Three things made the period — 1980–2022 — one of the most investment-friendly episodes in history. Energy was cheap. Labour was cheap. Credit (borrowed money) was cheap.
And now? Governments discourage investments in the traditional energy sector. The pool of Chinese peasants that held labour prices down since 1979 has dried up. And the credit cycle turned two years ago; since then, interest rates have been increasing, aided and abetted by the Fed.
In short, the situation has profoundly changed. Has anyone mentioned this to investors?
But the thing that neither they, the administration, nor the Fed can ignore is inflation. It raises consumer prices and puts the voters in a foul mood. It also scratches the Fed’s veneer of faux competence, forcing it to take unpleasant action. And so, with consumer prices rising at the fastest pace in four decades, the Fed promises to keep raising rates until the ‘job is done’.
We doubt it will have the stomach to see it through.
Instead, as our investment director, Tom Dyson, puts it, the Fed will raise rates ‘until something breaks’. Then, it will pause and pivot.
Today, we look at the teacups.
Longshot lunacy
‘Financing Dries Up on Wall Street’ says a headline in yesterday’s Wall Street Journal (WSJ).
The gist of the story is simple enough. When all of Wall Street was carefully cottoned up in the lowest lending rates in human history, it was hard to break anything. There were plenty of delicate pots and dainty cups around. But whenever they were rattled, their owners could simply coddle them with more cheap credit.
The result — in the US’s corporate sector — is some US$10 trillion in debt outstanding, much of it owed by companies with no means of paying it back. From WSJ:
‘North American companies will have to come up with at least $200 billion in 2022 and 2023 to cover rising interest expenses…’
What happens?
Cathie Wood is a celebrity fund manager specialising in long-shot tech plays. She reached star status in 2020 when her portfolio went up more than 150%. Then, it was easy to bring in new capital; many people wanted a piece of the action. Tech firms were given absurd valuations…even many that were as fragile as fine porcelain.
The trouble with ‘tech’ start-ups is that they are often unprofitable. Of Ms Wood’s top 25 positions, for example, 21 of them are money-losers. And many of them have no way to reach profitability anytime in the near future.
So, they can only stay alive by borrowing…or raising more investment capital. And that is becoming increasingly difficult. In the WSJ report, for example, we learn that ‘mergers and acquisitions dropped 43% in recent months and initial public offerings of stock plummeted to their lowest level in more than a decade’…
In October, IPOs were 95% down from a year ago. ‘Funding of investment vehicles called collateralized loan obligations plummeted 97% from last year’s level’, WSJ continued.
Non-profits and loss
Of course, there are other sources of capital. There are private lenders and private equity deals. The trouble with those is that people who invest their money tend to be tightwads. Valuations are usually much lower than those in the public markets…especially those of the Bubble Epoch.
In his business life, your editor works with one public company and one private company. The two are very similar. But the stock of the public company trades at a price-to-earnings ratio of more than 10. The private company, were it sold, would expect a multiple of around five — only half as rich.
But what happens when there are no earnings to multiply? Here are just a few examples compiled by colleague Garrett Baldwin in his delightful Postcards from the Florida Republic:
‘Shopify trades at 8.1 times sales, and it’s unprofitable.
‘uPath trades at 5.7 times sales, and it’s unprofitable.
‘Crisper (CSPR) — sure, it’s “disruptive” in gene editing. But we’re talking about a stock at 83.9 times sales…it’s unprofitable.
‘Roblox is off 48% this year. It should be off more than this. It’s trading at 11.4 times sales and 44 times book value. It’s unprofitable.
‘Nvidia (NVDA) — while profitable — is still trading at 12 times sales and 14.8 times book.
‘Toast, a restaurant software platform that is unprofitable, is trading at 3.9 times sales. It’s 8.5 times book.
‘Bill.com — an HR solutions software company — is widely held in ETFs by Vanguard, but it’s unprofitable and trades at 16.9 times sales.
‘Cloudflare is at 16.2 times sales, is unprofitable, and trades at 23.1 times book. The insider-selling to-buying ratio is 331. Executives have dumped $332 million in a year. This goes on and on.’
No bid
Many of these unprofitable techs will find no funding at all in the public markets. They will go ‘no bid’ and be forced to slither back into the private world. There, they may or may not be able to stay alive. The skinflints in private markets will demand huge discounts. Many companies will find no buyers at all…at any price.
Big companies, as well as little ones, are now sweating their interest payments. Some of them already face interest charges north of 10% — which is a lot to pay for a struggling business. One by one…tiny cracks will appear. And then, like the proverbial bull in a china shop, Mr Market will stomp on them all.
Finally, when the whole place is a wreck of broken investors sifting through the shards of broken companies, Mr Powell will rush in…with glue.
Regards,
 |
Bill Bonner,
For The Daily Reckoning Australia
