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Commentary on The Capital Markets- Category [Market Musings]

This is no longer "just" a profit recession, you see.

Nor is it "just" a commodity recession.

Nor is it "just" a transportation recession, although that one ought to get your attention, and fast.

No, it's also in industrial machinery and, well, pretty-much everything else, with few exceptions.  Even retail sales are getting hammered.

How do you square where the market is with this economic fact and outlook?

You don't.

One of the two is wrong, and that one will move (and probably quite rapidly) to match the other.

PS: I've seen this movie before, and so have you.  Topping pattern, swoon, attempt to break out above old highs fails on false, pumped media hype and hope, and then........


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Ok, analysis time.

Facebook is currently selling at a 110 P/E and 20x sales.

Many people point to the firm's "large" profit margin.  That's false; the firm has a margin of about 19%.

The usual mantra is that "it'll be fine because the company should earn $4/share in 2017."

Ok, let's analyze that.

First, there's a huge problem with that assumption -- the current year earnings are $2/share, so that's a double.  To do that it has to manage to pull off a ~40% EPS improvement in each of the next two years.

Assuming operating margins remain more-or-less constant this means revenues have to double, and that in turn means users do too, or something close to it.


No, and here's why -- the company already has the majority of Internet users on the system.  There is no additional reservoir to tap.  This, in turn means that user acquisition must slow -- remember, you're not looking forward one year here to get your "reasonable" figure, you're looking forward two years, and if you do get there the stock still sells for 50x earnings and 10x sales.

For it to be worth that it would have to be expanding at roughly 50% annually on an indefinite forward basis in 2017, but by then more than the entire current Internet user base would be on the platform.

In other words it's not going to happen and the analysts know it -- it's basic arithmetic.

Therefore, the current price is unsupportable -- period -- because we live on a finite rock with a finite population and therefore a finite opportunity, and Facebook, even if nothing goes wrong with the story, is already near full penetration of the available opportunity!

There's nowhere to go here folks but down, although the idiocy of the analysts and you lapping it up may well drive it materially higher before this is figured out.

However, the arithmetic always wins, and when it does the haircut is going to be really aggressive; a saturated market is perhaps worth 12x actual earnings, not 100x.

You do the math on where that puts the share price.

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The Naz is being notably amusing today.

Facebook, Amazon, Tesla and Netflix are all up big, as is Bidu.

A few other things are up marginally.

Everything else is down hard.  With the exception of Amazon, Netflix and Tesla (all "consumer discretionary" according to the classifications) the group is a disaster.  Consumer Staples, Industrials, materials and Health care are a blowup, not blow-out.  IT is up only because five firms are the bulk of the group; Google (twice since there are two listings) Facebook, BIDU and Ebay, all of which are green.  The rest are mixed.

The S&P is pretty ugly too.

Own one of the high-flyers?  You're ok for today.  Don't and you're red.

This is exactly like the "Four Horsemen" of 2007 and we know how that ended.

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If there's a good way to characterize this earnings season in a phrase, it would be this: Narrowing strength.

There are a number of firms that have moved sharply higher -- that is, 10% moves upward -- on earnings releases.  But there are many that have also been utterly destroyed even on earnings that met expectations, and this leaves the market's move upward in the last month resting on an every-narrowing group of companies.

I've often drawn comparisons to other times in the market; it is very rare for markets to repeat themselves exactly, but they often trade on similar themes.  In 2006 there was a "summer swoon" that was quite-severe, and yet it proved to be great buying opportunity in the names that were most-punished, particularly among tech firms -- provided you were prudent and got out in early 2007.

If you didn't you got destroyed over the coming two years.

What you have going on now is the same sort of thing but on steroids, and just as then the market crooners such as Cramer, who was creaming all over himself with regard to Starbucks this morning, will once again lead you straight off the cliff.  Who doesn't remember his infamous call that "Bear Stearns is fine" just a week or so before it blew up?  He tried to backpedal and say that he meant if you had money deposited there you'd be fine but that's nonsense since Bear Stearns, as an investment bank, didn't take deposits!

He clearly wasn't speaking to the hedge funds that did business with them; how many of those folks take advice from people like Cramer?  No, he clearly was speaking to people in the "general public", 99% of whom aren't qualified investors and thus can't be involved in such transactions even if they wanted to be (and they shouldn't be, by the way.)

Again we see the same thing going on in the market today.  Firms with very little in the earnings relative to their stock price are "leading"; Amazon (P/E 900), Facebook (P/E 106), Starbucks (P/E of 35?!), LinkedIn (negative P/E; they posted a loss!) gains 11% on said report, etc.

For a couple of years now many of the "hot" names have rocketed on ridiculous valuations.  Buffalo Wild Wings was one of them, quadrupling over the last few years despite being a sit down restaurant chain with a P/E north of 30.  Insane.  They took a nice haircut the other day.  Solar City was trading at nearly $64 as recently as June; today they trade at more than half-off, or $31, with the latest shellacking coming in the form of a 18% loss while reporting the latest excursion in their cash-furnace exploits.

Tesla is another, from $286 just a few months ago now down to $210, again, the firm is a cash furnace that has existed solely on the willingness of people of shovel ever-more-money into said furnace.  Then you have Netflix with a P/E of over 280 that is only positive on the earnings front at all by off-balance-sheet liabilities that, were they to be recorded, would result in monstrous losses.  In other words this is another cash furnace funded by gullible fools on Wall Street that keep shoveling money into the feed hopper.

I have no idea in the end how long this crap will go on, but this much I can see just by looking at the numbers -- the "strength" is narrowing a lot, just as it did in the late part of 2006 and early 2007 and the "quality" of that leadership is deteriorating markedly.  We don't have bullwark firms that sell real products and a reasonable valuation leading this market, we have speculative crap that burns investor cash based on the guile of their CEOs leading the market higher instead.

Who really believes that what Starbucks thinks up in "mobile payments" is going to change coffee?  C'mon folks; you still either walk up or drive up and pick up the coffee.  How much faster is it?  Not very, if at all, and while there's a cost difference it's small (discount rates for traditional cards on card-present transactions are well under 2%, especially in volume.)  Schultz is talking about being a mobile first, consumer-facing company yet this is horsecrap as Starbucks by definition is a firm that delivers a physical product in a physical store from their hand to yours!

The idea that this will "get rid of lines" (Schultz' latest nonsense) is a load of crap; lines exist in such a store because the rate of production is limited; it takes X time to pull said coffee and if you get my order before I get there I no longer have a piping hot, right out of the machine coffee served to me, which destroys my customer experience.

Cut the crap.  There is no "innovation" there and what does exist among Starbucks' proprietary payment interface and card system is an unknown, and unknowable potential for security problems with the risk being theirsunlike the traditional card systems where the risk is on the bank.

If there was some meaningful advancement in any of these firms predicated on an actual earnings stream that is either present or has some demonstrable ability to materialize I might see value there.  But I don't -- what I see is accounting games, gullible people being conned by Wall Street out of money to buy bonds that are then used as fuel for a boiler, and while that may contribute to the top line the bottom line is negative and as a result this furnace does nothing at all other than warm the executives pockets and, for as long as it lasts, pump the stock price.

Cash flow always eventually wins; this is why all ponzi schemes eventually collapse.  You run out of suckers in the end as you must, simply because someone eventually sticks their hand up and asks why they should keep giving your money if there's no real return in the offing and the day at which you promise it will happen keeps being moved into the future.

Enjoy it while it lasts folks; all the cheers will be tears soon enough.

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