Daniel Shainberg
November 23, 2018
Where have I been these past few weeks? There is a famous quote "It's better to shut up and give the impression that you're stupid than to say something and erase all doubt." Over the past few weeks we have seen many of our bearish calls prove accurate dating to the beginning of this newsletter just a few months ago.
At the time, the markets were hot, Trump was taking credit for the stock market's performance, indexes were inching higher daily, equities were trading devoid of valuation and bitcoin bros were a thing. Now that seems to have all reversed. Stock market investors are nervously asking "what's next?" The bitcoin bulls have gone into hibernation. Real estate brokers, builder and bankers are wondering why their businesses have slowed. The spot price of oil has finally caught up with its depressed futures curve. Boeing's shares have plummeted, as we have predicted, and overvalued tech companies have seen their valuations come crashing back to earth. Credit spreads and rates are blowing out.
When volatility spikes you simply cannot predict the daily moves. On Thanksgiving eve the equity markets rallied after its bearish performance over the prior week only to give back all its gains into the close. As we have said numerous times before, you cannot predict the short term movement of the stock market accurately. But you can certainly safeguard your assets from significant downturns by taking a longer term view and focusing on valuation metrics.
I recently read a bullish posting on Boeing (BA), a company we have been bearishly inclined over the past few months, even before its stock price downturn. The bullish article pointed to their 8% Free Cash Flow yield and duopoly status in the aerospace sector. What the article failed to mention is that there free cash flow is not a rock solid figure. It can change. It is fluid. Their valuation implies an 8% yield on their current free cash flow. But their business is a mix of commercial Aerospace and Defense contracts. On the Aerospace side of the business they have experienced a temporary boom from cheap global credit and inflationary domestic spending in China (and India). That growth bulge in middle income consumers in the emerging markets led to a temporary boom in orders. But the aerospace sector, like the emerging markets sector, is very cyclical. Once that downturn occurs, the supply and demand balance for these aircraft could plummet, sending Boeing's Aerospace segment cash flow cratering down along with it. And their Defense business is ~1/3 of their total EBITDA. This is a business essentially with 1 key customer - the U.S. Government. And the outlook for that business over the next few years is even uglier. Sure the government has been spending without a care in the world, running over a trillion dollars deficits annually. But we now have well over $20 trillion in federal debt and our national credit metrics are approaching junk status. Defense spending is the largest expenditure of the U.S. government by an overwhelming degree. It is also the easiest to cut in a downturn. And given the national security implications involved, the U.S. government can also restrict Boeing from selling their products internationally. This is a business and sector that used to trade at 10x earnings, and is now trading at or above 20x earnings. And the earnings are inflate. When their earnings start crashing, their over-inflated multiple will as well. All their investors who have been attracted to their dividend yield will ask why they overpaid for the yield when competing rates offer larger returns with lower risk.
Investors in Boeing, like their risk friendly equity investors in momentum driven tech stocks and other inflated asset classes will start blaming everyone but themselves. Even President Trump stopped taking credit for the stock market performance and started pointing fingers, most recently at Steve Mnuchin. "Trump is blaming Mnuchin for picking Jerome Powell to lead the Federal Reserve. Powell isn't very popular in the West Wing right now, as Trump has made abundantly clear with his repeated attacks on the Fed. Trump has blamed Powell for insisting on raising interest rates, and even hinted at times that he could be open to making a change at the central bank, something that has evoked nothing short of abject horror on Wall Street."
November 23, 2018
Where have I been these past few weeks? There is a famous quote "It's better to shut up and give the impression that you're stupid than to say something and erase all doubt." Over the past few weeks we have seen many of our bearish calls prove accurate dating to the beginning of this newsletter just a few months ago.
At the time, the markets were hot, Trump was taking credit for the stock market's performance, indexes were inching higher daily, equities were trading devoid of valuation and bitcoin bros were a thing. Now that seems to have all reversed. Stock market investors are nervously asking "what's next?" The bitcoin bulls have gone into hibernation. Real estate brokers, builder and bankers are wondering why their businesses have slowed. The spot price of oil has finally caught up with its depressed futures curve. Boeing's shares have plummeted, as we have predicted, and overvalued tech companies have seen their valuations come crashing back to earth. Credit spreads and rates are blowing out.
When volatility spikes you simply cannot predict the daily moves. On Thanksgiving eve the equity markets rallied after its bearish performance over the prior week only to give back all its gains into the close. As we have said numerous times before, you cannot predict the short term movement of the stock market accurately. But you can certainly safeguard your assets from significant downturns by taking a longer term view and focusing on valuation metrics.
I recently read a bullish posting on Boeing (BA), a company we have been bearishly inclined over the past few months, even before its stock price downturn. The bullish article pointed to their 8% Free Cash Flow yield and duopoly status in the aerospace sector. What the article failed to mention is that there free cash flow is not a rock solid figure. It can change. It is fluid. Their valuation implies an 8% yield on their current free cash flow. But their business is a mix of commercial Aerospace and Defense contracts. On the Aerospace side of the business they have experienced a temporary boom from cheap global credit and inflationary domestic spending in China (and India). That growth bulge in middle income consumers in the emerging markets led to a temporary boom in orders. But the aerospace sector, like the emerging markets sector, is very cyclical. Once that downturn occurs, the supply and demand balance for these aircraft could plummet, sending Boeing's Aerospace segment cash flow cratering down along with it. And their Defense business is ~1/3 of their total EBITDA. This is a business essentially with 1 key customer - the U.S. Government. And the outlook for that business over the next few years is even uglier. Sure the government has been spending without a care in the world, running over a trillion dollars deficits annually. But we now have well over $20 trillion in federal debt and our national credit metrics are approaching junk status. Defense spending is the largest expenditure of the U.S. government by an overwhelming degree. It is also the easiest to cut in a downturn. And given the national security implications involved, the U.S. government can also restrict Boeing from selling their products internationally. This is a business and sector that used to trade at 10x earnings, and is now trading at or above 20x earnings. And the earnings are inflate. When their earnings start crashing, their over-inflated multiple will as well. All their investors who have been attracted to their dividend yield will ask why they overpaid for the yield when competing rates offer larger returns with lower risk.
Investors in Boeing, like their risk friendly equity investors in momentum driven tech stocks and other inflated asset classes will start blaming everyone but themselves. Even President Trump stopped taking credit for the stock market performance and started pointing fingers, most recently at Steve Mnuchin. "Trump is blaming Mnuchin for picking Jerome Powell to lead the Federal Reserve. Powell isn't very popular in the West Wing right now, as Trump has made abundantly clear with his repeated attacks on the Fed. Trump has blamed Powell for insisting on raising interest rates, and even hinted at times that he could be open to making a change at the central bank, something that has evoked nothing short of abject horror on Wall Street."
Dan Shainberg
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#RecessionResister
@DanShainberg
@DanShainberg
