Friday, January 15, 2021

A Look Ahead

 I want to start by looking back to the beginning of 2020.  Life was simple then; we could travel as we liked, hold social gatherings, go to the beach, attend music concerts, go out to dinner and the movies, and generally come and go as we pleased.  After Covid was declared a pandemic, the world’s health authorities closed the global economy, businesses were shuttered, millions laid off and free money was printed as a temporary stop gap to keep things afloat. 

 Twelve months later we are at the beginning of a vaccine roll out that will take time to implement and who’s effectiveness is being questioned but while we wait more money is being printed but many businesses are still shuttered or gone for good.  Some sectors of the economy have benefitted; logistics, software, delivery, golf gear (one of the few sports that is allowed, and which has seen a remarkable resurgence), video games, home health, fitness and entertainment and several other industries are flying, however if you are in the restaurant business, travel or leisure then you are either out of business or fighting for your survival.  One of the largest and most important industries, housing (at least in the USA) is intriguing.  Prices for housing are spiraling higher due to the limited number of homes for sale but banks are not allowed to foreclose on Covid victims who are months behind on their mortgage payments.  Once this bandage is removed there should be an avalanche of properties coming to market and this could undermine this industry right as the stimulus ends creating a massive drag on any economic growth. 

 Political unrest created by the Trump supporters and Trump himself has created temporary political chaos.  Biden takes office in a week and while I am not convinced that he is the man for the job he certainly will be a welcome change from what has turned into a barbaric exit to Trump’s presidency.  A new President, a new Treasury secretary in Yellen (another money printer) and an economy being kept alive with fake money makes it anyone’s guess as to how the market will react but the reality of the situation is that without depressed interest rates and trillions of fake dollars being printed the stock market would be well below current levels.

 Looking at some of the stock valuations shows an amazing picture.  Tesla with a market capitalization of over $800 Billion produces 140 times less cars than the top ten automakers but has a value higher than all those combined.  It trades at 30 times sales and 1,550 times earnings.  It is the most overvalued stock in market history, and this has catapulted Elon Musk into the position of the world’s wealthiest person even though his company makes no money and is only showing a profit due to carbon credits!  His net worth has jumped from $30 Billion at the beginning of 2020 to $170 Billion today, an increase of $140 Billion in a year or almost $12 Billion a month!

 Apple’s market capitalization soared by almost $1 Trillion in 2020 to $2.26 Trillion at year end.  It was only 17 months ago that it was the first company to reach $1 Trillion but despite lagging sales and profits the stock keeps climbing.  Although certainly not a growth stock, it now has a price to earnings ratio (P/E) of 40.5 up from 24.7.  In a normal market Apple’s P/E ratio would have been in the mid-teens but now is three times that valuation. 

 It is now the most overvalued stock market in history and into the 13th year of the longest bull market in history.  The price to sales ratio of the S&P 500 is now 20% HIGHER than it was at the peak of the Nasdaq bubble in 2000, the previous record.  There is full blown stock mania in the USA where the small players are piling in just as they always do at market tops.  JMP Securities estimated that a record 10 million new brokerage accounts were opened in 2020.  Most of these are leveraged using margin to juice returns.  Options contract volumes have soared to 30 million contracts a day, 12 times the number traded in 2000.  The insane are running the asylum and this will not end well.

I was recently on the golf driving range trying to fix my golf swing (a never-ending job) and I overheard a few youngsters (market newbies) talking amongst themselves.  One of them was boasting that his day trading profits were so great that he was quitting his job to trade stocks!  Sounds like 2000 all over again.  Another person recently called me (another market newbie) to ask why his option contract had not gone up in value even though the market had moved in his direction.  There was no concept of time value, volatility value or other market driven option values and yet here he was trading options!

 Another crazy metric is the SPAC market.  For those of you who have been with me for a while you will remember that back in 2008 the SPAC market was hot.  A SPAC is a Special Purpose Acquisition Company, essentially a shell of a company that raises money and then buys companies with its cash.  Most of these have no credibility or plan; just invest your money and results will magically follow.  These companies raised $74 Billion in 2020 more than 5 times the previous record which also occurred at the previous market peak!  What are they going to acquire with that hard earned money?  As before, a lot of these SPACs will go to zero.

 The final stock bubble analogy that I will mention is the ARKK fund.  This is now the largest active ETF (exchange traded fund) in the world, and it is run by Cathie Woods.  Cathie’s fund has raised more money in the last two weeks than it did in its first 5 years, and she is now a regular on CNBC where she is touting her positions.  Cathie recently said that Tesla could go to $15,000 a share making Tesla worth $15 Trillion.  Tesla is the basis for her entire fund’s returns, and therefore it is outperforming the market however, back in 2000, there were similar Internet funds that went to the moon only to return to earth in a hurry when the market cratered.  The Jacob Internet Fund, run in 2000 by a 30-year-old money manager Ryan Jacob, was flying high on the New Era Internet stocks.  His fund lost 95.8% of its value when the NASDAQ bubble burst and I anticipate a similar exit for Cathie and her investors.  Interestingly today Cathie announced that she was starting a new fund for Space Exploration where she will invest in public companies involved in space exploration.  After the announcement Virgin Galactic stock surged 22%!  No news just a supply demand play.  This market has gone insane!

 Behind this madness is a Federal Reserve bent on printing money as the only way out of its hole and a government with a mandate to continue to support the economy at any cost.  The new mantra on Capitol Hill is Modern Monetary Theory (MMT).  Some people are now referring to it as Modern Money Tree as apparently you can print as much money as you like with no repercussions.  To the MMT proponents, history is irrelevant.  The tales of woe of the Weimar Republic, Argentina, Zimbabwe, and other economies that printed money without concern are irrelevant.  Their problems of hyperinflation and economic collapse are due to their lack of understanding of modern economic theory so it will be different this time!  Not that I anticipate a return to hyperinflation any time soon but if there is not a check on monetary growth, global inflation will return and with it higher interest rates which any debt ridden individual or country knows is the death knell for balanced budgets and repayments.  This weakens the economy reducing tax receipts and down we go.

 While I am still not convinced that inflation will rear its head soon there are already several warning signs; copper is up 27% in 2020, oil has recently past $53 a barrel and this is before the return to normal travel, the dry goods freight rate is up from below $400 a day to over $1,700 a day, and the USD has declined more than 12% against a basket of currency (all imports into the United States have increased in price).  On the local front I have witnessed the cost to construct a new property climbing from $200 a square foot to $250 a square foot due to lumber and labor shortages.  While these metrics have not fed into the Federal Reserve’s measure of inflation, they are showing some market froth, and this is starting to create a concern in the inflation camp.

I cannot see a way for the Federal Reserve to extract themselves from this mess without a market collapse and a recession to wipe clean all the excesses.  The problem is that the market is so overvalued that anything short of a 75% correction will not do the trick and I doubt that the Federal Reserve (particularly with Yellen now the Treasury Secretary) will stand by and watch that happen so more money will be printed creating a larger problem and a bigger collapse.  Stay tuned but 2021 is going to be a very interesting year it just remains to be seen whether the madness will continue or whether reality will finally restore order.

 As always, I will monitor the markets daily.  Once the music stops and the market finally bakes the reality of the situation into stock prices, I plan to act but at present I will wait until the bandage is ripped off and the true state of the global economy revealed.  In the interim I will not be participating either long or short but will patiently wait for the collapse, sidestepping the volatility and continue to produce excellent returns for all of us throughout this crisis.

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