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And now to the newsletter…
Topic of the Week: Economic Doom and Gloom?
The stock market is at an all-time high. The Fed is bullish. Consumer confidence has surpassed pre-recession levels. A former sexting app, now camera company, went public at a $28B valuation. By all accounts, 2017 is off with a bang.
Basic economic theory tells us this ride won’t last forever. However, there is an overwhelming market rhetoric that “this isn’t like last time, we are better off today.”
I would like to challenge that rhetoric by presenting you with data. At the end, I would like to get your perspective on whether we are better off today. To the data…
Do Underlying Fundamentals Support Current Price Levels?
While it isn’t fair to use one company as proof of a broader systemic issue, that’s exactly what I’m going to do. Let’s talk Netflix.
Netflix’ has a whopping P/E ratio of 201x and a TEV/EBITDA of 107x. The stock price has skyrocketed over the last few quarters, and despite massive revenue and subscriber growth, Netflix is burning about $2b in cash a year.
Per Netflix, this cash issue is due to the creation of original content, which has a high upfront cost, but yields long-term profitability. Netflix is the poster child for prevailing market sentiment: “Revenue growth is more important than profitability and lack of profitability is due to expenditures that will pay dividends in the long-term.”
Here is where I get confused: Will Netflix ever be able to decrease its spending on new content? Don’t consumers expect new, fresh shows to binge watch? Further, what is the ROI on original content and what is the longevity of user engagement for original content?
Unfortunately, these questions are not addressed in the latest earnings call transcript, which leads me to my point. We are in a strange period, where the market is blindly accepting half-baked, unsubstantiated rationale for excessive cash burn. Companies are making multi-billion dollar bets right now and very few people are asking the hard questions.
While Netflix is an aggressive example, the S&P 500 P/E ratio recently surpassed 2008 levels and is on-par with depression era levels. While we aren’t near the dot-com era levels, today our underlying fundamentals are much weaker than they were in 1999.
Are We Overleveraged?
Let’s not forget about the U.S. government’s debt.
Debt isn’t inherently a problem. The problem with debt is when you can’t pay it back.
While total corporate cash reserves are at an all-time high, this cash is meaningfully concentrated in a small number of companies.
You may have missed this, but the government quietly reforecasted the level of student loan delinquencies. 40% of student loan holders aren’t making payments.
Other Developments to Note:
Retail store closings are reaching epic proportions, followed closely by retail bankruptcies.
Canadian mortgage lender, Home Capital Group, saw 80% decline in deposits and had to get bailed out by an Ontario Pension Fund. Coincidentally, the head of the pension fund is on the board of Home Capital Group. Don’t worry; he stepped away from the talks to avoid conflict of interest.
I don’t have enough time to get into China’s economy, global housing bubbles, political tensions around the globe and the uncertain future of the EU.
Here is the funny thing about market crashes. They are never expected by the broader market and the Fed has a poor record of predicting them. I won’t pretend to make a claim that I know what is going to happen to the broader economy over the next few years, but the data has me worried.
Are We Better Off Today?
I obviously have a negative bias. If you are more bullish, I would love for you to send me any supporting data you rely on to come to that conclusion.