February 7, 2019
Chasing returns... keeping up... outsmarting the market... or just being plain greedy gets you into trouble. Like the Road Runner, our antagonist has no remorse. In today's bull market there isn't a shortage of innovations. Technology is arming investors and businesses alike with new ways to capture that elusive road runner.
Reality check. The majority of us end up like Mr. Wile E Coyote.
Not you and I. The other guys. Because we are taking a sensible and sober approach to all the promises made by the future of everything.
The troubling news is, it looks like its happening again. That danger zone the market enters when valuations have hitched onto a SpaceX rocket. Where is Tesla's rocketman anyways? He hasn't fallen back to earth, that's for sure.
Howard Marks writes in, The Most Important Thing:
“the investors’ occasional willingness to accept the novel rationales that underlie bubbles and crashes, usually out of the belief that, it’s different this time.”
some new development will change the world,
patterns that have been the rule in the past (like ups and downs of the business cycle)
the rules have been changed (such as the standards that companies are creditworthy and their debt worth holding), or
traditional valuation norms are no longer relevant (including price/earnings ratios for stocks, yield spreads for bonds or cap rates for real estate)
It is fair to say that neomania is ever present. Web 2.0, which includes AI, big-data, cloud computing, mobility, and the sharing economy are the unstoppable forces in today's economy. 'Disruptors', are staples of the market.
Central bank intervention is supplanting cycles with economic smoothing. Massive government deficits and negative interest rates are the new norms. We are now 9 years without a negative downtick in economic growth.
Standards and protections on new debt issuance are lower than before the financial crisis. See the chart.
Price to Earnings is no longer useful for the fast-growing e-commerce trailblazers, the investor should use metrics like Price/GMV or sets of subscriber KPIs that emphasize their growth and market share. The use of EBITDA has always made companies look more appealing than they really are. However, EBITDA is no longer good enough. Adjusted EBITDA is the new norm and to scrape the bottom of the barrel further, Adjusted Adjusted EBITDA for all our precious unicorns.
Chart of the Week
In my letter to investors for the Madiron Equity Fund, I reviewed Shiller’s PE and discussed broad market elements that I am mindful of.
The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio because it eliminates fluctuation of the ratio caused by the variation of profit margins and inflation during business cycles.
Word of the Week
BULL MARKET, n. A period of rising prices that leads many investors to believe that their IQ has risen at least as much as the market value of their portfolios. After the inevitable fall in prices, they will learn that both increases were temporary.