Most business leaders knew the Dot-Com Bubble was ridiculous.

Perhaps the most famous quote to that effect comes from a founder and CEO who knew his company was drastically overvalued at the time. But he had to keep it to himself, for fear of being sued and losing control of his company. Here’s what the founder and CEO said…

“Two years ago, we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends.

That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate.

Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

The quote comes from Scott McNealy, the founder and CEO of dot-com darling Sun Microsystems. He was talking to a Bloomberg reporter in March 2002, two years after the dot-com bubble peaked.

Bloomberg then asked McNealy, “What were you thinking?” He replied…

“I was thinking it was at $64, what do I do? I’m here to represent the shareholders. Do I stand up and say, “Sell”? I’d get sued if I said that. Do I stand up and say, “Buy”? Then they say you’re [Enron Chairman] Ken Lay.

So, you just sit there and go, “I’m going to be a bum for the next two years. I’m just going to keep my mouth shut, and I’m not going to predict anything.”

And that’s what I did.”

No CEO can or should talk about their stock valuation…..except Elan Musk! Hahahaha! Musk posted on Twitter on May 1, 2020, “Tesla stock price is too high [in my opinion].”

The stock was trading at a split-adjusted price of between roughly $150 and $170 per share at the time… And it had showed some weakness for two trading sessions, dipping into the high $130s. Then, after Musk’s post, it was off to the races again… hitting $200 by June 10 and $300 a month after that.

The founder and CEO told the whole world his company was overvalued. He effectively told the whole world to sell his stock, exactly what McNealy said he could not do for fear of getting sued. Yet Tesla’s stock has more than quadrupled since Musk’s tweet.

This is what a bubble looks like.

Tesla’s stock is crazier than ever nowadays. Just yesterday, the company’s market cap increased by $56 billion – more than two times its annual revenue. It now trades at a vertigo-inducing 25.5 times annual sales.

That might work for some software companies, but not for a car company. And no matter what Musk or the starstruck Wall Streeters in his orbit might tell you, it’s a car company. It’s a capital-intensive, low-margin, highly competitive car company.

 

Tesla

 

Tesla (TSLA) shares just finished a fabulous year. The company was added to the S&P 500 and is now, as the chart shows, valued more highly than the rest of the world’s major automobile producers combined.

Toyota Motor alone sold 17 times more cars through November 2020 than Tesla did all year. Tesla lost $862 million last year, while Toyota made $13 billion. Toyota’s stock trades for nine times earnings and pays a dividend yield of 2.7% – more than two and a half times the current yield on the 10-year U.S. Treasury bond.

 

 

One does not have to be a Tesla critic to think this makes no sense. The company sold about 500,000 vehicles in 2020, giving it a whopping 0.7% global market share. By any definition other than market cap, it is a small player. It is true that electric vehicles are superior in many ways, and Tesla has a head start in that segment. It may well become the industry leader. Investors appear to believe so, at least. But the other companies will have a say in the matter. We doubt they will give up easily.

 

US Economy

 

  • Consumer sentiment deteriorated going into the year-end.

 

 

  • Home prices continued to rally in October, with the Case-Shiller index now up 8% vs. a year ago.
  • However, pending home sales pulled back in November.
  • Initial jobless claims are holding above a million per week.
  • Record numbers of Americans have been missing work due to illness this year.
  • The Chicago PMI index, which measures business activity in the Midwest, surprised to the upside in December. It bodes well for manufacturing growth at the national level.
  • US trade deficit in goods hit a new record as imports outpace exports.
  • The dollar weakness should help improve US exports.
  • The COVID situation shows no signs of easing.

 

 

  • But Americans’ interest in vaccination appears to be rising.
  • The updated December manufacturing PMI (from Markit) shows faster growth in the nation’s factory activity.
  • However, the report points to rising supply bottlenecks as the pandemic worsened.
  • As a result, manufacturers’ cost increases have accelerated.
  • The gap between residential and nonresidential construction spending continues to widen (a shift from office buildings and retail establishments to home-offices and online purchasing).
  • CoreLogic expects home price appreciation to slow later this year.
  • Goldman’s financial conditions index hit the lowest (most accommodative) level on record. The stock market, the dollar weakness, and tighter credit spreads have been the key drivers of this easing trend.

 

 

  • The new orders index is near the highs.
  • Manufacturing employment is back in growth mode (PMI > 50).
  • Supply-chain issues contributed to rapidly rising costs for manufacturers.
  • Morgan Stanley expects inflation to climb well above 2% next year.
  • The ADP report showed a contraction in private payrolls last month.
  • Here are the key drivers of employment weakness – Manufacturing, trade & transportation, leisure and hospitality
  • Small business employment data from Homebase points to a decline.
  • Factory orders remained robust in November.
  • US vehicle sales finished the year on a strong note. But sales were lower for the full year.
  • Goldman boosted the US GDP forecast in response to the election outcome.
  • The ISM Services PMI surprised to the upside.
  • Mortgage rates hit another record low.
  • Government support kept incomes elevated last year.
  • Bloomberg’s consumer sentiment index remains depressed.
  • Older Americans are especially pessimistic.
  • The above results contradict the sentiment index from Morning Consult. Whatever the case, Wednesday’s events in Washington, DC will probably put further downward pressure on consumer confidence.
  • US imports from Canada, Mexico, China, Japan, and France declined last year. On the other hand, Switzerland and Vietnam sold more to the US.
  • US Loses 140,000 Jobs, First Monthly Loss Since Spring
  • Currently, investors hope that with more stimulus, increased deficits, and infrastructure spending is soon on their way. Goldman Sachs just upgraded their estimate of GDP growth based on the expectation of another $750 billion stimulus bill.
  • The surge in deficit spending, combined with the pick-up in short-term demand for construction and manufacturing processes, will give the appearance of economic growth. Such will likely get both the Federal Reserve and the “bond bears” on the wrong side of the trade.
  • The impacts of these “one-off” inputs into the economy will fade rather quickly after implementation as organic productivity fails to increase. While many always hope these programs will lead to an ongoing economic expansion, a look at the last 40 years of fiscal and monetary policy suggests it won’t. Why? Because you can’t create economic growth when financed by deficit spending, credit, and a reduction in savings.
  • While more stimulus and infrastructure spending may spur the economy and markets initially, the payback tends to be severe.

 

Jobs Data from Last Week

 

The December US jobs report caps the wildest economic year in living memory, and not on a good note. The pandemic-driven consumer slowdown and associated business restrictions once again took jobs from the low-wage workers who can least afford to lose them.

Key Points:

  • December payrolls fell 140,000, much worse than estimates of a 50,000 gain, but revisions brought the two prior months up by 135,000.
  • The job losses were concentrated in low-wage leisure and hospitality occupations. Construction, manufacturing and retail all saw gains.
  • Long-term unemployment rose and a record number of former workers have left the labor force completely.
  • Average hourly earnings showed a strong gain, but mainly because the loss of low-wage jobs raised the average for those who were left.

Counting revisions, today’s report shows the number of employed people held steady over the last three months. That’s better than an outright loss but hardly encouraging. The overriding question now is how soon the vaccination campaign will control the virus and enable more normal economic activity. We don’t have an answer yet.

 

Inflation?

 

TVs cost $600 in 1983 and now they cost about $99 for a 24-inch screen.

In real terms, the price of a TV has declined by over 90%. The Bureau of Labor Statistics says that it has declined by more than that.

BLS does this thing called hedonic adjustments. That’s where the inflation bean counters take into account the quality differences in a TV as well as the price.

Not only has the price gone down, but the quality has improved. According to the BLS, that means the price has gone down even more.

This is one way in which we systematically under count inflation. There are other ways, but this is the biggest, at least when you’re talking about the Consumer Price Index (CPI).

Critics of hedonic adjustments say that you still have to buy a TV and you’re not getting it for 99% off. A TV is a TV.

Of course, TVs are an example where prices have declined over the years.

In healthcare and education, prices have risen, proportional to the amount of government involvement. In places where entrepreneurs were free to innovate, prices declined the most.

That’s the difference!

 

 

But Have You Seen Commodities?

Check out this chart of corn prices, for example:

 

 

This looks like a lot of commodity charts out there right now, going from the lower left to the upper right, whether it’s agriculture, energy, metals, or soft commodities.

Bond expert Mark Grant is dubious of the increasingly common forecast that inflation will rise this year, sending US Treasury yields higher. He foresees significant pressure on the Fed to do the opposite, sending US rates into negative territory along with some of our European and Asian peers. He also expects difficulty for municipal bonds as states and localities come under financial pressure. Louis Gave chimes in as well.

Key Points:

  • When China did this in 2008, they funded massive infrastructure projects: airports, railroads, roads, ports, you name it. Some of these projects turned out to be productive and some not, but I always thought they would be definitely more productive than social transfers. But this year, the debt buildup in the US has funded zero new productive investments. No new roads, no airports, railroads, nothing. They were basically just sending money to people to sit at home.
  • Worldwide, there is already $18.1 trillion in negative yielding debt and Grant sees a very good chance the Fed will further expand its balance sheet.
  • When I look at markets, there are three key prices in the world economy: Ten-year Treasury yields, oil, and the Dollar. One year ago, yields were going down, oil was going down, and the Dollar was going up.
  • Today, Treasury yields are going up, oil is going up, and the Dollar is going down. This is a huge reversal. When I see a market where interest rates are rising and the currency is falling, alarm bells go off.
  • This is what you would see in a sick emerging market. If you’re invested in, say, Indonesia, rising interest rates and a falling currency is a signal that investors are getting out, because they don’t like the policy setting there.
  • Today, the US is starting to act like a sick emerging market.
  • Government debt in the US has increased by more than $4 trillion this year, which adds up to $12,800 per person. This is a world record, but actually most Western governments have gone on a massive spending spree during this crisis.
  • In a way, they’re using the playbook that China followed after 2008, when they allowed a massive increase in fiscal spending and monetary aggregates.
  • Today, Beijing sits on its hands in terms of fiscal and monetary policy, while the West knows no limits.
  • Grant would also pay close attention to municipal bonds, as revenues are down significantly for those tied to airports, hotels, and many other activities.
  • Raising taxes to offset these losses is almost impossible in the current environment.
  • A population shift aggravates this problem as many individuals and corporations flee high tax states.
  • Grant is cautious on equities due to high valuations.
  • Gave believes the Federal Reserve will have to cap interest rates at 2% in order to keep government debt costs under control. In this case, the dollar would tank, real interest rates drop and gold thrive.

Louis was asked if he expects the Fed to cap interest rates (yield curve control). His answer: Yes, I do. And when they do, I’d say the Dollar will take a 20% hit.

  • I think they will have to cap interest rates at 2%, otherwise the drag on the government will become too big.
  • That question will arise rather soon, because come this spring, the base effects for growth and for inflation will kick in.
  • Growth will be very strong, and so will inflation, which means that yields will quickly try to get back up to 2%.
  • Inflation will come back with a vengeance as businesses prioritize safety of delivery over cost.
  • The Dollar is down 20% to the Mexican Peso over the past six months, down 10% to the Korean Won, down 8% to the RMB, so whatever Americans buy from abroad will be more expensive.

In the world as Louis Gave sees it, investors should focus on commodities (particularly gold) with financials as a hedge.

Mark’s muni bond point is important. The combination of a weak economy and rapid population shifts could have serious effects in fairly short order, and not necessarily where you would expect. It could affect bondholders, homeowners, pensioners and anyone who depends on local services that may be cut. This will bear watching as 2021 unfolds.

The news of Democrats taking control of the US Senate reignited the reflation trade. The market is betting on the federal government unleashing further fiscal stimulus, boosting consumption, economic growth, and inflation. Here is the relative performance of stocks that benefit from higher prices (Citi inflation long index) vs. those that do well in a deflationary environment.

 

 

Market-based inflation expectations are climbing.

 

 

The issue is that over the next few years, there is a tremendous amount of debt coming due. If rates risk markedly, or if the market demands payment for the relative risk, refinancing could become problematic.

 

 

The Wealth Gap Explodes

 

The problem of the disconnect between the economy and the markets is that it is unsustainable long-term. According to the Economic Policy Institute, the top 1% take home 21% of all income in the United States, the largest share since 1928.

There are various social, political, and economic factors driving this growing discrepancy, but one critical factor is ignored – The Federal Reserve. When the Fed inserted itself into the economic equation, their contribution led to rising imbalances between economic classes.

Over the last decade, as stock markets surged, household net worth reached historic levels. If one just looked at the data, it was clear the economy was booming. However, for the vast majority of Americans, it wasn’t.

The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.

Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A full 33% of that gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.

 

 

Top Risks 2021

 

Ian Bremmer and the Eurasia Group team assemble an annual risk of top geopolitical risks. These are increasingly economic and market risks, too, which means investors should pay attention.

Key Points:

  • Risk #1: The US is deeply divided with a large part of the population thinking the incoming president as illegitimate.
  • Risk #2: COVID-19 impact will linger, threatening not just lives but political stability and the global economy. We need these vaccines to work in order to have a global recovery. What if we have mutation?
  • Risk #3: After almost a year of radical, unprecedented Federal Reserve action, it’s not clear whether we actually have functional capital markets anymore.
  • Risk #4: Climate policy will create both political conflict and politically-driven investment opportunities.
  • Risk #5: The US-China rivalry will broaden with disagreements over vaccines, technology, trade, Hong Kong and climate policy.
  • Risk #6: Cross-border data flows will become a sensitive issue for governments and international businesses.
  • Risk #7: Potential cyber conflict will create technological and geopolitical risk for which few are prepared.
  • Risk #8: Under political pressure, Turkish President Recep Erdogan will generate more unrest in an already-sensitive region.
  • Risk #9: Low oil prices combined with the pandemic will put financial stress on many Middle East and North African governments.
  • Risk #10: Europe faces an economic hangover from pandemic restrictions and won’t have Angela Merkel’s leadership.
  • Risk #11: Latin America faces intense problems, with vaccinations unlikely until late in the year and elections scheduled in several countries.
  • Risk #12:  The prospect of higher corporate tax rates. Biden and the Democrats basically want to reverse the 2017 tax cuts. If they succeed, it’s fair to expect some of the market gains since then to reverse as well.

At this point last year, we were just getting first reports of a virus in China. A few weeks later it took over everything. All the risks on this list are significant but others could come out of nowhere.

 

Market Valuation

 

The Nasdaq 100 valuation multiple is the highest since 2004.

 

 

The S&P 500 price-to-sales ratio continues to hit record highs.

 

 

Reasons for Hope in 2021

 

Here’s some good news.

First, we now have weapons against the virus. The US has two approved vaccines. England, China and Russia have developed their own vaccines. Additional options are under development, and will likely be available later this year. These will be game changers if we manage to deploy them widely and quickly. Which, I admit, is a big “if.”

Second, the recently passed fiscal package will give some relief to unemployed workers and small businesses. The process was late-night political sausage-making at its worst. It took way too long but had the bill not passed, I think we would certainly be looking at a double-dip recession in early 2021.

Third, 2020 was (of necessity) a year of massive innovation throughout the economy. Businesses forced into an “adapt or die” position worked hard to adapt. A disturbingly high number didn’t make it but many did, finding creative ways to operate under new constraints. Those investments having been made, we can now begin to reap the benefits.

Fourth, New tech breakthroughs.  One amazing new technology could double the production of proteins from chicken and eggs with no additional cost. A new prostate cancer urine test will not only tell if you have prostate cancer, but show its stage with some precision. It would replace many cancer biopsies.

The agricultural world is getting ready to go through a revolution. Non-GMO crops will proliferate with fabulous traits using revolutionary new processes. Cheaper, less need for pesticides and disease control, less need for fertilizer and more nutritious. I hear many such things weekly. How can you not be optimistic about humanity’s future?

 

Interesting

 

 

 

 

 

All content is the opinion of Brian J. Decker