Risk Events

Investing is managing risk as a cost of entry:

“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you’re going to get.”

Charlie Munger

When a narrative of major risk arrives active managers sell off the associated stocks, as he who acts last loses. This is true in almost every case unless

  • the risk turns out to be a nothingburger which is vastly over-exaggerated, and
  • the holder does not exit their position after the initial reaction

Even if you know the risk narrative is junk, it will still ultimately impact short term stock price as other investors reposition. If you are smarter than the market you still lose if you have a mismatched timeline on a position. Early is no different than wrong unless you have the ability to endure.

Take healthcare recently. One could have saw how a top Nancy Pelosi aid was promising good things for health insurance lobbyists while also being aware of how President Trump has done virtually nothing to reign in healthcare spending costs & dropped some of his campaign promises on the issue the day he was elected. Other than dropping the individual mandate driven Obamacare policy there hasn’t been any major upgrades in terms of improving healthcare cost & efficiency.

In spite of the above, political rhetoric from the fringe end of the left promising socialized medicine scared the shit out of investors who owned a significant stake in health insurance companies. Then there were other pile on issues as Trump half-heartedly pushed through “reform” agenda talking points on drug care pricing and rebates.

When the White House announced they were killing the rebate idea CVS opened up about 7.5% while Cigna was up 14%. That is the sort of move a stock might get when a risk event disappears on the most favorable terms possible.

If you have some dogs in your portfolio & get hit by a black swan that nobody saw coming that can be seen as a bad break, but sitting on a big loser when the risk narrative has been in the press regularly for months on end puts an investment manager in the awkward position of explaining why they are down so much on a position when the media made it clear the risk was both large & known.

You can be right about the eventual outcome & still lose capital under management as a dog pulls down the aggregate performance.

Each additional media story has the potential to create another wave of selling. Each story drives demand for additional follow ups, causing more reporters to probe for angles.

When the risk event is solved, the sort of catastrophic downside disappears, so the uncertainty being removed causes the stock to jump because the issue is now solve & there is no longer the toxic narrative associated with it.

Shortly before close the FTC announced they were finalizing their Facebook settlement and – as expected – the stock rose on the story of the risk event going away. Tech bloggers who do not understand the capital markets are complaining about the stock going up as proof the fine was an embarrassing joke.

Facebook telegraphed the potential fine long ago & their initial whisper number on the expected fine turned out to be what the finalized number was. If the information they conveyed along the way was vastly off then the story would not be over, as the stock likely would have slid if the penalty was far larger than expected & that would have been followed up by shareholder lawsuits from shareholders who suffered losses.

There’s a limit to how heavily U.S. regulators can fine domestic tech companies for egregious behavior while simultaneously threatening France & the U.K. about potential blowback for clipping U.S. tech companies (while thumbing the eye of Germany for good measure).

“The United States is very concerned that the digital services tax which is expected to pass the French Senate tomorrow unfairly targets American companies,” Mr. Lighthizer said in a statement. “The President has directed that we investigate the effects of this legislation and determine whether it is discriminatory or unreasonable and burdens or restricts United States commerce.”

The domestic tech companies created the fabric of the web & are perhaps even a big part of the draw for investor capital flows into the currency:

“globalization is ending and the world is breaking into three separate economic zones with their own (i) trade and reserve currency, (ii) bond market of reference and, perhaps most importantly, (iii) dedicated supply chains. … China’s vulnerability stems from semiconductors being its biggest import item (about US$260bn a year against energy’s US$170bn) and that US semiproducers hold most of the world’s important patents. … Looking past current tensions, US tech stocks are threatened by the US-China standoff becoming a full-scale cold war. First, this would devastate supply chains, with major consequences for productivity and profitability. The second, and more alarming prospect, is that the breakdown in relations worsens to an extent that China’s policymakers conclude they have no interest in respecting intellectual property rights. After all, if we move into a world where Chinese exports into the US, and other developed world countries, become constrained, China may decide to forgo those markets. It could instead focus on reverse-engineering Western products like jet engines and medical devices with a view to selling them into emerging markets. … Perhaps the utter domination of US tech has not only triggered the massive outperformance of US equity markets, but has also helped keep the dollar high in spite of the US’s sustained twin deficits.”

This might have been a big piece of why the U.S. was so slow to regulate the likes of Google & Facebook.

Facebook also could have been slowed down in 2012, particularly in regard to its purchase of rival social media site Instagram. The FTC had the ability to file a lawsuit to block that merger, and considered doing so. During the investigation, the agency uncovered a document written by a high-level Facebook executive (no name is given). According to the New York Post, the executive said bluntly that Facebook was buying Instagram to eliminate a competitor. One source called it a “spectacular” document.

Externalities were seen largely as bullshit, sour grapes, or complaints from irrelevant dinosaurs who were technology passed by. It took the election of Donald Trump to give the dominant platforms the appropriate level of scrutiny they deserved:

“The Palo Alto Consensus held that American-made internet communication technologies (both hardware and software) should be distributed globally and that governments should be discouraged from restricting speech online. Its proponents believed that states in which public discourse was governed by “everyone” — via social media and the internet — would become more democratic. This would mean both regime change in authoritarian countries (the Arab Spring) and more responsive politics in electoral democracies (something like the White House Petitions). … We can now evaluate how this technology affects politics and the public sphere. More information has been flowing, circumventing traditional media, political and cultural establishments. But the result hasn’t been more democracy, stronger communities or a world that’s closer together. Countries with weaker social institutions felt the effects of social media most violently and immediately. … If the West had supplied basic internet technology and allowed local, domestic competition, social media would be more diverse and more culturally sensitive than it is today. That diversity would give scholars and policymakers a variety of concurrent experiments. The Palo Alto Consensus entailed running the same yearslong experiment in dozens of countries.”

Stocks are a leveraged long on a market, thesis & company. So long as the central banks keep pushing liquidity into the markets, then financial asset prices are likely to remain elevated versus historical prices. But if you are a contrarian & have patient capital that can stand a bit of pain, investing in risk event overreactions is a great way to have capital in the market with some of the downside price already taken out of it. It is important to keep position sizes small enough that you can keep capital in the position even after reading near daily stories about how the stock is a dog, anyone who owns it is an idiot, etc.

Many trends in the capital market tend to remain in place well past their logical conclusion, until they are so far past rational that they violently break in the other direction.

As Tom Sosnoff states, volatility is mean reverting but price is not.

It matters how big the risk event turns out to be versus what is perceived / priced in. When risk is perceived to be extremely high, much of the potential downside has already been removed.

Some risks are temporary and/or cyclical. Others are structural.

Going private doesn’t eliminate shareholders, but rather leaves CEOs facing a handful of more powerful ones, Mr. Questrom said. He noted that it is possible to invest for the long term as a public company and be rewarded for those actions by shareholders, as is the case with Walmart Inc. and Target Corp. “The companies whose stocks are down are doing a lousy job of running their business,” he said.

The delineation there (along with the debt servicing costs of the entity in the market) are often the difference between stocks that eventually mean revert back up to historical valuation metrics (e.g. P/S P/E etc.) & those which become absolute zeros or get acquired by someone else on their way to zero.

If a stock gets acquired before the company goes under that acquisition locks in an exit price for existing shareholders, though it might create a compelling buying opportunity in either the acquirer’s stock or the stock of the company being acquired.

Bloomberg recently conducted an interesting interview of Research Affiliates founder Rob Arnott. He mentions many contrarian value ideas like investing in emerging market value stocks, embracing maverick risk, preferring European stocks to US stocks at current prices, stocks which are removed from indexes like the S&P 500 outperforming stocks that are added to the index, reducing rates to near zero or below zero ends up being counterproductive as it signals panic, and a host of other similarly interesting tidbits.

Fun With Funko

Late last year when the market imploded Funko slid hard. They went from an all time high of $31.12 a share down to $11.22 a share. Over the past couple months they started to recover again with the broader stock market, and have touched $25.

When the market was up big on the narrative that trade talks would resume (did they ever actually stop?) Funko was off about 12% on a day when just about everything was up.

Seeing that divergence, I put a chunk of change from my IRA into Funko only to see the stock quickly bottom & fly up about 6%.

I intended to hold it longer, but if you get 6% in an afternoon, there’s no shame in exiting & waiting another entry.

And, as it turns out, looks like that was a good call, as FNKO has slid for a couple days now.

Of course it could jump at open, but I suspect there will be many more opportunities to go in and out of Funko.

If you were going to try to put a lot of money to work Funko would be a horrible investment vehicle, because even small trades can move the stock price a dime a share sometimes. That’s a big move on a stock trading at around $20 a share.

This year I’ve done well in my IRA because I have mostly done rather high conviction trades & made them rather concentrated.

I have been in cash most days, but you really only need to catch a few of those 3% or 5% moves to have a solid month.

But my IRA is so small as to be meaningless, so it isn’t really going to move the markets & it is easy to aggressively invest it without being too emotionally impacted because the sums are so tiny. (I was stupidly poor for a long time & then went to where I made too much to invest in a traditional IRA, I should set up another retirement account that I can deposit some savings into though).

My main trading account has only done a fraction of what the market has returned, in part because I have mostly stayed in lower beta value trap garbage & even a big chunk of it is in cash, just in case the market totally melts down…I wouldn’t want to see a 2008 repeat having $20ish FNKO hitting about $4 a share & then a management-led buyout that locks me in at the bottom.

I sold out the last of my Bitcoin on the 26th of June, with it nearly doubling from what I paid for it last year. I then bought back in at just above 10k & sold the following day for a quick 6ish percent gain. I think Bitcoin ran too far, too fast & we are likely to see $6k before we see $16k. If it goes back around $7k or $8k I might buy a bit more of it, though it could fall even lower than that as lawmakers & regulators dig into Facebook’s Libra project & what was once a catalyst becomes a headwind.

One other interesting thing to note is in spite of all the various alt coin hype, this recovery has largely left the alternatives behind. In July of 2017 it looked as though Ethereum could eclipse Bitcoin, but it hasn’t seen the same upward momentum recently.

This is a good video about cryptocurrencies.

I still think the trade war stuff is absolutely over-hyped at each extreme. Now that we are near record highs on fake progress it might make sense to lighten up exposure waiting for a narrative shift. Overall I am over 90% cash, though I could quickly invest if I saw a great opportunity.

One opportunity which was snatching defeat from the jaws of victory was quickly exiting Seagate & Western Digital. I bought both of them near recently lows and they’ve went up relentlessly since I sold. My narrative/idea on those is pretty basic though…they sell for 1x to 2x sales, do not have a ton of competition, and the amount of data being created every year is still increasing geometrically. Even data that is stored in the cloud is usually stored on hard drives because the data is often backed up/replicated at multiple locations and hard drives are so much cheaper per gig than solid state drives, RAM, or any other form of storage.

Hard drive stocks sold off with semiconductor stocks, but we’ll still need far more hard drives every year even if RAM demand & margins go through a soft patch.

Trillion Dollar Tweets, Again

For over a year now, every time the market says “oh trade war, things are going to fall apart” has been a buying opportunity, whereas every time there’s a Trump tweet with some blindingly optimistic prose like “Xi is a great friend, he is fantastic beautiful man, trade deal all but signed” it is a selling opportunity.

Yesterday the market looked hot. Today it’s on fire. I quickly sold out of that Seagate for about a 4% gain. I’ve been better at reading Trump than the Federal Reserve, so I don’t want to hang around for any surprise announcement tomorrow where the market craters if the Federal Reserve is the least bit reserved with their opium.

Today the ECB jawboned more rate cuts & QE to come, promptly nuking bond yields across the continent

Ahead of this week’s Fed meeting, Trump activated his own QE program by jumping on the bird to put out an APB

He continued to put pressure on the Federal Reserve

Asked in an interview with ABC News’s George Stephanopoulos about whether his criticism of Fed Chairman Jerome Powell could undercut Mr. Powell’s credibility, he said, “Yes, I do. But I’m gonna do it anyway.”

He also promised more goodies on the trade talks theme

The Cloud

A couple weeks ago Google acquired data analytics company Looker for $2.6 billion.

Google acquired YouTube back in 2006 for $1.65 billion. Core internet services seem bargain bin relative to the valuations of anything with a bit of cloud pixie dust poured upon it.

Salesforce paid about 40x projected forward revenues when they acquired Tableau at a $15.7 billion valuation in an all stock deal.

The transaction is expected to increase Salesforce’s FY20 total revenue by approximately $350 million to $400 million. This estimate reflects a fair value adjustment to reduce unearned revenue and unbilled unearned revenue by approximately 30%, adjustments related to the combined customer base, and inter-company revenue elimination, as required by U.S. GAAP. FY20 Revenue is now expected to be $16.45 billion to $16.65 billion, an increase of 24% to 25% year-over-year.

FY20 non-GAAP EPS:  As discussed further below, guidance updates for GAAP EPS for all periods discussed are not currently available and Salesforce expects to provide the applicable updates when the transaction has closed and the purchase accounting has been completed. The acquisition is expected to decrease FY20 non-GAAP diluted EPS by approximately ($0.20) to ($0.22). FY20 Non-GAAP EPS is now expected to be $2.68 to $2.70.

I understand the concept of investing in the future & investing in growth, but paying 40x revenues with stock to lower your earnings power per share about 8% really feels a bit out there to me.

Some business models & businesses simply become outmoded as technology pass them by. But there are still some older first-generation internet companies which could likely get kicked into high gear if they had new management.

Consider web hosting company Endurance International Group. They are not really growing, but they have a lot of recurring subscription customers & they are valued at far less than 1 times revenues. And that is after their stock had a massive short squeeze today on above 3X normal trade volume.

If you have 10s of thousands or 100s of thousands of hosting clients, how many cross sells (ecommerce shopping cart? security certificates? domain names? domain privacy? email marketing?) or other upgrades (security certificates? enhanced uptime guarantees? premium customer support? premium on-site analytics services? ad management?) do you need to do in order to really turn things around.

The duality in valuations between innovative stories & companies that are not particularly growing has perhaps never been greater.

There are no asset managers who represent their strategy to clients as “We buy the most expensive assets, and add to them as they rise in price and valuation.” That’s unfortunate, because this is the only strategy that could have possibly enabled an asset manager to outperform in the modern era. It’s one of those things you could never advertise, but had you done it, you’d have beaten everyone over the ten-year period since the market’s generational low.

But almost every investment professional says that they do the opposite of this. Even the explicitly growth-oriented managers use terms like “at a reasonable price,” to communicate their place on the spectrum of speculative chastity. There are no textbooks lauding an investment approach where it makes more sense to buy PayPal at 4 times book on its way to 9 times book while forsaking Goldman Sachs at less than 1 times book.

In the battle for capital right now, the brands and intangibles and user bases and networks are winning by a landslide against the things that used to be important. And the companies that are rich in those old fashioned things, like Walmart, Disney and McDonalds, are spending all of their time and attention to transform themselves into the spitting image of their upstart competitors. Disney wants to look like Netflix, Walmart wants to retail like Amazon, McDonalds wants to be as habit-forming and celebrated for its freshness as its former protege Chipotle is. Goldman Sachs wants to grow up to be BlackRock. And in emulating these younger models, they hope, their multiples will soon be following suit.

Fast-growth money losing online retailer of pet foods Chewy (CHWY) raised about $1 billion in an IPO that valued them at about $9 billion. And that is a literal modern analog to Pets.com. Except it also has a dual class share structure where insider shares have a 10:1 voting advantage. And, of course, the market ate it up with shares trading up 60% on the first day, giving them an enterprise value of just under $14 billion.

in the most recent fiscal year, Chewy notched a 68% y/y growth rate in revenues, but still found itself with a -$268 million loss

Two analogs for pondering the valuation of Chewy…

  • Online pet medicine retailer Petmed Express isn’t really growing & has perhaps been driven down quite a bit over the past year as it has competed against the ad budget of Chewy. Anyhow, PETS has a market cap of $351 million, no debt, an enterprise value of $251 million after subtracting cash on the books, a P/E of 9.6, an enterprise value to sales ratio below 1, and a 6.14% dividend.
  • Kroger (KR) is the leading pure-play grocery store across the United States. Their market cap is under $20 billion & their enterprise value is under $35 billion.

Going back to the cloud & internet services for a moment, there is a massive duality in how things are priced. Cell tower REITs like American Tower (AMT), Crown Castle (CCI) & SBA Communications (SBAC) trade like we are going to increase data usage 5-fold annually for the next couple decades. The REIT cell tower plays give dividend value investors at least a bit of cash they throw off, but then they also sell the narrative of perpetual geometric growth.

Telecom players like AT&T (T) or Verizon (VZ) which license the services of the above REITs are viewed as dinosaurs allergic to innovation, with steep dividends & large debt service costs that prohibit innovation.

Is it certain FANG will keep eating most the enterprise value growth as the web continues to grow?

And then with all the data we are creating it has to be stored somewhere. Its in the cloud. Ok, but on what? Still mostly on hard drives, because replicating data across multiple of those is far cheaper than putting everything on flash drives. Western Digital (WDC) is valued at under $11 billion & is worth about 45% of their 52-week high. Seagate (STX) is valued at around $12 billion.

I have been more than a bit overwhelmed with the web recently, so haven’t been trading as much as I did a few months back, but I did trade in and out of both WDC & STX early in the day for small wins. Segate was down a couple percent early in the day & now it is up about a percent. I still have a small position. And as a bonus, tomorrow they go ex-div, so that’s another percent and change. 🙂

Taking a Bath

I sold off about half my CVS stake early this morning after seeing their Aetna merger might get reversed by Judge Leon.

US District Richard Leon — who warned lawyers at a little-noticed hearing last week that they may want to cancel their summer vacation plans — looks like he is setting the stage to reject the mega-merger on concerns that it could raise prices and kill choices for consumers, sources told The Post.

I am sure that narrative is likely to drive lots of investor uncertainty, which will likely have the stock re-testing recent lows, as all the projects from the investor day & all that jazz mean zero if the company which is being restructured to synergize then ends up having to desynergize (is that a word?) and rip itself apart. Most likely the sort of worst outcome there won’t happen, but the headline risk will probably pull the stock down about another 5% to maybe even 10% from here.

I still have a decent sized exposure to CVS, but no reason to carry a Godzilla size position in a beaten down security that is facing a fresh round of headline risk ahead of other rounds of headline risk tied to the upcoming election.

On the upside, I offset much of the losses from the above errant play by exiting a decent sized PETS position shortly after open today. I sold something like 5400 shares into the morning ramp without really moving the price as the momentum was headed up, and then it slid later in the day.

I also had a bit of a position in WY that I sold after the ex-div date. The stock was sold at a slight loss but the dividend was between double & triple the loss, so I am fine with that & I kind of want to lighten up exposure to the market after the recent run it has had, especially as I have had a few fiascos to deal with outside of the market & the constant distraction of the market probably wasn’t helping my productivity elsewhere.

I am probably somewhere around 95% cash now. Have a small position that is up in Disney, small position that is up in Apple & then a few beaten down ones in CVS, WBA & SKT.

I might start buying some lower beta beaten-down value stocks of the type recommended in Sure Dividend in my Vanguard account & view those as more long-term positions vs something to trade in and out of. Value investing is all about being able to eat pain in the short term until sentiment approves. The odds of finding a bottom when trading beaten down stuff is low, but if you hold enough positions for a long enough time & stay away from absolute garbage like Sears the value stuff will definitely outperform the market in a downturn & can give you much of the upside in an ongoing expansion.

I’ll probably wait at least another week or two to do much because with the recent run the market has had it will probably consolidate for a bit given the morning open & afternoon pullback today.

Trillion Dollar Tweets, Continued

There is no point going through all the dirty aspects of politics to gain a position of power unless you intend to use it. Some have believed Trump to be a slave to the stock market, but in rapid succession he…

  • raise tariffs on Chinese imports
  • announce escalating tariffs on Mexican imports until illegal immigration crisis abates
  • hinted he was looking at putting tariffs on Australian aluminum & other exports
  • had leaks from the justice department & FTC announcing that Facebook, Apple, Amazon and Google are all being looked into

In such a way he flipped the script & forced the Federal Reserve’s hand:

President Donald Trump’s Friday move to slap tariffs on Mexico meant “the dam broke” for economists who had been hesitating to join the market in anticipating Fed rate cuts, Goldman Sachs Group Inc.’s Jan Hatzius and his team said.

The above Bloomberg article concludes with

investing superstar Stan Druckenmiller is piling in. He said he could see the Fed funds rate going to zero in the next 18 months if the economy softens.

A separate Bloomberg article states

“When the Trump tweet went out, I went from 93% invested to net flat, and bought a bunch of Treasuries,” Druckenmiller said Monday evening, referring to the May 5 tweet from President Donald Trump threatening an increase in tariffs on China. “Not because I’m trying to make money, I just don’t want to play in this environment.”

Yesterday as there was sector rotation into value stocks I bought a bit of beaten down stocks like AbbVie, Foot Locker, Bank OZK, etc. & also traded in and out of PetMed Express 3 or 4 times. On today’s explosive open I sold out of most those positions I put on for a few hundred dollars gain each. I also sold out a small stake I had in Western Digital & a bit of AT&T. I am down to a couple boring holdings in a couple REITs & the 2 biggest pharmacy chains. If they suck I will hope on steady dividend payments until they stop sucking & if they turn up a bit more I might lighten up even more. I think I am probably a bit north of 90% cash at this point.

I am probably going to remain mostly in cash & shorter duration bonds as if the market has someone as talented & experienced as Stanley Druckenmiller sitting on his hands, it would be a bit bold for me to try to go big in such an environment.

Abrupt Shift from Growth to Value?

Google is drawing regulatory scrutiny from the United States Department of Justice, which has sent their stock sliding about 7% so far today.

At this point, Google has literally almost nobody on their side in the political game. Everyone has a reason to hate them. Republicans think they squelch free speech that does not align with their political bias. Democrats think they are too economically powerful & use their monopoly to dominate smaller competitors (and, worse yet, they combined with Facebook & Russia to help get Trump elected).

Google is now off over 20% from where they were trading on April 29th, sliding from ~ $1,288 to around $1,027 a share.

One line in a WSJ article about the pending investigation is particularly absurd:

it created new design features like the “knowledge graph,” which populates the boxes that appear at the top of search, often answering a query without requiring the user to click through to another website. In March, 62% of Google searches on mobile were “no-click” searches, according to research firm Jumpshot. Google has argued that if consumers don’t find the rearranged content useful, they won’t click on it.

The bolded part directly contradicts Google’s historical behaviors when enforcing guidelines on others. When manually penalizing sites for link spam Google presumes the target site acquired the links on their own accord (even if they were built by a competitor). Google further justifies manual interactions on the basis that perceived attempts to manipulate the result set are verboten, not that searchers are so sophisticated that they can easily skip over any lower quality stuff that makes its way to the top.

They’ve recently redesigned their mobile search results while making both domain names & their ad labeling less obvious. That & other changes (like adding favicons to organic results to make the organic results look like ads & scrollable local results) should juice earnings, but the broader narrative of perceived risk certainly creates incentive for some people to lighten up their positions.

Making domain names less obvious will push more brands to bid on their own brand as a broad-match keyword in order to try to curtail phishing & other forms of lowbrow brand arbitrage which will now take off since the search results usually no longer show the domain name the content came from.

My guess is during this quarter Google constrains infrastructure spending, has blow out revenue growth (in addition to the mobile shifts mentioned above, some YouTube vids have double pre-roll & post-roll ads) AND announces a buyback. Though they only have a month left in the current quarter to drive blow out revenues.

The Google narrative likely has another day or two of spook out ahead of it, but I wouldn’t be against putting on a small position of a few shares of it here. I haven’t yet (largely because I dislike them :D) but if they slide below $1,000 a share at some point much of the risk is priced out of the stock.

Their big issue (in addition to the regulatory pressure) is Amazon is rapidly growing their ad business & Google seems unlikely to compete on the logistics front with Amazon unless Google were to acquire companies like Target & Kroger, but their ability to pull off those sorts of acquisitions is diminished when they are already under regulatory scrutiny.

Whenever they start reporting YouTube as a separate revenue stream (like Amazon.com did with AWS) that should lead to a good move higher in the stock. Though investors will likely remain in a wait-and-see mode given the recent slowdown in revenue growth & new regulatory headwinds. And they will still want to attribute a massive portion of their overhead costs & infrastructure costs to YouTube to show low margins on that. If they show high margins they’ll get revenue re-negotiation from a lot of players AND they look even worse each time an article like today’s NYT feature On YouTube’s Digital Playground, an Open Gate for Pedophiles gets published.

Growth has outperformed value for nearly a decade.

“Value stocks are either cheap for a good reason or cheap because of (unfairly) low expectations,” Patrick O’Shaughnessy, CEO and Portfolio Manager at O’Shaughnessy Asset Management, told IBD. “The market has left a lot of these stocks too cheap,” he said, but he can’t tell you when things will turn around. “Any good value investor knows how to suffer.”

Retail is once again dead

Amazon.com is also apparently going to get investigated by the FTC. They’re off 4.5%

The FTC’s plans for Amazon and the Justice Department’s interest in Google are not immediately clear. But the kind of arrangement brokered between the Justice Department and the FTC typically presages more serious antitrust scrutiny, the likes of which many Democrats and Republicans on Capitol Hill have sought out of fear that tech companies have become too big and powerful.

And so is Facebook. They’re off about 7.5% today.

The Times They Are a Changin’

Here is a snapshot of the market today.

FANG pulled down communications, the Nasdaq 100 & the S&P 500, while defensive sectors like healthcare, consumer staples, etc. and haven assets like gold are up on the day.

As government bond yields fall they make corporate bonds & bond alternatives (like REITs & value stocks) look more appealing by both offering higher relative yields AND having lower debt service costs (provided yield spreads do not blow out).

Effect and Cause of The China Probrem

I think it was the venerable Jim Grant who I remembered hearing emphasize that markets are reciprocals. Risk is what you take, price is what you pay & value is what you get.

Quite often the explanation after the fact is getting cause and effect backward.

Bonds strengthen with volatility, leading to market sell off.

Um maybe the market falling caused the spike in volatility & rush into bonds?

The flattening then inverted yield curves across many countries do not happen in isolation of cause.

The Yuan has slid to offset tariffs, though perhaps not enough to put them on a currency manipulator list. Other regional Asian currencies have been weak as well. Kyle Bass put out a paper on the quiet panic in HK, noting how he believes the HKMA has spent north of 80% of their usable reserves defending their peg to the US dollar & the Singapore Dollar has been slipping too.

Turkey is doing Turkey.

I remember drinking there back when I was in the Navy & we pulled into port on my 21st birthday. They had a lot of zeros on their currency, as they will soon have again.

Huawei maintains their R&D budget is being spent on innovation rather than theft. They say we need them more than they need us & they are fine without us.

Yet they claim their blockage from the US market is unconstitutional.

If tariffs were costing US households $831 each & Huawei technology was legitimately superior I am skeptical we’d go through with cutting them off. Their wholesale theft of Cisco IP including the typos in user manuals would indicate their “tech” is more recycled than cutting edge.

Rather their theft-based economic growth miracle is coming to an end. It is smart for the US to do unto China as China would do unto others. If they block your legitimate enterprises based on “security” to drive subsidies for home grown (cloned?) competition, then block their tech exports based on “security”

If things are unbalanced & such lack of balance is hollowing out your economy you need to launch economic grenades at the other side so they eat a bit of their own home cooking.

Not to mix metaphors, but… nothing is more unpalatable than home cooking when the chef knows the cut rate foods that made the ingredient list to create the poisoned stew.

Other countries like Japan are implementing foreign ownership limitations in vital economic areas like IT & telecom.

Baidu is priced like a heavy industrial commodity tied to a cyclical company that has been through a couple bankruptcies in the past 20 years. Baidu’s share price is around where it was at the end of 2010. Skepticism is high & even a $1 billion buyback announcement had no real impact on the decline, as that is only about 5% of their investible capital & they might further dilute the company by listing it in China.

Each day their stock looks cheaper than the past. But how low might they go if the fleeing foreign capital is followed up by a bit more selling to drive the price down in order to repatriate the company as a whole?

Think of how much stimulus China has done in the past decade (via the rule of 72 & an 8% growth rate they’ve more than doubled) & yet such a core company tied to the rapid growth of the web – sitting in a monopoly position – has went nowhere in terms of market cap.

Net buybacks have had a bigger impact than most would believe.

net buybacks—the number of shares that companies repurchased across the entire stock market, less the number of new shares issued—explain the bulk of the intermediate- and longer-term differences in stock-market returns around the world. … China’s real GDP, in U.S. dollars, grew at an 8.0% annualized rate over the 10 years through year-end 2018, versus a 2.1% annualized rate for U.S. GDP. And yet U.S. equities’ annualized return over this decade was more than double that of China’s. … net buybacks explain 80% of the difference in countries’ returns between 1997 and 2017. … The researchers calculated that the issuance of new shares in the Chinese market—largely as state-owned enterprises went private—had a “massive dilution effect” of nearly 24% a year between 1997 and 2017. Little wonder, therefore, that the country’s equities struggled over this period, despite its economy’s incredibly fast growth.”

Alibaba – the great company that it isis considering a dual listing in HK. Those share sales would be in spite of recent weakness & would be the opposite of a buyback. Why rush to buy any of it with that risk in place & momentum clearly to the downside: “China’s central bank has warned in a report that uncertainties brought by trade frictions between China and the United States could have an adverse impact on the global economy.”

As far as the broader stock market goes we are back in December in terms of momentum. Jawboning isn’t really driving the markets: “the short-squeeze in yuan lasted around an hour, before sellers returned… Erasing all Guo’s hard jawboning work.”

For now we’ll sit on the sidelines as China sticks to a managed decline:

Their strategy is perfectly clear, therefore also the implications. Managed decline. … But in order to manage just that minimal growth in currency, the dollar squeeze on the asset side means something has to give. The only thing left, China’s big monetary fudge factor or plugline, is bank reserves. Therefore, in order for currency to stay positive bank reserves have now to contract by around 8-10% every month.

The Federal Reserve can’t eat the risk of stoking further inflation until there is some other fire they are fighting:

The leader of the free world has a super hero name for himself and it’s “Tariff Man“, a state of affairs you’d think would be conducive to inflation. As it happens, Tariff Man has a penchant for pro-cyclical fiscal policy that borders on the fanatical. Again, that should be conducive to inflation, as piling fiscal stimulus atop a late-cycle dynamic when unemployment is parked at a five-decade nadir is tempting fate, assuming the Phillips curve is “just sleeping” (and not “gone to meet its maker”, like the Norwegian blue). And “Tariff Man” is also engaged in an around-the-clock effort to commandeer monetary policy, which he’d like to be pro-cyclical too. One more time: That should be conducive to inflation.

Our solution to every bump in the road is more intervention versus more capitalism:

“The economic engine we have in place today has for decades produced virtually no increase in wealth for the majority of earners. According to information pulled from the Federal Reserve, the median net worth of the bottom three quintiles of families declined in inflation-adjusted dollars from 1998 until 2013, tumbling by 20 percent or more. This decrease has hit working-class families the hardest; their real net worth has been halved over this time. … I’d argue that we don’t really have all that much capitalism anymore. Individuals simply do not have equal, competitive rights to own the means of production. Corporations, which have replaced both the feudal empires of the 1600s and the trusts of the early 1900s, are the contemporary preferred owners of capital goods to be extended privileged rights by central governments. … With Blackstone able to offset the cost of its 400 lawyers against $5 trillion of assets, how can small banks or asset managers compete? The answer is they can’t, so they get acquired (or go out of business). … researchers at Harvard Business School have shown that favorable merger reviews are more likely for firms that make large political donations to the politicians who sit on the two committees that oversee the FTC and the DOJ. … From 1950 to 1980 or so, prices on average goods were marked up roughly 18 percent above marginal cost; this level was largely stable during the entire period. However, beginning in the 1980s, prices began to rise, rocketing to 67 percent above cost today. When you are an oligopoly and customers have no real choice among the top three to five providers, you don’t need to openly collude. Just all raise your prices together, and customers are stuck. … it’s critical for the government to normalize the legal rights of individuals to, at the very least, give them equal status with the current preferred neofeudal empire, the corporation.”

The belief in the Fed put is a mistake because they’ll have to wait for the market to crash before they can use the market crashing as pretext to intervene further.

Once they indicate they’ll buy ETFs it is off to the races.

Trillion Dollar Tweets, RIP

Here’s an actual Bloomberg headline which shows just how fake the “markets” have become…

Stock Traders Wait Anxiously for a Trump Tweet to Reverse Rout

three weeks after the president rekindled the trade war with China, sending the Dow into a 4% tailspin, traders are growing increasingly impatient for their dose of White House succor. Where is it?

There is literally no incentive for the Federal Reserve to intervene after a 4% correction. They’ve exited their market distorting QE efforts, already announced QT will end in about a quarter & now President Trump owns the stock market narrative.

A big part of the purpose of the Trump tax cuts was to let the economy run hot to where wages were improving & he had a big cushion he could use to put the screws to China to force a more favorable trade deal. However the Federal Reserve used the economic strength to justify lifting rates.

Many states & local governments also lifted income taxes to fund underfunded pension plans. In many areas the state & local increases more than offset the Federal rate declines.

So now there is rising input costs, disrupted supply chains, net tax rates that are flat to up, faltering stock markets, & inverted yield curves. What’s more, the Federal Reserve engaging in QT & lifting rates has been a large part of why the stock market has went nowhere over the past year and a half. So that means lower capital gains driven tax revenues, which when combined with higher interest expense on servicing the debt have blown out the deficit.

It almost feels as if the Federal Reserve prefers China dumping Ozone-depleting chemicals into the environment & supply chains with Chinese re-education camp labor in them versus the prospects of sustainable livable wages for the ordinary American.

That view is perhaps cynical, but a decade ago it was the financial economy that was saved while the actual economy was allowed to burn to the ground.

And now that Trump owns the market, the bubble fomenting arsonists at the Federal Reserve would prefer to remain in the background & wait until such a crisis emerges that they can don the firefighting suit & claim they saved the world.

So the market probably has at least another 10% to the downside before there is any serious jawboning to presage any further non-market interventions.

Financial Securities Melt Down, Bitcoin Melts Up

Once again the stock market was down bigly on the ongoing trade war headlines.

One of the few asset classes that has not crapped the bed recently is cryptocurrencies, which have rallied hard over the past couple weeks.

Are cryptocurrency investors betting on financial conditions getting so bad the Fed has to cut rates?

Why would Bitcoin be treated like gold or longer dated treasuries while art prices were collapsing along with stocks?

Is it one of the few safe asset classes during turbulent times? Or is there another liquidity issue at a major exchange causing them to go all-in on a pump-n-dump to mask their losses? Bidding up an existing coin might have less legal risk than launching another ICO.

When almost nothing is real, it isn’t hard to move the markets.

“Ninety five percent of spot bitcoin trading volume is faked by unregulated exchanges, according to a study from Bitwise this week. The firm analyzed the top 81 crypto exchanges by volume on industry site CoinMarketCap.com. They report an aggregated $6 billion in average daily bitcoin volume. The study finds that only $273 million of that is legitimate.”

Cryptocurrencies are hacking targets and are still widely used for money laundering, plus a variety of other financial crimes

“Crypto Capital worked with organizations associated with financial crime, money laundering and securities fraud—and major crypto exchanges too.”

They might also have actual real world uses soon.

You can use Bitcoin at Whole Foods, Microsoft launched a decentralized identity tool based on blockchain, Amazon offers a managed blockchain service & Facebook is building a mainstream cryptocurrency.

Facebook aims to burrow more deeply into the lives of its users. It is building a type of checkout option that consumers could use on other websites, some of the people said. Similar to how a Facebook profile can be used to log into hundreds of websites (including The Wall Street Journal), Facebook envisions allowing those credentials to be selected as a payment method when users buy goods online. … One idea under discussion is Facebook paying users fractions of a coin when they view ads, interact with other content or shop on its platform—not unlike loyalty points accrued at retailers, some of the people said. … It is also working to tie online purchases more closely to ads.”

The idea of using cryptocurrencies for regular day to day purchases is still for the most part unrealistic unless they have that sort of loyalty program incentive bonus integrated with them.

Stable coins typically do not change in price much, though some of those are not even fully backed by fiat currencies:

“As of the date [April 30] I am signing this affidavit, Tether has cash and cash equivalents (short term securities) on hand totaling approximately $2.1 billion, representing approximately 74 percent of the current outstanding tethers.”

Even if stable coins become more integrated then they still run up into all the costs associated with regulation & KYC laws while also eating legal bills tied to lawsuits.

Volatility is the main reason people invest in & believe in cryptocurrencies.

The transaction fees are more than a bit overwhelming. E-trade may soon offer cryptocurrency trading, but they’d mostly appeal to daytraders & daytraders would need much tighter spreads than what something like Coinbase offers.

The following shows why cryptocurrencies are utterly horrible in terms of transaction costs. As of about an hour ago Coinbase would buy a Bitcoin for $7,993.35 though they would also charge a $119.10 fee, driving that buy price down to $7,874.25. The same service would sell a Bitcoin for $8,073.37, with an additional bonus fee of $120.29, bringing the cost to $8,193.66.

If you average together the buy & sell price it comes to $8,033.96, with a $319.41 spread. That means if you invest $8,000 at a time, you are getting clipped for a 1.99% spread in each direction each time you trade.

BuySellSpreadMidpointSpread %
default$7,993.35 $8,073.37 $80.02$8,033.361.00%
fee$119.10 $120.29 $119.70 avg
after fee$7,874.25 $8,193.66 $319.41$8,033.963.98%

How much more ridiculous do those fees get if you are dealing in smaller sums? Do they go from 2% in each direction to 5%? And what convenience do they provide over cash that offsets the massive conversion fees & the headache of dealing with the accounting of gains and losses on all those FX transactions.


The spreads are much better if you use Coinbase Pro. For a similar transaction fee you could put through a $50,000 transaction & the spread outside of that fee is frequently only a dollar or two.

I am a bit surprised they haven’t damaged their brand with what a rip off their core platform is relative to the rates available on their pro subdomain. Even so, the PRO user interface would probably overwhelm most people who’ve never traded financial instruments.

A person who was willing to hold a small amount of inventory could probably run a decent arbitrage business creating something like the core Coinbase site while buying & selling off the PRO subdomain.

Price up. Volume up.

Though the critical question remains: is any of it real?