock rolled into one (but not a financial crisis like 2008 was). So when should I buy stocks?

The market clearly priced some of this in. The chart below shows the Russell 2000 drawdowns in the past. We’ve already surpassed the drawdown of 2001-2002 and did so much more swiftly. If anything, this drawdown is looking like 2008 just from the slope of the line (its steep).

Obviously, hindsight tells us if you chose to buy stocks during these drawdowns, it would have paid off very handsomely.

IWM Chart

IWM data by YCharts

The Fed has acted quickly, congress knows it needs to get its act together, Trump views the stock market as the best polls, proposals are coming together to give every American $1,000 to bridge the gap, and there is plenty of talk of bail outs. Seems like some lessons were learned from 2008… act fast.

But is that enough? Is everything “priced in”? How will the market react to new information of cases vs. stimulus? That’s a billion dollar question. Does this tell me when I should buy stocks?

Personally, I think we have further to go before I can say we all need to “back up the truck“. Yes, I view this as temporary and there will be pent up demand, but as I think through what happens over the coming months, it goes something like this:

  1. Markets have tanked, fear is palpable, there have been runs on grocery stores. Consumers are literally quarantined so the only thing they can think about is the pandemic which drives more fear
  2. Congress and Fed acted quickly, but this also tells people that things are serious. Congress puts together a bill to give $1,000 to every American; agrees to provide some loans to essential industries
  3. Just like GM – I don’t see why Congress would give a subordinated loan to these industries. In other words, it primes (or comes in front of) existing lenders plus equity holders. It’s hard for me to see how equity holders get out scot-free here, as well as bond holders. Haircuts will be taken.
  4. Even with Congress taking action, if I work in the restaurant, bar, travel, event hosting, leisure, or any service industry remotely attached to that, I’m thankful for $1,200, but I am worried about my job. I pull back spending considerably. As a consumer, thanks for the grand, but I still am not spending much.
  5. This ripples through the economy. First pullbacks on major purchases (vacations clearly cut, but also autos and home buying) and that continues through everything else.
  6. All the while, US count of the virus will likely grow considerably. We likely reach 100,000+ cases as more tests come out. This will cause the market to freak out and people will go from thinking this is a four week thing to a 12 week thing… maybe longer. The market always assumes the bad things will last much longer than they do.
  7. Media headlines will run rampant.
  8. You will also see bankruptcies of small and large businesses. BDCs and middle market private equity that invested (& levered up) companies with major customer risk and exposure to small business? See ya later.
  9. Elsewhere, cases will begin to decline. Markets will take a deep breath that the measures are working, even if they continue to climb in the US. The market is forward looking so they will see hopes for the US.

So what does that mean for equity prices? I think we have further to fall, unfortunately. Don’t get me wrong – I fundamentally do not believe you can time these things (“Well gee, you sure did waste a lot of text writing about what you think will happen…”) and I have bought many names throughout this bear market. As I noted in my cruise lines post, which was really clickbait for readers to see that long-term intrinsic values of businesses will be fine,  I think this creates a good opportunity to buy high quality businesses.

At the same time, I look at the market and it is just below / slightly above Dec 2018 lows depending on which market you’re looking at. As a quick barometer or sanity check, that doesn’t seem low enough for truly pricing in a destruction to GDP in Q2 this year and people worrying about systemic issues.

Backing it up to a P/E ratio: If we did $164 in EPS for 2019. There’s probably 0% chance we’re up from that number. We can haircut it though and multiple to see where things could shake out this year.  You can argue that because these are depressed earnings and we all likely expect a rebound, that the market should trade at a premium multiple. However, I rarely see that play out in real life. Panic causes people to over shoot. And again, this is a cheapness indicator, not an intrinsic value indicator because one year of bad earnings does little to impact your DCF.

This essentially tells me that my “back up the truck” moment for S&P500 is somewhere around 2,000 and below and I’ll still be a buyer at around 2,300 because I believe the storm clouds will eventually pass and this shows if we go back to 18x $164 in earnings, that is very solid upside.

Ok – I put my thoughts out there. I open myself to being wrong in the future and this post won’t be deleted. Where do you think we shake out? Why?

Is it Time to Buy Stocks? Here are Data Points Worth Considering. $SPY

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The market is clearly in panic. Americans and other global citizens in quarantine will clearly not help most businesses (and therefore it doesn’t help stocks). Is it time to buy stocks now?

One piece of data I came across this weekend was Open Table’s data on restaurant reservations, found here.  As shown below, the US saw a ~42% decline in reservations Y/Y and globally they are down 40%.

Update: this data has only gotten more ugly

Not to mention, we have many public school closures, work travel has been postponed, cruises are putting up ships, and restaurants and bars are limited to take-out meals only. Heck, I can’t even go to the gym anymore. This will clearly crimp many businesses and could pressure liquidity.

This feels like SARS and 9/11 rolled into one. After 9/11, business confidence was hammered and many consumers were fearful and did not want to travel or go out to eat as much. United’s CEO said that this experience has been worse than 9/11 –

After 9/11, revenue was down 40% for two months and then began a gradual recovery… Our gross bookings in the Pacific are down about 70%, so there are still some bookings occurring even in the Pacific region. In Europe, our gross bookings are now down about 50%. Domestically, we’re currently seeing net bookings down about 70% and gross bookings down about 25%. While those numbers are encouraging compared to international, we’re planning for the public concern about the virus to get worse before it gets better.”

After 9/11, we had a tremendous shock to the system and it took some time to recover. Peak to trough, the S&P declined ~30% but within time, we recovered relatively quickly. Recall at this time, we entered a recession and also had a lot of air coming out of the tech bubble as well.

So on one hand, we have an extreme scenario. Short-term funding for a wide array of industries will need to be provided and I personally think we will need to see the US government step in meaningfully.

On the other hand, let’s look at the positives to see if it can help us answer if it is time to buy stocks:

  • Short-term pain, long-term gain. It appears the US is now taking the virus more seriously. While there will be short-term pain from a quasi-quarantine, this will help damped the rapid spread of the virus. This will also prevent a overrun of our hospitals and healthcare system
  • Authorities acting relatively quickly. The fed has now cut rates 2x and initiated bond buying (QE5). Although this won’t cure the virus, it could help calm financial markets which will then allow for liquidity to flow through to businesses who need it now. While not established yet, I bet we will see a cut to banks’ reserve requirements to also help the system
  • Not a financial crisis. While there are financial aspects to this (i.e. liquidity, companies drawing on revolvers) this is not like the 2008 mortgage crisis. Although banks are now cutting GDP estimates for Q2 and Q3 2020, many expect that demand will rebound meaningfully.
  • The US is behind the curve, and that is a good thing. Although the outbreak is hitting US shores later than Europe and China, it also means we can look at their data to when cases tend to peak and level out. The US now is essentially in quarantine and that will help fight the spread. (Note, I thoroughly enjoyed the charts posted in this WaPo article for how social distancing actually does work). I think the market will move up even if cases in the US are rising once we see Italy, South Korea and China under control.
  • The biggest companies in the world are flush with cash. Add up the cash held by Apple, Microsoft, Google, Berkshire Hathaway, and Facebook. These businesses fortunately will not be facing liquidity needs, represent large proportions of the S&P, and have longer time horizons than most investors today.

With many stocks I look at down 50-60%, this could be an opportunity of a lifetime given they are pricing in a long-term pronounced downturn. As discussed previously, a one-year impact to earnings that everyone largely expects will be temporary has little impact on the intrinsic value of businesses.

In sum, do I think stocks can continue to go down? Yes. They have historically over shot in both directions. But we can’t time it. I personally am looking at a collection of businesses that will continue to compound earnings at extremely attractive rates.

In this case, I think the situation will be written about extensively. There will be things we don’t even know about yet that books will be published on. 

But as you think about the past and uncertainty, realize that those times are actually the best in terms of investing. Buying when everything looks amazing and nothing can go wrong typically turn out to be poor outcomes (e.g. peak of tech bubble, the calm before the 2008 storm). Everyone knows in hindsight to buy when others are fearful. I’d also add the richest people in the US are typically perma-optimists, not perma-bears.

Is it time to buy stocks? Up to you, but you should have a plan for when you will. 

Are European Stocks Cheap? 3 Reasons Why They are NOT

Reading Time: 4 minutesAre European stocks cheap? I keep hearing that European stocks are cheap relative to the US at least so that means you should buy.

It follows then that because the US has outperformed so much over the past 10 years, there is bound to be a reversion to the mean. This chart is often thrown around with no real context other than “lower P/E means great buy”. I don’t believe that to be true.

I wanted to break that down and test the hypothesis. I downloaded the holdings for the S&P500 (from iShares IVV) and the European stocks fund (EZU). But before we go through that, check out the relative performance.

Bottom line: Europe has gotten its A$$ kicked.

But wait – this isn’t totally true.

We can’t forget currency’s impact on performance. The dollar has strengthened massively (since the US is the best house in a bad neighborhood). Here is the hedged Euro performance. Not nearly as bad as some pundits might have you believe over the past few years…

So how do the companies that make up the index compare? Here is my simple pivot tables using the weighted avg to assess the relative forward P/E multiples.

Weightings of sectors matter.

Note: the amounts don’t add to 100% due to rounding plus a small amount of cash held in the ETFs.

As we can see, looking 2 years out the S&P trades at 20.8x earnings compared to 16.0x for Eurozone. That does indeed seem steep. What is driving it?

Several sectors stick out: Consumer Discretionary, Tech, Real Estate and Financials.

Why does Consumer Discretionary trade so much higher in the US?

One word: Amazon. The company is labeled as consumer discretionary vs. Tech. Watch what happens when I relabel Amazon as a tech company.

It drops precipitously! Given Amazon is such a big weight in the index, it has a dramatic impact on the sector. It is still high relative to Eurozone, but not crazy.

Europe Doesn’t Have Silicon Valley — Technology is a Standout:

I personally thought that the US would rank higher in P/E solely because of Tech. And that does seem to be a big driver. Including Amazon, Tech weighs in at almost a quarter of the S&P500. If I include Facebook and Google (currently in the communication sector) it would be close to 30%!  

 

While remnants of the tech bubble make this a concern, I would rather have these businesses than not and think they actually trade at reasonable valuations. They grow 20% a year and are secular growth stories while also requiring little capital to grow.

So another adjustment here, but we’re starting to parse out the large drivers here.

Real Estate:

One reason for the high multiples in the US is REITs. These entities pay no income taxes and should therefore trade for higher multiples. However, that’s not the whole story. Think about the best businesses in the REIT space: oligopolies, contractual rent escalators, increasing demand each year… Yes the tower REITs.

American Tower, Crown Castle and SBA Communications dominate the real estate sector. Arguably tech exposed as well, this is the big driver. In addition, they are investing heavily for growth and REITs tend to carry higher leverage. This means increased EBITDA but EPS can be pinched by interest in the short-term.

Financials:

Last but not least… Financials. Look at where they trade in the US vs. Europe. More importantly, look at their relative weights. We all know the struggles of European banks due to (i) negative interest rates and (ii) weaker economies. Do I want to own those banks? Perhaps because some day their troubles will reverse… but for now, I’ll pass.

Bottom line: I don’t think Eurozone stocks are cheap, at least not THAT cheap. The further and further you peel back the onion, the more I want to buy the US vs. Europe.

Is the multiple higher than Europe? Yes.

Is it a concern how big tech has become in the US indices? Yes, but I also want to own those companies. As they continue to disrupt and change the way we do things, Europe’s older economy may be left holding the bag.

As one final comparison, here is what you are buying. In my view, missing secular growth and asset light businesses in exchange for “cheap” cyclical names (banks, Oil and  Gas, Autos, Chems). I think the US will compound at a much higher rate going forward as well and should perform much better in a recession. If you think the US$ will depreciate or that we are headed for a tech crash, then sure, go with europe.

It’s up to you on whether or not you think European stocks are cheap… I just don’t think its that simple to look at the P/E. I also think they are moving further and further away from true capitalism, so it makes it tough for me to prefer investing there as opposed to the US.

What do you think?

Is a recession coming? past recessions have begun with unemployment bottoming…

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The million dollar question 10 years into an expansion like this is, “is a recession coming?”

We have heard pundit after pundit claim that 2012 was the top. No 2013. No 2015. No 2018. Each, so far, has been wrong.

It makes sense why they do it. If they are seen as the investor that “called the top”, they instantly gain success for the balance of their careers. That means more media coverage, more book deals, and better asset inflows if they manage money.

This clearly has been one of the most hated bull markets in history, but even I, a “bottoms-up” investor, must admit that I am watching for signs of the top. Is a recession coming?

That brings me to the unemployment rate. Each time it has gone below 5%, this usually signaled that things can’t possibly get better and a recession would loom.

The unemployment rate got down to 3.7% in December 2018 which is one of the lowest levels since the 1960s. Does this mean the end is near?

Not so fast. The unemployment rate represents those people who are unemployed that are still in the labor force. Those who are not in the labor force are not counted. If we look at the labor force participation rate, it is at the lowest level in decades

Let’s put some math behind it then.

Using the data from the Bureau of Labor Statistics, I can see that a 4% unemployment rate equates to 6.5MM people looking for jobs. The flip side of that is that 162.5MM are in the labor force, but we know some have dropped out since the recession.

As such, let’s try to “normalize” the numbers. In other words, what if the participation rate went back up to ~66%. That would mean the labor force would grow by about 3%. That equates to 4.9MM workers. If these workers were counted in the participation rate, that would mean that the current unemployment rate is more like 6.8%.

Of course, these workers won’t enter the workforce without prospects of jobs, but even if 1/3 don’t, the unemployment rate ticks up to 4.8% from 4.0%.

Another factor this doesn’t include is underemployed workers. Think, college educated engineer who drives for Uber for employment. This is an exaggeration, but also not factored in the results.

Bottom Line: Be careful of scary statistics. “There are three kinds of lies: lies, damned lies, and statistics” Clearly unemployment is low, but that only tells one part of the story.