Too FANGtastic for their own good
If You Only Look At One Chart…
Time is short, so here is one chart to get you thinking in a new direction.
Peak Indexation – Time to Go Active?
Source: BofAML – h/t Jawad Mian
- Falling correlations between stocks means that the individual characteristics of a security are now a more important source of returns – think alpha rather than beta.
- This is a call to arms for active investors – a ‘stock pickers’ market. Time to dust off your copy of The Intelligent Investor.
Right Here, Right Now
The best trading ideas of the week from RVP Contributors
Says Jesse Felder
The FANG stocks are under threat – could now be the time to shift to a long-term bearish outlook? Jesse Felder thinks so: Threats to the digital advertising market are emerging from ineffective campaigns that fail to deliver tangible results. Big-spending consumer staples groups like Proctor & Gamble are pulling the plug.
Furthermore, the deployment of unethical marketing tactics by Facebook and Google will shift public sentiment against two of the world’s most popular brands. Netflix faces new competition from Disney, and Amazon is just everywhere. Is this the pinnacle of FANG-mania and the start of a broader secular decline?
Adam’s Portfolio Picks
I have picked only the most compelling and highest conviction trade ideas of our RVP Contributors and will track them in a portfolio for you to follow.
No new Portfolio Picks this week.
Note: This is not investment advice. You understand that no content published as part of the services constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction, or investment strategy is suitable for any specific person
The Big Call
Legendary hedge fund manager Stanley Druckenmiller said when you see something in the market that really, really excites you, “Bet the ranch on it.”
These are the Big Calls, the investment themes that can make or break you. Think differently from the crowd and have a different time horizon, and you have an edge. RVP, with its crack team of financial minds, identifies the Big Calls and guides you through the investment opportunities when they present themselves.
The Bond Bears
What will it take?
I set out my secular bull case on bonds in The Hack 16 June. I see bonds staying lower for longer because the central banks have trapped us in a low-rate, low-growth environment where over-indebted governments have no fiscal firepower to stimulate the real economy. The 30-year secular bull bond market that started in the 1980s has shown little meaningful sign of reversing. Yet top money managers like Ray Dalio and Jeffrey Gundlach have been vocal in calling time on the trend toward lower and lower yields.
If nothing else, a medium-term tactical rout looks possible given the weight of long-term positioning in bonds. It’s crucial to explore the potential for a bearish move in bonds.
Stray Reflections sets the stage
One vocal bond bear is Jawad Mian of Stray Reflections. He thinks the bull market is over, having succumbed to extreme positioning, with investors adopting a ‘There Is no alternative’ mentality towards the bond trade – a complete volte-face from the 1981 peak in negative sentiment where bonds were seen as ‘certificates of confiscation’. The delta on bonds to interest rates hugely favours a taking a bearish stance now, says Jawad:
The long-run return prospects for Treasurys, and by extension most government bonds, remains unappealing as evidence continues to pile up that we are close to a major turning point in yields. A 100bp increase in yields would deliver a 9% loss in 10-year bond prices… in 30-year bonds, the same increase would lead to a 21% loss.
But what could drive yields higher? Rates are low, policy is accommodative, inflation is under control…
Gundlach’s view: the copper–gold ratio
Jeffrey Gundlach is the founder of Doubleline Capital and a legendary bond investor with $50bn under management – he is not afraid to make bold calls.
One of the things that I follow to give a really good short-term cyclical indication of the yield of the 10-year Treasury is the ratio of copper to gold. When the copper-gold ratio is rising, it’s incredibly suggestive that something is going on that might be a little inflationary. It suggests to me yields are going to break out to the upside.… The leg up in yields will be a catalyst of volatility in the market.
The copper-to-gold ratio has been rising, and the recent breakout in copper noted by Greg Weldon this month may herald a groundswell of economic growth – something the bond market is not betting on:
Ray Dalio’s view
Ray Dalio is one of the world’s most famous hedge fund investors, known for his outspoken calls and the somewhat bizarre culture of his $150bn hedge fund, Bridgewater Associates. Back in November Dalio called a bottom on bond yields:
We think that there’s a significant likelihood that we have made the 30-year top in bond prices. We probably have made both the secular low in inflation and the secular low in bond yields relative to inflation. When reversals of major moves happen, there are many market participants who have skewed their positions to be stung and shaken out of them by the move, making the move self-reinforcing until they are shaken out.
That inflation Gundlach sees in the copper–gold ratio might just be the thing that shakes out the structural positioning that Dalio alludes to. That structure is all part of the ‘risk parity’ trade.
Risk parity: rise together, fall together
The risk parity trade works by allocating portfolios across stocks and bonds to improve risk-adjusted performance. It has been increasingly popular since the GFC, because it performed well when global bonds rallied and stock volatility was high. But deeper historical back testing shows it was a poor strategy in the 1990s and earlier, when equity returns and bond returns were more highly correlated:
Source: Artemis Capital Management
The risk is that both stocks and bonds fall together – such that leverage in the risk parity trade is forced to unwind in a catastrophic manner. What the chart above shows is that investors are betting on a recent and relatively unusual phenomenon of a high anticorrelation between stocks and bonds – the historical norm is a moderate-to-high positive correlation. But what could possibly cause a breakdown in the trend and a selloff in bonds and stocks?
Chris Cole of Artemis Capital Management identifies the volatility of inflation as the key driver. Inflation has remained surprisingly benign since the crisis, carefully managed and guided by the central banks.
It is not hard to imagine a regime whereby central banks lose credibility or are not capable of moderating swings in inflation in a way consistent with the past three decades. Any period of sustained correlation failure will result in rising volatility and selling pressures across bonds and stocks in a self-reflexive cycle.
Now recall Gundlach’s copper–gold ratio. The risks of inflation are real.
Central banks hold the key
The next six months are crucially important for asset markets. As I said in The Hack July 6th, the central banks are cautiously hinting at tightening and shifting in their chairs to set up the first baby steps toward withdrawing nine years of extraordinary liquidity. This week, the Jackson Hole gathering may shed a bit of light on a roadmap for the future – the movers and shakers have one last tiny sliver of a chance to regain some credibility.
So I’ve changed my view?
What the bond bear arguments show you is just the other side of the same coin: The longer CBs remain loose, the more they invite inflationary outcomes and the more dangerous the risk parity trade becomes. I still think they have enough sense to at least try to climb out of the rabbit hole.
I remain a long-term bond bull: The mathematics of debt, deflation, and demographics in the West means growth rates won’t get us out from under these debt loads. I see central banks trying on some tightening for size in an attempt to rein in the market – and when it blows up they will have carte blanche to ease again, sending yields crashing.
Are You On This Yet?
In such a fast paced world staying on top of relevant market news and developments is tough. RVP scours the globe for the most interesting stories and distills them, keeping you ahead of the crowd.
How to Avoid Being a Patsy
Buy the Story, sell the news
Inevitably, very few investors are able to get in on the ground floor of the ‘next ‘big thing’. Very few people will be close enough to the genius who creates the next billion-dollar business to see the stratospheric gains that will accrue to the founders and entrepreneurs.
Amazon, for example, was founded in Jeff Bezos’s garage in 1994 as an online bookstore. But unless you were Jeff’s friend or neighbour, it’s hard to see how you could have got in on it at the start.
Even if you had been involved with the startup, it’s likely you would have been bought out at an early stage because of proto-Amazon’s lack of success. We’ve all heard of Steve Jobs, and many have heard of Steve Wozniak, but few have heard of Ronald Gerald Wayne, who sold his share of Apple to the two Steves for $2,300 in 1976.
The investment timeline
The stealth phase is where smart insiders get in on an idea. Usually these are the friends, colleagues, acquaintances, or family of the founder of something big. Soon they are joined by people who help convert the venture from an idea to reality. They are the big-thinking entrepreneurs who say ‘yes we can’ to an idea that most people wouldn’t quit their day jobs over.
Source: Dr Jean-Paul Rodrigue Dept. of Global Studies & Geography Hofstra University
Survivorship bias dictates that those who ‘make it’ appear to have always had an inevitably good idea – like Mark Zuckerberg and Facebook or Bill Gates and Microsoft. But the reality is that many a great idea – think of Betamax or the DeLorean DMC – died on the vine.
Early adopters get in during the ‘awareness phase’ – this is for venture capital and institutional investors, people with money who embrace and bankroll the idea. The funders of ventures like Facebook take big risks for big rewards. As the funding process matures, bigger institutions come in and start to embrace the new ideas, looking for growth at a reasonable price.
Finally, the new idea becomes a mania: The ‘new paradigm’ captures the public imagination. and the crowding in of so many new investors – the so-called ‘dumb money’ – sends the price of the stock to a parabolic blow-off top. This is the most dangerous phase for any good idea, whether it’s railways in the 19th century, internet stocks in 1999 … or possibly big-tech stocks today. There comes a point where you have to ask, if you, the average Joe, who found out about the next big thing by watching the TV news, is jumping in, who will be buying it off you?
‘If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.’ – Warren Buffett
Old man Buffett tells it like it is. If an idea has already peaked in popularity, it stands to reason that the investment in it might have peaked too. The process goes through several phases. First, public perception shifts, and you start to overhear street-level conversations about a stock; then the idea is all over the TV, and your best friend just quit his job to follow the new gold rush in computers/the internet/mobile apps/robots.
The signs are there
There are always signals in day-to-day life, whispers that all is not well. Before the 1929 crash, Bernard Baruch tells us,
Taxi drivers told you what to buy. The shoeshine boy could give you a summary of the day’s financial news as he worked with rag and polish. An old beggar who regularly patrolled the street in front of my office now gave me tips and, I suppose, spent the money I and others gave him in the market. My cook had a brokerage account and followed the ticker closely. Her paper profits were quickly blown away in the gale of 1929.
Inevitably, human psychology doesn’t change. Manias and panics are as old as the human race. So the way for the average investor to benefit is to by stopping to take stock of the situation. Look for clues that suggest that, just maybe, this thing has gone a bit too far.
The crypto connection
Those of you who have been following The Hack will know that I’ve been positive on Bitcoin for a long time. I see blockchain as a game-changing technology, and Bitcoin’s first-mover advantage is incredible. I have Bitcoin in my Portfolio Picks as a long-term investment.
I’ve recently noted the conversion of many a sceptic as more and more smart minds from the world of finance have moved to buy their first bitcoins. And their sound reasoning could upset many a gold bug:
On the Silk Road two thousand years ago, you needed gold to settle transactions. Because from Korea to the Asian Steppe to the Mediterranean, there had to be one thing whose value was never questioned. Gold facilitated trade and liquidity from one end of the known world to the other. My opinion is that this property of the element – its universal acceptance – remained in force for centuries… until it was disrupted by the internet.
Once computers arrived, we had instant access to values and prices of goods around the world. Gold’s role in global liquidity and verification suddenly mattered less. No one realized it at the time, but gold as a currency had been permanently disrupted by the microchip and the operating system. – Josh Brown (The Reformed Broker)
Greed or delusion?
But signs are emerging that Bitcoin and other cryptocurrencies may be entering a mania phase – and not for the first time. The history of Bitcoin has included several major parabolic moves followed by long periods of consolidation. Greed and fear start to set in as people worry about missing out on the gains that have accrued to early adopters. The recent move above $4,000 dollars is one such flag, which may mean that now is not the best time to build a ‘crypto portfolio’.
If you haven’t bought any cryptocurrency yet and Brian Kelly is on CNBC telling you exactly how to do it, then maybe you should reconsider getting that account at Coinbase. I mean, on what rational basis has Brian designated 10% of the portfolio to Ripple and 10% to Monero?
Hedge funds are back – in crypto
So if the guy who bought Bitcoin at $2,000 is giving you trading advice, and the guy who bought it last year is starting a hedge fund to get into ICOs, you have to wonder.
The sudden proliferation of cryptocurrency hedge funds is another sign that the patsies may be taking us over the peak and down the other side. Brian Kelly himself just launched a new digital asset fund – one of 15 recent start-ups in the hedge fund space, as noted by Forbes:
If you rush gains, valuations, expectations, hype, etc…. the whole thing will crash down. That is what happened in 1999–2000 with the web. Suddenly, everything was going to be on the web, whether they were good or bad ideas, and whether they were experienced or non-experienced teams – William Mougayar, Virtual Capital Ventures.
Remember when commodity hedge funds were popping up like gophers after the GFC? Well, follow the money: Today the commodity sector is dwindling due to a widespread price collapse. Nobody starts a hedge fund for an asset that is in a major bear market.
It isn’t just hedge funds, either. Fidelity Investments have tied up with Coinbase, as announced by CEO Abigail Johnson in May, to provide Fidelity clients with a way to track their crypto holdings alongside their traditional investments. Crypto is rapidly going mainstream, and within that space, it is slowly but surely moving into fields associated with regulated finance: hedge funds and other investment platforms.
Let’s be clear: I haven’t changed my fundamental view. I remain positive on the long-term future of Bitcoin, which I have had in my Portfolio Picks since May, with a two-year view. But the recent proliferation of ICOs and new currencies has me worried…
The history of speculations is rife with patsies – after all, somebody needs to open the bag so the smart-money investors can cash out. If the recent signs in the cryptocurrency space are anything to go by, we can expect a major episode of teeth-gnashing from aggrieved late-cycle investors – and probably a lot more government intervention thereafter.
How long before a FANG gets called a squid?
The FANG stocks have been the belles of the ball for the past few years, steadily pushing to heady new highs with their attractive mix of growth and monopolistic power. Their future predominance seems so assured today, but could something happen to spoil the soiree? Is there a risk that these darlings will turn back into pumpkins at midnight? That hour may be approaching.
This week I have a blow-by-blow account of the threats facing these mighty names, in the form of Jesse Felder’s ‘FANG and the Illusion of Infallibility’.
Mark Zuckerberg’s social network firm has become one of the predominant global tech stocks –principally through a massive network effect. Facebook use snowballed from 2005 to date, with a massive rise in users to more than 2 billion as more and more people chose the site for the bulk of their social communication. Remember, Facebook is more than just a social news feed; they own Instagram and Whatsapp, two crucial and complementary services that help them target a younger audience and access a vast amount of messaging and contacts.
What could possibly go wrong?
The company may increasingly be perceived as sinister.
A problem for Facebook arises with its monetisation. Back in 2004 when Facebook was launched, it was free and anyone within the academic network could sign up. It was an amateur affair with relationship options like ‘Whatever I can get’ and ‘Random play’. Each user had a page or ‘wall’ that others could post on, and things were generally sedate.
How things have changed. The challenges of monetisation led Facebook down the path of advertising, and they excel at targeted advertising: They use the data you give them for free to sell you things. They might just be getting too good at it:
‘Researchers found that the more people use Facebook, the less healthy they are and the less satisfied with their lives. To put it baldly: The more times you click “like,” the worse you feel.’
Facebook knows this. They cultivate it and actually use it as a feature in selling their services to advertisers. ‘We can help make your customers even more dissatisfied so that they are that much more likely to buy your goods,’ or something like that is how I imagine it going. But we don’t have to imagine. It was leaked recently that Facebook did just this very thing with their teenage users in Australia.
– The Felder Report
If people started to find their experience on Facebook increasingly distasteful, they might just stop using it. This notion seems farfetched now, but look at the pace at which Facebook obliterated Bebo and Myspace – all it takes is a better platform to emerge, followed by a surge of people to that platform, and Facebook’s business evaporates.
Source: h/t Shawn Carpenter – tech founder/investor
And it isn’t just the users; advertisers are bailing, too…
Click fraud? Just Google it
The issue of click fraud is one that Raoul Pal highlighted in his January GMI thought piece:
Google sell you that this is cost-effective and the only way to do things. It isn’t. There are many, many cost-effective ways to gain new customers at a fraction of the click-rate costs, such as sponsoring podcasts, which we found hugely successful for us. But these approaches do not pay fees on opaque practices, so understandably no agencies are interested in suggesting or assisting in taking this route.
We found that once Google were in full swing spending our money, traffic came from California and Amsterdam and a few Eastern European countries. These visitors remained for less than half a second on our site, did nothing, and then left.
Google capture the lion’s share of the digital advertising market, yet Raoul found there was very little substance to their advertising traffic – and not only that, but it came from several suspicious locations, suggesting that much of it may not have been real in the first place. Raoul is not alone; big consumer brands like Proctor & Gamble have recently binned their digital advertising spend, seeing it as ineffective, As Jesse Felder explains:
Proctor & Gamble is one of the largest and most successful advertisers and brand stewards in history. During its latest quarterly conference call the company revealed that it cut its digital ad spending by $100 million. What effect did it have on its business? According to the company, it had none whatsoever.
CFO John Moeller explained, “What it reflected was a choice to cut spending from a digital standpoint where it was ineffective, where either we were serving bots as opposed to human beings or where the placement of ads was not facilitating the equity of our brands.”
If big staples like Unilever and P&G are pulling the plug, then who else could follow? Google faces challenges on several fronts now, including criticism of its advertising model, regulatory fines and antitrust investigations, and a lack of revenue diversity (90% of revenue is digital advertising, and that is a cyclical discretionary spend for customers).
The law of large numbers dictates that Google will really struggle to get a lot larger – at more than a 30x P/E you are betting on a supernormal growth trend.
Speaking of valuation – Netflix
There is nothing ‘chill’ about the valuation of Netflix. At a 200x P/E, investors are seeking interstellar growth potential. This from a company that is struggling to transform itself from a platform for content into a producer of content. Netflix plans to spend $6bn a year on content!
Major players like HBO, Disney, and Time Warner have spent decades building up vast back catalogues of popular material, while Netflix intends to create a content library to better theirs in just a few years. Of course, when you pledge to spend $6bn a year, you can be sure that the quality will suffer and the cost of producing that new content will inflate.
The fundamentals of Netflix speak for themselves. Lots of top-line growth, declining cash flow, and inflating liabilities, along with a parabolic price move to the upside. Is this rational investing?
The Disney connection
The announcement last week that Disney plans to go it alone from 2019 could certainly upset the Netflix applecart. Disney isn’t just Mickey Mouse and some Dalmatians. Disney owns the Star Wars and Marvel franchises as well as the digital Pixar studio. Millions of Americans currently use Netflix to entertain their children. How many would leave Netflix to use Disney’s new streaming platform in 2019?
What this shows is that Netflix has built its brand on a very shallow moat of cheapness and convenience. When it was a physical-DVD-rental service, many content providers had little reason to get into the business – high capital costs and logistical headaches meant it wasn’t worth the trouble. A digital platform, however, gives better control of material and that ensures you don’t have to share revenues. All Netflix has today is a platform and a limited amount of in-house content, the quality of which is highly variable.
Oh, and their entire business is also being encroached upon by Apple (which has $250bn to burn) and Amazon. For the latter, Prime Video is just a loss leader to drive Prime subscriptions.
Amazon is everywhere
Source: Digital Capitalist
The Amazon empire extends far and wide. Amazon has branched out from its humble beginning in books to all manner of homewares, electronics, and clothes, not to mention Kindle, Prime Video, Audible, and Alexa… oh yes, and now Whole Foods! Amazon is going physical.
Groceries are Go!
Remember the old days when service was at a premium? You went to the store, asked for the needed items, and then had them packed in the bag by a helpful grocer.
Well, now Amazon is offering this service in digital format with ‘Amazon Go’. The difference being that the friendly grocer is now an app on your phone – you scan your items as you shop and then walk right out of the store.
If Amazon now ventures into physical stores, that tells you that the disruptive impact of their business may have gone full circle. Sure, Go will be ‘transformational’, but what are the limits to the Amazon of everything?
The Wa-Po conundrum
Trust-busting remains a real risk for Amazon, as I discussed in The Hack July 28th. Given their ability to put almost everybody else out of business, it can’t be far from many a politician’s or regulator’s mind to take on the Bezos behemoth.
As Amazon moves into more physical stores, the whole of Main St will be under assault. Perhaps, however, something better will simply come along. Amazon has become dominant in the way that Walmart was 10 years ago. A decade from now, who knows what new entrants will have upset Amazon’s vast apple cart?
The first thing you need to know about Goldman Sachs is that it’s everywhere. The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.
– Matt Taibbi, Rolling Stone
How long before someone says a similar thing of Amazon? In the next crisis or downturn, we could see a major backlash against the dominant players of the day. Going into the GFC, the banks could do no wrong as the financial sector swelled and outgrew the economy. Today that baton has been handed to tech.
The four FANGsmen?
Just as with the Internet 1.0 bubble, there will be winners and losers amongst these four – and some of them may not survive at all. Back in 1999, investors couldn’t get enough of CIMQ – Cisco, Intel, Microsoft, and Qualcomm. All four stocks survive today, but if you bought them on the 1st of Jan 2000, only Microsoft was in the black. Qualcomm and Cisco remain 40% below their highs, and Intel is down 15%.
CIMQ were priced for perfection back then, and they did grow into their opportunities, but the shares never really recovered – in part because the FANGs captured the real value of the internet: intangibles rather than hardware. Could we be about to witness a similar topping moment for these Tech 2.0 maestros?
There isn’t time each week to discuss everything that is going on in markets. Here we piggyback on previous RVP Weekly Hack talking points and let you explore some stories further.
The latest cybersecurity scare involves a very simple and accessible piece of data. The NY Times reports that prominent digital currency entrepreneurs and other public figures are falling victim to a scam that involves hackers hijacking something very simple: your phone number.
With just a phone number a hacker can reset your online accounts and drain your cryptocurrency wallet in seconds. This kind of attack goes to show how even advanced layers of cybersecurity can be circumvented if someone simply steals the master key!
Sparks have been flying recently on the China-India border, where the world’s two most populous nations meet. A border skirmish last week involved only a few stones. But these nations are two of the world’s nuclear superpowers! Business Insider takes a look at the origins of the dispute and the potential for escalation in the region. As China’s OBOR gets underway, things could get worse for India as China picks up the tab for developing India’s neighbours – including archrival Pakistan.
Until next time
You understand that no Content published, as part of the Services, constitutes a recommendation or a statement that any particular investment, security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Neither the Site nor the Services are intended by Real Vision to provide, tax, legal or investment advice, and nothing on the Site or in the Services should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by Real Vision or any third party. You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation. You should consult with an attorney and tax professional regarding your specific legal and tax situation. You further understand that none of the creators or providers of our Content and Services, or their affiliates will advise you personally concerning the nature, potential, value or suitability of any particular investment, security, portfolio of securities, transaction, investment strategy or other matter. To the extent any of the Content published as part of the Services may be deemed to be investment advice, such information is impersonal and not tailored to the investment needs of any specific person but is for general, educational purposes.