Wall Street heavyweights are sounding alarm about stock prices
bloomberg.com
bloomberg.com
If the market is going down, then even cash is a better alternative.
However, at this point in the cycle most people have missed the boat. Probably best to ride out the cycle (assuming you have a diverse portfolio).
said the billionaires, and continued pumping money into rent seeking, cornering existing markets.
then one of them got inpatient and built "new" things
- SpaceX [$36b] - cheap access to space, potential to revolutionise travel with starship
- Starlink [$30b] - ubiquitous planetary Internet
- Boring Co. [$1b]
- Tesla [$150b] - electric cars people actually want, OTA upgradable software, potential for autonomous cars, recover up to 60% of cities land are currently used for parking.
- Neuralink [$0.1b]
- OpenAI [?]
True, but what are they going to do about it?
They would be hard-pressed to find a rewarding asset class today that has billions in liquidity, with less risk.
If they hold cash/tbills, they risk losing a good chunk to inflation from the new monetary policies.
They could try to hedge for a market crash, but timing it seems difficult - the market can remain irrational longer than they can remain solvent. And hedges are aren't cheap with the higher IV levels today.
Additionally CPI tends to be a lagging indicator. In other words it is a good way to determine if we have just seen massive inflation. The stock market is forward looking, meaning analysts are considering future risks in pricing the assets.
This is true, but various parties have been predicting a large increase in inflation in the US for years and years and they keep being wrong. I expect them to be wrong again this time too.
But we'll see!
Anything with inelastic supply has gotten more expensive by an average of about 3% every year for the last decade: health care [0], education [1], real estate [2]. That's 50% higher inflation than the 2% conventional target, and arguably after the revelations of 2008 one might justifiably expect even lower than 2% natural inflation.
Then there's the very rapid rise in the price of stocks which is itself a form of price inflation (it takes more money to buy the same share of the productive economy).
Anything rich people/institutions hold or supply in exchange for dollars from laborers has gotten more expensive at a substantially-higher-than-normal rate.
[0] https://www.in2013dollars.com/Medical-care/price-inflation
[1] https://www.in2013dollars.com/College-tuition-and-fees/price...
When we talk about the rate of inflation we aren't talking about the cost of health care or education or real estate or really any other particular good. We're talking about the value of money.
I'm just saying that the nature of the problem isn't runaway inflation. It's a different problem than that.
I will leave you with this — do you think there might be a reason why the conventionally promoted inflation definitions and measures allow rapid increase in cost of living on fixed income to be called "not inflation"? Do you think that's a good definition, if it means someone with a fixed future cash flow can now buy a smaller stream of future goods? What/who is served by sticking to these (IMO gerrymandered) definitions of "value of money"?
We've gone deep enough and I will leave my contribution at that (though obviously feel free to reply). I too was educated on these technical definitions of inflation and I have become extremely skeptical of them as I have seen the mismatch with lived reality.
Edit: I won't make any more points, but I will say that I consider the implications in the response below here uncharitable and unresponsive to the points above.
I do understand that there are others with this point of view including, apparently, you.
I have tended to notice that people who believe these things don't tend to defend them on technical merits but tend to retreat into accusations against the rich and powerful instead, because of course that group of people must be pulling a fast one on everyone else. I do not find these sorts of arguments persuasive.
How do you figure that risk, numerically? Historically high US inflation sits around 15% (per year, obviously). The market crashed 30%+ literally a month and a half ago, and per the linked articles (and a straighforward naive reading of the fundamentals!) seems poised to do that again.
I can't believe you genuinely view a short term 2-3 year cash holding as riskier than a stock position. It's true it lacks upside, but that's not the same thing as "risk".
You don't make an investment on the basis of "you can't prove to me this won't happen", you have to come up with numbers the justify it. So I'm asking again: what are your numbers that you feel the probability of a historically high burst of inflation is higher than another market crash like the one in March?
There have been a few big events in the past 50 days which would make me think the market is different today than it was 50 days ago.
For one the Federal Reserve has dropped interest rates and committed to backing up money market funds as well as short term commercial paper. I definitely think that this removed some risk for investors.
A large part of the fear was that companies would face serious solvency issues. I think companies access to funding (either selling new shares or selling bonds) have made this less of a concern in the short term.
Additionally, Congress passed bills to extend unemployment benefits and fund 2 months of payroll expenses for small businesses. While we have to wait to see the effects I don't think it is unreasonable to expect that paying people not to work will have some impact on inflation.
I completely agree that we are not out of the woods yet with regard to this pandemic but I would say that we are 50 days closer to being on the other side. 50 days ago, in the New York/New Jersey area where I live, our government officials were telling us we were days or in some cases hours from having our hospial ICU's at full capacity. While I am not saying that we can't find our selves in the same situation again, I do think we are in a different place now.
>You don't make an investment on the basis of "you can't prove to me this won't happen"
Just to make sure I am 100% clear. I am not making investment advice. I have no idea if the stock market will go up or down. You made the claim that the market will drop by 30%. I was interested in how you came up with that number.
I think this depends what reasons you would pick to make the above statement, at least for US market.
My subjective reasons to be more positives are (in no particular order):
- The covid-19 induced death toll that was project in March is no longer assumed valid and is halfed, at least.
- Unfortunately, many deaths appear to be due to mismanagement of nursing homes. Therefore, focusing on how to fix that problem (and hold incompetent policy makers accountable in the process) -- is a manageable way forward.
Point in statically sampling there, (and may be I am too optimistic), is that these horrific outcomes for our elderly in these homes, may not apply to overall larger population.
- The analyst assumed unemployment rate by May was 16%, but numbers came out to be below that.
- The increased availability of testing, ventilators, personal protection equipment, and the reduction of bottlenecks in CDC, FDA happened faster than I expected.
- Not surprisingly, overall traffic in US is reduced by 38%. Which has is temporary positives (eg reduction of traffic fatalities). To be honest, not sure why I am including this in the list, but feels a temporary positive. My driving is reduced, but feels safer. May be something good will come out in this regard, long term. The traffic death/injury toll in big cities is just terrifying.
Overall, though, I think the market is overpriced at this point.
There is a shift in earning potential from 'travel and commute' related industries to online/telecommute.
But that shift will take years (may be 3-5 years), so that folks reposition their skills/workforce participation to accommodate the new realities.
However, the market thinks it 'has already happened'.
So I agree that the market is overpriced, but not because 'same reasons from 50 days ago, still hold'.
P.S. I lost a 93 year old relative in NY, they said person was not covid-19 positive, but no relatives were allowed in the hospital during treatment, and they used ventilator.
[1] https://www.newsmax.com/health/health-news/car-crash-acciden...
This too sounds like a prediction to me. Keep in mind that a bunch of huge companies like Google, Amazon, Wal Mart, etc. own a ton of commercial real estate. If commercial real estate does collapse, it’s going to have impact. The tech giants seem to be sitting on massive piles of cash, but I guarantee that’s not true for everyone.
We all saw how devastating the CDO monstrosities were in 2008, and it’s hard to see how this outcome will fare much better if the commercial real estate sector has been playing the same games since the last crisis.
"Stock trading" is already just another form of online gambling. Novices have been doing day trading for quite a long time and it does seem to attract more people during times of volatility.
1) Open 20 different Reddit accounts.
2) In each of them claim to make a different crazy bet, preferably using options and “document” it. Doesn’t matter if you actually make the bet, photoshop works fine too.
3) Once the trades close, abandon all your losing accounts, and start posting photos of “your” new Ferraris and luxury yachts on your winning accounts.
4) Announce you are using your magical trading skills to open your own trading fund open to a select few redditers who wire you money first.
The stock market is about speculation, plain and simple. At some level is people playing "business owner" without having a clue how to build value or where it comes from. Go back to my prior 5x scenario for context.
Nothing wrong a speculative market, it's just a matter of accepting that reality and everything that comes with it. I made a pretty nice living a couple of decades back day trading full time. Traditional investors putting their money into the market have no clue what goes on in the speculative battleground they trust with their savings.
Again, to clarify, I am not saying it is a negative. One can do very well in a speculative market. The key point is that it is important not to confuse it with reality in any way.
But if you mean small businesses like a restaurant or a dentist's office or whatever I would say that the comparison you are making doesn't really make much sense in the first place. Large companies have huge economies of scale and brand value compared to a mom & pop enterprise who's revenues are just as much labor income of the owners as return on capital.
I do realize private data is hard to come by, but this is known to people in the business world. It's very, very hard to sell a company for more than about 5x. I am talking from personal experience as well a from knowledge of friends who have sold non-VC tech businesses.
One way to look at it is that in the real world the buyer has an expectation of ROI that has to align with reality. Buy the business, run it, make money, pay for your investment and make money beyond that. People paying 123 times P/E for stocks have no connection to reality whatsoever, it's pure speculation.
BTW, I am not using "in the real world" as a pejorative. It simply means "non VC, non public".
Indeed this is definitely true. That doesn't, however, mean that firms with higher multiples are not connected to reality. It just means they have achieved some form of economy of scale or market dominance where there is a reasonable expectation that the ROI on the investment will be worth the risk.
have no connection to reality whatsoever, it's pure speculation.
Speculation isn't inherently unconnected to reality. There can be very real reasons to believe that a business currently making very little money (or even losing money) will, at some point in the future, make lots and lots of money. In these cases, it's very reasonable to see shares trade at very high PE multiples.
And so, what are people paying for when they pay 27x earnings in the stock market? It isn't real value. The stock is already grotesquely overpriced.
They are speculating that someone else is going to be willing to pay 28x or more. And the person who decides to pay 28x is hoping for someone to pay 29x.
This deal is obviously notable for its size, but companies being taken private are pretty common.
Panera Bread is another recent example and a good one since its business is pretty similar to Starbucks. That deal was for about 7B. Also a pretty big check. Also at a high multiple.
We have to separate the reality of the price of a stock from the value of a company.
I mean, the numbers don’t have to be very complicated: If a company makes $1MM per year, how much would you pay to buy it? $5MM? $30MM?
In the first case you get your money back in 5 years (simplified). In the other case in 30 years. A lifetime.
Another way to look at it: The guy who paid 5x will make $25MM in 30 years. The one who paid 30x walks away with zero profits in 30 years.
When people pay 20x, 30x, 100+x for stocks all they are betting on is that someone will be willing to pay more in the future.
Well sure. But you said no one would be willing to buy it at typical public valuation levels. And here are my counterexamples showing how that assertion was wrong.
And yes, there are lots of investments that take a long time to pay off. You ever invest in real estate? You aren't paying off that mortgage in 5 years in the vast majority of cases.
Price over Earnings. Earnings: What a company makes in one year.
Multiple: How many years of annual earnings you are willing to pay for the company. 5, 10, 30, 100.
This number doesn't exist int he vacuum, it very directly means --to a rough order of magnitude-- that you will need to wait 30 to 100 years to break even, assuming you take 100% of earnings every year for that duration of time, there are no economic downturns, the company remain viable and competition does not chip away at earnings.
Think about that for a moment, an investment that produces no gains whatsoever for at least 30 to 100 years.
This isn't hard to reason. Would you take everything you own, invest it into buying a company and know you are paying so much that it would take 100 years to break even? Or 30 years? Or 15? 10? 5? Ah. There you go. most people will say yes somewhere between 5 and 10, and that's because this is the real world.
I've said many times now, the only way these multiples exist is because the stock market is the domain of uninformed speculation. VC's and others love it because they can get ridiculous valuations for investments, for companies, that would have never produced those kinds of returns in the real world. Individual investors love it because the promise of of other speculators willing to pay more for their already inflated purchases would earn them money.
The whole thing is a speculative house of cards. I say this as someone who has been very involved in the markets for years. I very much like the reality that others are willing to pay more for things I buy. I also like the reality that these valuations are driven by emotion. I have made a ton of money recognizing and playing emotion in day trading by shorting stocks. I made money playing the emotion going up and emotion going down. Once you have that perspective it is impossible to look at the stock market as anything other than Las Vegas with different rules.
Today there's algorithmic trading. When I was day trading this wasn't so prevalent. People like me were using custom software tools to help make decisions but nothing even close to what exists today was in place back then. I am not sure I would do well day trading today. Not sure it would be easy to read emotion.
A typical counterargument is: Well, you buy the company, inject Y capital into it and increase earnings.
OK. Assume you buy the company for 100x earnings, inject Y and now increase earnings by a factor of 2. It will take a minimum of 50 years to break even. And, BTW, doubling earnings isn't that easy. Sure, yes, there are a bunch of internet companies who fly high and have done such things, but at some point earnings become somewhat asymptotic due to various factors, including competition, market size, etc. And it takes time, lots of time, for earnings to increase once a product offering starts to mature. In other words, from startup to flight altitude the rate of change can be incredible, once at flight altitude the scenario is very different.
In the VC world that's where the speculation lies. They are betting that these companies are going to be able to grow at a >45 degree slope for just enough time to go public, grab a really nice multiple and convert risk to cash, lots of it. Hey, more power to them, they are providing a valuable service (capital) and deserve to make money. However, I firmly believe individual investors have to be very careful about the idea of actually believing these valuations are real. They are only real if someone else is willing to pay more for what you just bought, otherwise the entire things is imaginary and fueled by speculation. Just like baseball cards.
The most fundamental question might be: What is reality?
I literally mentioned Panera Bread upthread which was taken private at these multiples.
I would not compare the later acquisitions or Panera to that of a bootstrapped non-VC businesses. I am thinking of LiveJournal, HotOrNot, Airliners.net etc - I am personally familiar with those multiples, and they are not 20 PE.
This Main St economy has as much in common with current public Wall St economy as Cessna 172 and the F-22. They both fly, but the rules are different..
Well obviously. There is a fundamental different in the economics of a single location coffee shop and a multinational company like Starbucks. The difference in these economics provides more than enough justification for one being worth a small multiple on earnings and the other a large multiple.
Only if earnings stay flat. Which won't be true for many, many companies. For example Startbucks (which you mentioned upthread) is currently growing earnings at a rate of 15% a year or so.
The fact that you are ignoring earnings growth is at the heart of your mistakes in reasoning especially for technology companies, many of which have the ability to grow very fast.
If you want to be more realistic, don’t assume a constant earnings growth slope and allow for market tracebacks and competition.
Very important: Do not look for companies to fit your model. The fact that there might be outliers that buck the norm does not modify reality. The vast majority of companies (public or private) don’t have never-ending constant high earnings and market share growth, far from it.
I invested in a modem manufacturer many decades ago. Imagine valuing that company at 20 or 30 times earnings! They were out of business five years after I bought the stock.
I actually do buy stocks valued at crazy multiples. The difference is I buy them based on a prediction that others will be willing to pay more in the future. The decision has nothing to do with ROI based on company fundamentals. If you can identify what the sheep are hot for, you can make a lot of money. And, when they scare, it’s priceless.
EDIT: In your calculations you have to account for the fact that you can’t take 100% of earnings from a company every year. If you did that you would implode it. You’d be lucky if you could take 25%. Breakeven is very distant in the context of real math.
https://www.gurufocus.com/stock/SBUX/dcf
In order to come up with a multiple of only 5X you do have to input numbers detached from reality. Seriously. Try to put some numbers in to get the DCF fair value down to the $14 range! Tell me what you put to make it happen.
1. http://www.philosophicaleconomics.com/2017/04/diversificatio...
Progress!
The inflation adjusted one could be interpreted simply as continuing concentration of capital and centralization. What about the overall market PE of all publicly listed companies (whose number is steadily declining by the way https://finance.yahoo.com/news/jp-startup-public-companies-f... )? I cannot find that data at the moment.
Which is not to say that this is bad, just different from the pre-2008 environment. Stocks used to be for the educated elite; now anyone with a cell phone and a bank account can participate.
Robinhood has maybe 20B in AUM. That's a drop in the bucket for a US stock market worth something like 30T.
This is no coherent analysis in this article, just a random collection of out-of-context opinions.
I generally expect better from Bloomberg.com .
When they crying, I'm buying.