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?

Roku, Zillow & Uber

Roku smashed their quarterly numbers, which led to a big pop at open yesterday & the stock was up over 25% on the day. They are winning on top of winning, with revenue per user up, users up, and users using their service more and more.

Zillow reported quarterly numbers which beat expectations & have their stock up about 6% today in spite of the market sliding on the trade war narrative.

I’m not seeing how the Zillow numbers were good. Their core high-margin business continues to decelerate.

  • their core (high-margin) Premier Agent business was up 2% YoY from $213.7 million to $217.7 million
    • in prior quarters they claimed slowing growth in this business line was from shifting the business model from selling email leads to selling a mix of email & phone leads
    • I think a couple other things hit them though:
      • the TCJA lowering salt deductions caused a slowdown in some of the bubble areas
      • some of the areas that were less bubble driven do not have as efficient of auctions for attention so Zillow is not able to capture as much of the vig on those markets
      • some state & local taxes have went up in a way that more than offset the federal income tax decline
  • Zillow claims they are already getting $200 million a day in dealflow to look through, with an offer to sell every 2 minutes. They refer sellers to local partner agents & in spite of this additional dealflow their Premier Agent business was still only up 2% YoY.
  • There is also an ongoing class-action lawsuit against the NAR which could blow up the 6% commission model.

I still see Zillow as having strong value that would be nearly impossible to recreate for less than the cost of buying the company outright. But you would think they would have more growth in their core Realtor-focused ad products given how dominant they are in their category.

Uber opened down about $3 below their IPO price of $45 a share. The wave of startups adding to the stock market could adversely impact aggregate share scarcity.

If this was just about economic growth, the S&P 500 this cycle would have peaked around 1,850, a thousand points lower than where we are now. … What has been the driver is this near-perfect symmetry we have seen: between a US$4 trillion expansion of the Fed’s balance sheet, a US$4 trillion surge in corporate debt, and US$4 trillion in share buybacks. By creating scarcity in the market for safe securities this cycle, investors were forced to move up the risk curve and this meant tremendous opportunity for CEOs and CIOs to issue gobs of debt to receptive yield-starved investors. And this debt, or at least 25 per cent of the new issuance, went to fund an unprecedented wave of share buybacks.

David Rosenberg

If the trade war goes astray, it could be a market top for some period of time, particularly if Uber has already seen their high.

“Gulf money is notoriously late to the party, purchasing Carlye Group in 2007 at the peak of the credit bubble, and anchor investors in Glencore IPO in 2011 at the peak of the commodity bubble. Now they are “all in” on Uber and opened offices in Silicon Valley to do more. … When the leading company in the hottest sector goes public, it reflects a peak in social mood and usually presents an important inflection point in financial markets. As a rule, insiders sell at the top. … The AOL Time Warner merger in 2000 culminated in the tech crash, the Blackstone IPO in 2007 presaged the 2008 meltdown, and the Glencore listing in 2011 marked the peak in the commodity super-cycle. Uber, we believe, will mark the peak in Silicon Valley and tech valuations.”

Jawad Mian

Update: The stock market turned up late in the day on (bogus) constructive trade talks, but Uber still closed off 7.6% down.

Those who expressed confidence in adverting a trade war based on the (bogus) constructive commentary get to wake up some presidential weekend Tweets stating otherwise.

There’s a very difficult problem with China and the trade situation: They have structured their entire economy around cheating and embedded it into the Community Party, which has top-level control over all of it.

Trying to change that is likely a bridge too far; it would require the Chinese Communist Party, and Xi himself, to acknowledge that (1) what they were doing was and is wrong and (2) they’ll cut it out.

The second you might get.  The first you won’t get.

Communists are never wrong, you see.  They can’t be.  To admit so is to admit their political and economic system is wrong and therefore that other competing ideas might be superior.  Down that road lies their own death and they know it.

Karl Denninger

The Credit Markets Drive the Stock Market

The following Brian Reynolds interview by RealVision highlights how important pension funds are for driving the credit markets & stock market.

A few notes from it:

  • pension funds are significantly underfunded & they roughly need to get about a 7.5% return to meet cashflow obligations
  • pensions tend to prefer the credit markets to the stock market & use leverage to drive further incremental gains over the yield on a particular bond
  • many companies issue debt into the hungry bond market & use the funds to buy back shares, goosing earnings per share by lowering the denominator with a lower share count
  • it is hard to outperform the stock market index with active management at scale & many active managers are short the market, driving further underperformance
  • it is much easier to outperform in bonds during a bull market by simply buying lower quality debts at higher yield, which works until it doesn’t.
  • the Detroit bankruptcy changed the actuarial assumptions for public pension plans because pensioners did eat a loss. thus state & local tax increases ramped significantly, which more than offset the much heralded Trump tax cut
  • market volatility dissipates & the market returns its grind ever higher until at some point pension plans ask to cash out of a particular issue & are unable to, which drives a rush for the exits.
  • the above sort of cycle has driven bubble after bubble. so far this century we have had bubbles in:
    • telecom / internet / information technology, which caused the Federal Reserve to lower rates, thus igniting
    • residential real estate / housing, which caused the subprime bubble crash after they began raising rates, which then led to large scale balance sheet expansion, which then led to a bubble in
    • commodities, in particular debt associated with oil fracking & then a commodity price decline, …
    • and now some sectors of commercial real estate
  • individual investors have favored ETFs over mutual funds, but largely that move has been a wash. most of the net buying of stock since the recovery has been from buybacks from companies.
  • he believes a while after yields invert there will be an LBO spree which will drive the final blow off top
  • in the next crisis pension plans are perhaps going to be more likely to receive a bailout than banks were in the last crisis
  • the pension-driven bubble cycle is likely only to end if we go from defined benefit pension plans to defined contribution pension plans

Scientific Games

Scientific Games (SGMS) reported earnings & the market reaction was beautiful with a powerful short squeeze causing the stock to jump 15%. I figured they were going to have a positive reaction to their earnings announcement, if for no other reason the ability to shift narrative.

  • they had just recently spun out their SciPlay mobile gaming subsidiary (SCPL) via an IPO, raising $301 million for a 17.4% stake. Funds were used to lower leverage on the parent corporation by paying down debt
  • as of this morning, SciPlay is valued at $1.86 billion
  • they still own most of that mobile subsidiary (much like IAC’s stake in Match)
  • outside of their 82.6% equity stake in SciPlay (valued at $1.54 billion), the remaining core business is highly debt leveraged but has limited enterprise value beyond the heavy debt load
  • many spin outs (or new line reporting) have led to a revaluation upward of the core remaining business
  • they would not have had strong incentive to spin out the other company while retaining the majority of its equity unless they felt the parent company was healthy enough to continue servicing the debt
  • Zynga’s stock (ZNGA) has been on fire this past year as mobile gaming keeps growing

Scientific Games has been beaten down for the past year & I figured even if they bombed the numbers the narrative shift would carry the day.

Last week I put most of my liquid savings in a low-yield Vanguard bond fund so I would sort of ignore the stock market & focus on other stuff, so I only put a tiny position on just before close yesterday using a bit of money that was in my IRA to quick flip Scientific Games around the quarterly results.

The short squeeze is still going with the stock up over 19% now, so I certainly sold too soon, but it will likely trend down later in the day as shorts finish covering & new shorts re-engage.

Trading the Trade War

The trade war ending has already been priced into the market, which is part of why the market has tanked for the last couple days after another round of Trillion dollar Tweets.

When the market sold off Monday I sold off the VIRT position I had recently established.

By close of Monday the stock market made up most of its losses & then today was once again down.

There are lots of obvious first-order impacts of the trade war. A slowing Baidu (BIDU) now trades for about a 15x P/E on fears of slowing down of the Chinese economy & potential capital flight from foreign investors if the trade war accelerates & supply chains move.

Today US federal government bonds & muni bonds are up. However most of the market is down.

There are also defensive sectors which can turn very much non-defensive if market behavior shifts enough. For example, if a market sell off continues it could not only project a recession, but it could cause one. That, in turn, would likely lead to an electoral landslide for the Democrats. That, in turn, would lead to some defensive sectors like healthcare getting dramatically repriced as some portions of the value chain are grown while others are gutted.

My view on the trade war stuff has been to fade consensus. When everything being perfect is priced in, expect turbulence. Whenever it seems all hope is lost with negative headlines everywhere, become a buyer. If the market is down again tomorrow it might be a decent day to nibble.

CMGI Sighting: Taking a Break from Trading

I’ll still read about the capital markets daily, but I have found trading quite distractive when considering my daily workflow. I’ve sold most my positions other than WBA, CVS, a REIT & a somewhat negatively correlated stock that tends to outperform when the market craps the bed. In the current market where a flood of IPOS are coming online, I’d hate to be in anything other than low beta stuff unless I was obsessively watching it.

I guess that near constant distraction would be worth it if my investing returns drastically outperformed what I was doing elsewhere, but the capital markets are far more competitive than most other markets. As a newbie it is better to wade into such waters when the central banks are pumping liquidity into the market after a pull back than to either buy beaten down value plays that keep getting more beaten down or diving into some beyond meat IPO pump-n-dump styled elevator price action.

I am the only person in America to have not filed an S-1 to go public this year. I love seeing endless IPO’s, but I know that with IPO’s comes supply and with endless supply comes lower prices (at least generally).

I also have some 1999 Déjà Vu going on.

SoftBank Group Corp. is considering audacious fundraising plans, including a public offering of its $100 billion investment fund and the launch of a second fund of at least that size, as it looks to seize on an exploding startup scene, people familiar with the matter said. … Highlighting the need for new funds: Mr. Son recently returned from China, where he negotiated informal deals worth several billion dollars that the Vision Fund doesn’t yet have, one of the people said.

If he & money from Saudi Arabia are existing, who is the next marginal buyer left in the market? I can’t believe the Wall Street Journal published an article with this analogy:

A Vision Fund IPO is the most ambitious of the plans under consideration and would take place after the fund is fully invested, likely by this fall, according to people familiar with the matter. The hope is to create a smaller version of Warren Buffett’s Berkshire Hathaway Inc. —only loaded with young technology companies, many of which have yet to turn a profit, instead of a stable of well-established utilities, insurers and energy companies.

Like Buffett, except the opposite.

  • Not value-based investments
  • Not profitable
  • No large insurance premium float to fuel other investments, but rather a bunch of marked up money-losing companies where the exit is done in part to raise funds to create another pro-cyclical investment vehicle which will likely invest in companies that also compete against the last batch of startups before they get profitable

Blue Apron is now profitable after a couple years as a public company & a 90% slide in their stock price.

Anyone remember CMGI? The Vision Fund feels like a high-stakes liar’s poker version of that. A loose collection of money losing somethings fueled by unrelenting optimism … sold to you.

Sounds like a press release to me

This sumptuous show last fall at the Hammerstein Ballroom in Manhattan represented the avant-garde not of theater but of Internet hype. It introduced a new home page and ad campaign by AltaVista, the search engine, to about 100 journalists and Wall Street analysts, and laid the groundwork for an initial public offering. AltaVista — prompted by its new owner, CMGI, one of the most successful incubators of Internet companies — promised to take on Yahoo with ”a portal as powerful and immediate as life itself.”

To do so, it would spend $120 million on a new slogan, ”Smart is beautiful.” These days, that strategy does not look very smart, and the prospects for the CMGI empire are not very beautiful.

CMGI’s shares are off 91 percent this year, to a value of about $3.8 billion, closing on Friday at $11.94.

And I wasn’t the only one who saw the CMGI parallel

If you lose 50% of your capital base, you have to double your base just to get back to even. If you ride a CMGI down 90% you’ll need a 10-bagger to get to par, excluding the impacts of inflation.

Maybe the market heads higher from here on a China trade deal & the Federal Reserve lowering rates once more to throw fuel on the fire, but I suspect the Fed will first have to see a catalyst to justify throwing more fuel on the fire & at the very least I’d rather wait for such a catalyst before putting much capital at risk.

CVS Panning 2018 Q4 Was…

… a great buying opportunity.

Which is part of why insiders were buying. CVS is up around 5% in premarket trading today. They beat earnings & revenues, raised full year guidance, outperformed in their retail business & outperformed in their health-care benefits segment.

A month ago they were under $52 a share & a week ago they were still just $52.50 a share. So shares currently trading at $57 have seen a big move & the bottom is almost certainly in.

Provided Bernie Sanders is not elected president (socialized medicine that nixes private insurance also guts the value of CVS’s Aetna) the current share price is still cheap. In Q1 CVS insiders invested hundreds of thousands of dollars buying shares at above $58 a share, so if you buy at open you’d be paying a price insiders felt was a good deal.

Here is a list of some of the recent insider buying

Date Director Shares Share Price Investment
3/11/2019 C. David Brown 10,000 $53.18 $531,800
3/11/2019 Fernando G. Aguirre 1,900 $53.59 $101,821
3/8/2019 David Wyatt Dorman 9,600 $52.71 $506,016
3/8/2019 Edward J. Ludwig 2,000 $52.8 $105,600
3/1/2019 Edward J. Ludwig 4,000 $58.27 $233,080
3/1/2019 Fernando G. Aguirre 3,410 $58.29 $198,768

And they also issued a bunch of options at $54.19 a share.

Date Director Shares Award or Strike Price Value
4/1/2019 Larry J. Merlo 20,858 $54.19 $1,130,295
4/1/2019 Thomas M. Moriarty 4,837 $54.19 $262,117
4/1/2019 Troyen A. Brennan 3,606 $54.19 $195,409
4/1/2019 Lisa G. Bisaccia 2,411 $54.19 $130,652
4/1/2019 Eva C. Boratto 1,336 $54.19 $72,397
4/1/2019 Alan M. Lotvin 863 $54.19 $46,765
4/1/2019 Joshua M. Flum 742 $54.19 $40,208
4/1/2019 James D. Clark 253 $54.19 $13,710
4/1/2019 Kevin Hourican 1,109 $54.19 $60,096
4/1/2019 James D. Clark 5,536 $54.19 $299,995

Disclosure: the author owns CVS shares.

Google Guts Stock Market

When I saw they were down almost $100 a share in after hours trading yesterday I knew today was going to be a down day for the market. You’d just about need a signed deal ending the trade war with China (allegedly resolved one way or the other within weeks) to get markets back up to par after such a key component nose dives.

  • Google is weighted heavily in key indexes & many tech ETFs
  • Google is seen as a bellwether. If they can’t get the numbers to work out as well as it looked like they would, then many money losing tech startups that are soon coming to market will have people question how they’re going to get their numbers to work.

Google rarely misses, but they stunk up the joint in Q1 by showing a rapidly decelerating ad growth rate, with the YoY rate decelerating from 26% to 17% in the quarter & operating margins falling from 25% to 18%. Google claimed a big part of the shift was due to changes at YouTube:

“While YouTube clicks continue to grow at a substantial pace in the first quarter, the rate of YouTube click growth rate decelerated versus a strong Q1 last year, reflecting changes that we made in early 2018, which we believe are overall additive to the user and advertiser experience,” Porat said on the company’s earnings call Monday.

If YouTube was the main driver of the miss you would expect to see rapidly slowing click growth & increased cost per click. What we saw in the quarter for Google properties was:

  • paid clicks (also includes video ad views): up 39% YoY, down 9% QoQ
  • cost-per-click: down 19% YoY, up 5% QoQ

Ads on search clicks are worth far more than video ad views because there is a lot more expressed intent in searching for a specific keyword than there is in watching a random(ish) YouTube video.

Over the prior 4 quarters Google grew their owned & operated ad clicks about 60% YoY while driving down CPC about 24% YoY. The rapidly decelerating click growth & CPC falling less than it had been would indicate YouTube is perhaps getting closer to ad saturation.

Historically a rising click count at above a 50% rate means massive YouTube ad view expansion, which normally correlates with blended click price being off around 20%. That Google rose their cost per click in the first quarter from the seasonally strong 4th quarter does indicate they’ve slowed down ad growth on YouTube compared against prior quarters.

When the first month of a quarter has an announcement that Google is culling a large partner from their ad network that can be seen as more than a hunch they had a soft quarter & are doing clawbacks.

Prior to the app removals, DO Global had roughly 100 apps in the Play store with over 600 million installs. Their removal from the Play store marks one of the biggest bans, if not the biggest, Google has ever instituted against an app developer. 

Though it also remains to be seen how or why Google needs BuzzFeed News to ensure click quality!

DO Global is a Chinese app developer that claims more than 800 million monthly active users on its platforms, and was spun off from Baidu, one of China’s largest tech companies, last year. At least six of DO Global’s apps, which together have more than 90 million downloads from the Google Play store, have been fraudulently clicking on ads to generate revenue, and at least two of them contain code that could be used to engage in a different form of ad fraud, according to findings from security and ad fraud researchers Check Point and Method Media Intelligence.

Google sending out questionnaires to small businesses about monetizing the hell out of local search is another clue the quarter was going to stink.

The weakness Google showed in the most recent quarter likely has to do with ad load saturation. They could add another ad unit on desktop search results, but key categories like hotels & e-commerce already stack ads via showing multiple different formats. They have also ramped up YouTube ad load a lot over the past year.

Google’s push of programmatic advertising has led to a greater share of their non owned and operated inventory being low quality garbage clicks like the stuff DO Global was offering.

Leading publishers have reoriented their focus to place more emphasis on subscription revenues & less on advertising. And some of the leading destination sites are not only ad buyers but are also becoming ad sellers.

Amazon.com now carries a heavy ad load. They are piggybacking on the install base of Google’s DFP to launch the Amazon Unified Ad Marketplace across the broader web. And then Jeff Bezos also has a sneaky secondary play to further peal off premium publishers from Google. Washington Post’s ARC Publishing has partnerships with the sort of premium publishers Google has perhaps taken for granted:

The software-as-a-service platform may grow into a $100 million business that would bolster the company’s bottom line.

Shailesh Prakash, head of product and information technology at the company, said Arc has expanded its clientele beyond WaPo to include almost every major advertising market in the United States. Its technology powers the Chicago TribuneLos Angeles TimesNew York Daily NewsThe Boston Globe, The Dallas Morning News and The Philadelphia Inquirer.

That gives Washington Post great benchmarking data on their competitors. But it (combined with Amazon’s first party data) also puts them in an enviable spot to launch a premium ad network. I could see them offering the technology free (or rebated to make it free) in exchange for using their ad server. At that point Google gets to have an ad netwrork consisiting of fat thumb misclicks on mobile games while premium advertisers & premium publishers are drawn in closer to Amazon’s orbit.

Look what Amazon recently did in the freight market. Offer a service at no margin to destroy the capacity utilization & economics of an incumbent, and then only after shifting the economics consider making a profit. The ad network equivalent of that is peal off many of the premium publishers while leaving the existing ad network with backfill dreck.

Walmart & Target are following Amazon in ramping up their ad load. eBay is also growing an ad business which will include a CPC aspect. Facebook’s Instagram now has a checkout feature.

With so much selling off it could be the beginning of a bear market, so no harm staying heavily in cash. That said, here are some stock ideas I am looking at…

  • PETS – earlier today Petmed Express was off over 3% in part on general market downdraft, fall of internet related stocks & an ultra bearish analyst call on PetIQ that pulled PETQ down about 15%. As of typing this PETS is down almost 3%. Chewy.com also filed for IPO, so that could have a big impact (hype around IPO could drive PETS higher until some analyst makes a call that Chewy.com will eat everything & downgrades PETS). Petmed Express reports earnings on the 6th.
  • VIRT – if volatility picks up this stock often has a negative correlation to many others, as they are an HFT shop that can scrape more meat off the bones when others are forced to liquidate positions. They were off about 2.5% earlier today & are still down about 1.5%.
  • MMYT – they made a strategic majority investment in corporate travel firm Quest2Travel & were downgraded by Bank of America in the wake of Google crapping the bed – a proper triple lindy. Last week did Ctrip increase their holdings in the company to 49%. They’re off over 10% today, putting their stock right where it was before the Ctrip announcement was made. This stock has low liquidity & sometimes spreads can be a bit wide on it, so it is worth considering a longer term position, particularly if you think the domestic India internet will parallel the development of the Chinese & US internet ecosystems.
  • I don’t follow commodities heavily, but African swine flu is causing big problems in China. Some of the related protein stocks have been strong & are up even on a day like today. Tyson (TSN), Seaboard Corp (SEB), Pilgrims Pride (PPC) & the JBS ADR (JBSAY) might be worth a look & a small exploratory position. Many of them are up about 50% off the bottom from late last year.
  • EIGI – probably has another day or two of decline, but Endurance International Group bombed earnings and lowered guidance. They’re now at fresh 52-week lows & are down over 10% today, so who knows when the bottom will be in. At some point they will be a P/E buyout target as they are trading at well under 1 times sales. Anyone who can come up with any sort of upsells on hosting that they are not doing could drastically expand their margins as they have about 4.8 million active subscribers. Hard to believe they were founded in 1997, have negative growth YoY & are still losing money.
  • Health insurers – if you don’t have any exposure to healthcare yet, these are quite beaten up & the current Congressional hearings are about as rough as it will get provided Bernie Sanders is not elected and/or the Senate does not flip in 2020