What To Make Of The Selloff?


So did you like the waterfall yesterday?

I bet you woke up thinking that there would be a nice relief rally this morning.

Thus far, not so much.

A bit of perspective is in order here.  The number of stocks that have been trading on nothing more than QE-addled leverage, with nosebleed territory P/Es including Facebook (96), Amazon (537!), Netflix (180), LinkedIn (762), Salesforce (Negative P/E) and Twitter (ditto; -$3.41 EPS.)

Yeah, but the market is “cheap”, right?  Sure it is with all these big-cap techs trading at prices like this — and this is after yesterday.

C’mon folks.  This sort of stupidity never matters until it does, and figuring out what will make it matter prospectively is somewhere between difficult and impossible.  But if you think there is “value” in a market that these sorts of prices expressed in it on a forward basis you’re simply nuts.

There is only one reason to buy such a stock — you’re convinced that some other sucker will pay you an even greater multiple to sales (say much less earnings) than you paid.

That the air will eventually come out of such a market is inevitable.  But the potential for a “forcible, violent unwind”, otherwise known as a crash, requires more.

That requires lots of margin borrowing so that when the herd gets spooked the selling is indiscriminate and forced, because the nice clerk on Line 1 is telling you that there are three options: Deliver another million dollars to cure the breach of your leverage limits within the next 30 minutes, liquidate enough of your position to come within limits or your positions will be liquidated until you are within margin requirements, and they will choose what to liquidate.

There is not now and has not been for the last three years any rational argument for the level of prices in these stocks.  None.  Zero.  Zip.  Nada.

Take Amazon as just one example.  Even after the selloff yesday it is trading at well-over $300 a share.  It has $27/share in cash and equivalents on the books, and a book value of about $21 (in other words but for the cash liabilities exceed assets.)  It has revenues of $74 billion but operating cash flow of just $5.5 billion andlevered free cash flow of $2 billion along with a 1% (really) operating margin.

As I have repeatedly noted the gross deceleration in growth, particularly in their overseas media area, has been marked, and yet media is all they make money on. Further, of late their greatest “innovation” has been to try to clone the Roku box.

Uh, yeah.

There are similar stories in the other high-flying tech stocks.  Each has differences, of course, in that each is in a different business.  But the underlying story is the same; these firms are trading on hopes and dreams — or if you prefer, field of dreams.

Facebook is an especially-amusing example.  Here is a company that unlike Amazon doesn’t actually sell anything — well, except you, that is.  They sell your eyeballs.  Like all these social media companies they claim engagement is a valid measure of future profits and thus stock price.  But all of this relies on increasing leverage through the economy, because irrespective of how much advertising you see unless you have money you can’t buy, and neither can anyone else.

So what have we done over the last 10 years?  We’ve hit the wall there in the consumer leverage area.  Oh sure, on a temporary basis we’ve also seen some loosening of credit standards, right?  Car sales are up and similar.  But where’s the biggest expansion in consumer credit?

Student loans.

What does that auger for the future?  Plenty.  How do you sell cars, houses and other things to impoverished young people?  Who takes the reins from the current generation when it comes to consumer spending?  How many young people today are either graduating from college with degrees in liberal arts related majors with $50k+ of student loan debt or worse, getting into school and then not finishing?  How is it that we have managed to siphon off six times the growth rate of a minimum wage job in the cost of credit hours, say much less fees and expenses, reducing the majority of college-attending young people to debt peonage compared against their 30-something cohort?

Yes, if you happen to be in a STEM field — for today — the educational value is probably worth it in earnings.  But it probably isn’t anywhere else, and the issue here is not (on a societal level) strictly where it’s worth it or not.  That’s an individual decision.

No, the issue on a societal and economic level is the amount of margin destruction and thus discretionary consumer spending destruction that has been embedded into the economy and will be recognized no matter what else we do in the next couple of decades.

Growth?  Where?  Pulling forward demand from tomorrow into today only keeps working so long as you can keep doing it.  Eventually the check has to be paid.  We have intentionally ignored this and our so-called “leaders” are the ones pushing it at all levels of society: Education, Obamacare, back-up cameras in your new car and more.  I don’t care if you’re Republican or Democrat (or for that matter Libertarian) the same applies; witness the Libertarian Party thinking they should take amortgage to buy an office building; their justification is that they will “save” on rent.  Of course the predicate here is that they need to participate in the bloated real estate market known as “Washington DC”, where funny-money has driven rents (and thus prices) to somewhere around the orbit of Jupiter.

I’ve never seen a better argument for a “correction” than the utter insanity expressed in stock prices over the last three or four years.  Couple that with the nutty garbage that passes for “value” among many consumer goods, especially capital goods such as cars.  It’s still possible to beat most of that insanity, but not all of it — and those being sucked into the idea of spending $30,000 to get less than you got for $20,000 as little as 10 years ago, which is in fact a 50% increase in price-to-value, are fueling this with cheap debt and longer payment terms.

But that’s just leverage — it’s not prosperity.

Are we on the cusp of recognition?  There are those who argue The Fed will step back in with more QE if the market starts to come apart.  I argue nope, because The Fed isn’t exiting (contrary to their claims) because the economy is improving.  They are exiting because the harm impressed upon long-duration bond portfolios, which underpin every single entity that relies on an insurance-like product (such as pensions, liability and hazard insurance and similar) were being destroyed and the damage they had impressed upon those firms and internalized, and which cannot be reversed, was reaching critical levels.

Those of you in the “strong market, strong economy” camp ought to take a look with your lens pulled back out a bit.

I believe that when taken on a wider-angle view you might have some trouble with the soundness of your sleep.

The Market Ticker

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