To the Barricades

Blain’s Morning Porridge 28th Jan 2021: To the Barricades

Is this the Market Spring? There is a serious mass delusion underway. It can only end badly…

“This thing’s really outrageous, I tell you on the level
It’s really so contagious must be the work of the devil

Mother please, is it just a disease, that has them breaking all my laws,
Check if you can disconnect the effect and I’ll go after the cause
No-one will tell what this is all about
But I will find out, I will.”

Back in medieval times, Ergot was a fungal mould that would infect corn stores and drive populations mad. Watching the current market action, and the Reddit memes, I’m wondering what particular malign madness is driving it all. Have the Chinese sneaked something into the water? Maybe some evil genius hacker has invented a bio-computer-worm that jumps from screen to infect human brains – spreading it through Reddit making millions believe they can trade capitalism into the ground?

Or maybe this is a genuine revolution..? Founded in frustration and genuine grievance?

As I highlighted yesterday, if you are one of the top 1%, then you’ve had a pretty good Pandemic. Your stock portfolio has gone up in value. You’re comfortable working from you pretty countryside home. You don’t have to commute and you’re pretty well off and happy.

The mob aren’t.

They live in the real world of lockdown frustration. They suddenly found a voice taking down hedge funds (or so the stories say). They have stumbled into the market and is discovered they have power. How corrupting. Acting in unison and driven by speculation, the masses expect to overturn the old order. Maybe storming the palaces of the rich online is preferable to the usual outcomes when angry, dispossessed bored angry mobs storm Versailles – which never ends well. Like all other mobs through history, they will likely be disappointed.

We do need to think about what’s driving this insane market behaviour.

The apparent rewards of speculation – fuelled by the very visible socia-media lived lives of the rich and the obscene wealth of the very few – has convinced millions of bored young people they can also make billions, change their lives and get everything they think they deserve from markets.

They are not ignorant – but well educated college graduates who see their life-chances far more limited than their parents. I recently read a fascinating article last year celebrating 3 decades of the Simpsons: 30 years-ago the yellow cartoon TV family represented the down-at-heel lower middle class tottering on the edge as they barely made ends meet. Today their unchanging lifestyle is way beyond the expectations of most American families.

Same thing here in the UK. When I was in my mid-twenties I was looking to buy my first flat. My son has a great job and is well paid, but he’ll have to save for years and see his income triple before he can realistically buy anything in London. He’s looking at markets and wants my advice on how to make his savings work for him. He’s tempted by the madness all around him – his favourable views on Musk are fashioned by the wisdom of the mob. He’s wondering and attracted to how Bitcoin might enable him to climb up the ladder.

So, this morning, let’s start with something for my kids and their generation – a very simple look at what is real and what is less real. Let’s do a very quick compare and contrast:

Apple is real.It has just posted its most profitable quarter ever. It has successfully commoditised a high value consumer discretionary product in its own name, the iPhone, and innovated a whole tech ecosystem around it. It can expect to sell more and more people a new phone every 2 or 3 years. It takes a massive margin from each sale, meaning it $111 billion in quarterly sales translates to a $28 bln profit.

I do have concerns about Apple. Its initial success came on the back of Steve Jobs disrupting the whole personal computing business, giving it status and style. Design and function were its core value. Now it’s become commoditised – which helps its profitability. One day someone will invent something new that will make the iPhone and the rest of the range obsolete. No company lasts for ever. Can Apple keep innovating to refresh and bring on board new customers. Its current customers are ageing. Will future generations be so keen on bright shiny tech things?

Apple is a very real company paying dividends with a market capitalisation of $2.4 trillion. But it trades at a P/E of 43 times – which is frighteningly high for an old market dog like me, constantly wondering about future challenges.

Tesla is an equally real company. After years wondering if it would survive, it’s now very well capitalised, has a clear path to expansion with new factories, and is meeting many of its promised targets. It just posted $31 billion in annual sales and a $721 million profit on 500k car sales. Its’ market capitalisation is $820 bln, and it trades on a P/E of 1700 times. That would terrify me.

Tesla is the market darling. Every Gen X, Y, and Z loves it. Yet, for all that it wishes to be Apple and a commoditised unchallenged market leader, it is not. It had created the EV revolution, but has spawned a host of competitors, and raises some very challenging ESG (Environment, Social and Governance) issues about the company. Tesla hasn’t yet made a penny selling cars, its’ made profits from selling regulatory credits, a form of government market subsidy.

The difference is…. Apple is a good stock. It provides investors with a solid return from dividends and rising value. But Tesla is a stratospheric moon-shot. $1000 dollars invested in March 202 is now worth $8000. That is a number no PBDJTGR (Poor but desperately keen to get rich) young speculator can ignore. But piling into Tesla at this level is one any experienced market professional would caution against.

In times of revolution no one listens to conventional experience. So, our young investor decides to do some research and end up on the Tesla fansites.. telling them what they want to hear. Reinforcing their hopes that $8000 invested today is going to double, triple or quintuple by next year they buy – after all, even bank analysts have jumped on board.

This where this gets really dangerous for everyone.

For the last 13 years since the Global Financial Crisis we’ve seen the most incredible transfer of wealth from the real economy into financial assets; stocks and shares. This has happened because of central banks propping up the real economy by bailing out bank, keeping interest rates low and buying bonds via QE. Meanwhile, voters have listened and watched as a strong financial asset markets are equated with economic success. They listened to Donald Trump equate the success of his presidency with a rising stock market, and many applauded as Trump bullied the Fed into easing to push up the index as his popularity wavered.

As I highlighted yesterday, most of the money the Fed and other central banks has barely touched the edges of the real economy. Most has gone straight into financial assets, driving up the price of stocks – which is why everyone who knows anything from experience about stock markets thinks they are in bubble territory.

Lots of Americans now equate success with a strong market, and wonder why it doesn’t percolate down to them in their rotting cities. They want a bit of it, which is why lockdown and bored young people with nothing else to do are now playing stocks like it’s a game. They’ve never heard my first rule of markets: “The market has but ambition: to inflict the maximum amount of pain on the maximum number of participants.”

It’s not just the Reddit mob who will likely be disappointed. We will all lose out due to distortion.  It’s killing capitalism. 19% of US companies are now Zombies – companies that will die if rates normalise. We’re seeing similar numbers in Europe and the UK. As long as rates stay low these dinosaurs continue to dominate and stifle market innovation.

Such firms defeat the purpose of capitalism – distorting the cost of capital and favouring the growth of corporate bureaucracy and inertia. Large companies that are too-big-to-fail, survive on the back of subsidy and bailouts, or can continue to borrow on the argument debt is so cheap, levering themselves higher and higher while doing nothing to improve productivity or their product lines either become long-term economic bed-blockers, or, as is happening now, become blocks on innovation.

Tesla is a great example of how a disruptive new company that created a paradigm shift from the old Internal Combustion Engine, and replaced cars with connected software driven Electric Vehicles, at a stroke reinventing the whole basis of personal transport and allowing us to move towards driverless cars, and new ownership models where cars can become financial assets making a positive return.

Maybe. But for every Tesla that’s created expectations of extraordinary disruptive profits, the end of Schumpeter’s Creative Destruction as the driving force of capitalism has created firms like Boeing: using the same old 1960s format plane with minimal and dangerous modification to reap windfall profits from mass production, which they invested in stock-buybacks to push up the stock price so the executives could pay themselves more.

If I was to bring a new planemaker to the market, based around new clean carbon battery technology that forms the wing and fuselage, with a power density enough to power meaningful lift capacity via electric engines, I’ll struggle to find finance. I’ll be told it doesn’t work because its too frontier finance, it will be tech risk, it will be “too expensive to succeed in current market”, and how-much-can it attract in subsidy.

But the real reason will be that money management has become as distorted as capital flows. All these years of financial repression hasn’t just killed business, but has killed investment as well. Markets are following money and not real growth and the real economy.

Finally, it’s worth bearing in mind some fundamental numbers about how this market is distorted – I took this from a piece on Linkedin: “Total stock market capitalization vs GDP on inauguration day of a new president: Ford: 40% Carter: 47% Reagan: 43% Bush I: 53% Clinton: 64% Bush II: 117% Obama: 60% Trump: 125% Biden: 190%”

It’s not just me that thinks the market is a bubble that should burst. There isn’t a single reputable name out there saying anything except this is dangerous. I listen to these guys because they suffer from experience. I’ve seen this in 1987, 1992, 1998, 2000, 2008 and today. I’ve seen this before.

No time for things to read today…

Out of time and back to the day job

Bill Blain

Shard Capital