David Stockman Derides The Delirious Dozen Of 2017

Authored by David Stockman via Contra Corner blog,

We have previously noted the massive market cap inflation and then stupendous collapse of the Delirious Dozen of 2000.

The latter included Microsoft, Cisco, Dell, Intel, GE, Yahoo, AIG and Juniper Networks - plus four others which didn"t survive (Lucent, WorldCom, Global Crossing and Nortel).

Together they represented a classic blow-off top in the context of a central bank corrupted stock market. When the bubble neared its asymptote in early 2000, the $3.8 trillion of market cap represented by these 12 names was capturing most of the oxygen left in the casino. That is, the buying frenzy had narrowed to a smaller and smaller group of momo names.

 

That severe concentration pattern was starkly evident during the 40 months between Greenspan"s December 1996 "irrational exuberance" speech and April 2000 (when he told the Senate no bubble was detectable). In that interval, the group"s combined market cap soared from $600 billion to $3.8 trillion.

That represented, in turn, a virtually impossible 75% per annum growth rate for what were already mega-cap stocks. As it happened, in fact, $2.7 trillion or 71% of the group"s bubble peak market cap vanished during the next two years.

What we didn"t mention yesterday, however, is that this bubble top intumescence never really came back. In fact, the market cap of the eight surviving companies---all of which have continued to grow----today stands at just $1.3 trillion or 34% of the 17-years ago peak.

Needless to say, that"s because the market no longer affords the Delirious Dozen of 2000 valuation multiples that are even remotely in the same bubblicious zip code.

Thus, the eight survivors posted combined net income of $52.3 billion during the LTM period ending in September 2017. On the far side of the 1999-2000 tech bubble, therefore, current earnings turn out to be worth 25X---not the 75X recorded back then.

We revisit the rise and fall of these turn of the century high flyers because we believe the same process of market narrowing into a diminishing number of momo names is exactly what is happening again as we reach the asymptote of this latest and greatest central bank fueled bubble.

 

In fact, we have identified a new roster for the Delirious Dozen of 2017 - and have tracked their course over the last 40 months. During that interval, of course, Janet Yellen did not even bother to muse in public about "irrational exuberance" like Greenspan did.

That"s undoubtedly because Fed orthodoxy now holds there just plain aren"t any bubbles---apart from isolated segments like commercial real estate. To the contrary, the 12 geniuses on the FOMC have purportedly vanquished the business cycle entirely, thereby insuring an economic nirvana of perpetual full employment, world without end.

We think otherwise. Accordingly, our new Delirious Dozen consists of the FAANGs (Facebook, Apple, Amazon, Netflix and Google) plus seven additonal high flyers (Tesla, NVIDIA, Salesforce, Alibaba, UnitedHealth, Home Depot and Broadcom).

Not surprisingly, their combined market cap has soared from $1.7 trillion to $4.0 trillion during the last 40 months in a pattern which is highly reminiscent of the last go round. And for our money, that $2.3 trillion gain represents the same kind of bottled air.

Thus, Amazon is now valued at $550 billion and thereby trades at 293X its $1.9 billion of LTM net income. But all of that net income is attributable to its rent-a-cloud service (AWS) which is arguably worth $100 billion on a standalone basis.

That is to say, the great Bezos E-commerce juggernaut is implicitly valued at $450 billion, yet has not generated a dime of profit from the scorched earth its has left behind in retail land. That"s what we call bottled air.

Likewise, Broadcom trades at 246X net income and Netflix is valued at 194X. These companies may well be the equal of Cisco and Intel as innovators and value generators with a long life of growth ahead.

But both are challenged by ferocious competitors, and have no more chance of sustaining their current absurd valuation multiples than did Cisco (200X then, 19X now) or Intel (60X then, 16X now).

Next consider Salesforce (CRM), which is currently valued at $77 billion, and Tesla, which sports a market cap of $54 billion. Yet both had large net losses during the latest 12 months. In fact, during the last five years, CRM has posted cumulative net losses of $650 million and Tesla has lost $3.3 billion.

Even if these two do manage to avoid the fate of Nortel and Global Crossing, the red ink stained charts below suggests that earning into their combined market cap of $131 billion will take more than a few miracles.

Even Alibaba at 55X, NVIDIA at 50X, and Goggle and Facebook each at 35X are essentially defying math and the business cycle.

The latter two companies, in fact, may be the greatest thing since sliced bread, but they are also virtually 100% dependent upon advertising revenue. During the last recession, global ad spending plunged by nearly 9%, as shown below, and by more than 14% in the US alone.

Moreover, the digital capture of market share---of which is 85% is attributable to FB and GOOG----has nearly run its course. Accordingly, no company in a cyclical 3-4% growth industry can sustain a 35X PE multiple for any appreciable period of time.

Much the same can be said for Home Depot (HD), which is currently flying high, but is not capable of permanently sustaining a 25X PE multiple. In fact, its recent results have been flattered owing to the capture of significant market share from the collapse of Sears and due to elevated sales from a standard home improvement spending cycle that is now reaching its peak. Additionally, it has not yet been attacked head-on by Amazon (but that"s surely coming).

But like much else at the current bubble top in the casino, Home Depot"s elevated short-run gains have been confused for permanent growth capacity. However, the verdict on that is crystal clear: During the 11 years since the 2006 housing peak, HD"s net income has grown from $6.1 billion to just $8.6 billion in the October 2017 LTM period.

That computes to a 3.2% per annum growth rate, and Home Depot"s best years are surely behind it. After all, the tsunami of baby boom retires are emptying their nests, not renovating them.

At the same time, America"s soon to be shrinking work force will face ever higher taxes to pay for the upkeep of the former, thereby sharply constraining the discretionary income of the overwhelming share of working households. Man caves and granite kitchen counter-tops are not likely to survive the generational squeeze looming ahead.

Accordingly, we believe that HD"s days as a 25X PE stock are numbered.

In short, among the Delirious Dozen for 2017, only Apple has a reasonable multiple at 19X. But then again, Apple has been cycling along the flat line for more than three years at its towering sales level of $230 billion and $50 billion of net income.

Yet even today"s casino recognizes that given Apple"s monumental size, it is virtually impossible to move the growth needle; and that even one delayed or botched product cycle could cause its $50 billion of net income to take a not inconsiderable plunge.

In short, aside from the unique case of Apple, the Delirious Dozen of 2017 are set-up for a repeat of the massive 2000-2002 deflation of bottled air. That is, in June 2014 the group (ex-Apple) had a market cap of $1.1 trillion, representing 34X its combined net income of $32 billion.

During the 40 months since then, the group"s market cap has nearly tripled to $3.2 trillion, while its net income has climbed to $65 billion. Consequently, the group"s PE multiple has now soared to 49X or to nearly the nosebleed level that pertained among the previous group of high flyers back in April 2000.

Needless to say, the business cycle has not been abolished and this expansion is now 101 months old. In fact, the chart below suggests it may be reaching its "sell-by" date.

But here"s the thing. The bottled air resident among the Delirious Dozen of 2017 is where all the top of the bubble mania has again gotten concentrated.

So when the Black Swan, Orange Swan or Red Swan, as the case may be, finally arrives and they begin to sell AMZN, FB, TSLA or CRM----look out below.

That"s where Wall Street"s next central bank fueled bloodbath is hiding in plain sight.

Bears Throw In The Towel: FANG Shorts Hit All Time Low

At the end of May, when Bank of America looked at some of the most widely held stocks by active managers, it found that FANG stocks (FB, AMZN, NFLX, GOOG/GOOGL) have returned nearly 30% YTD vs. 8% for the S&P 500. More importantly, it found that managers were 32% overweight Information Technology + Internet & Catalog Retail (a Discretionary industry), which was driven by a remarkable 71% overweight in FANG stocks.

This week, BofA"s Savita Subramanian updated the study of most widely held active manager stocks, and found that while fund managers holdings of FANG and FAAANG (which also includes ACVO and ADBE), have modestly declined over the past two months, they still remains remarkably stretched, or as she puts it "active managers" disproportionate overweight in FAAANG relative to the Tech sector and Internet and Catalog Retail is even more dramatic than the FANG stocks."

But more interesting is BofA finding - both then and now - that since long-only funds did not appears to be bidding up FANG (or FAANG) stocks, which had remained relatively constant among their total portfolio hodings...

... the answer was that "the recent move in FANG may be driven more by short-covering than by active buying."

However, as Bank of America also notes, that short covering, if indeed that is the cause of the levitation, is ending as the short interest for both FANG stocks is now down to all time lows.

A separate analysis released today by Bloomberg"s Stephen Gandel confirms as much, and notes that despite the seemingly pervasive negative sentiment against FANGs, everywhere from Goldman to Howard Marks...

Goldman Sachs Group Inc. strategists predicted an "air pocket" was coming in the FANG bubble. After a survey of investors, Bank of America strategists called FANG and other technology stocks the most crowded trade in the market. Oaktree Capital co-founder Howard Marks recently compared the FANG to the Nifty Fifty and dot-com stocks of the 1970s and 1990s, respectively, as well as other bubbles.

... the short interest for the four companies has sunk to a new record low: "collectively, the short bets against FANG stocks accounted for just 2 percent of their traded shares. Exclude Netflix, and the average short interest for the group drops to just 1 percent. That compares with an average of 4 percent for the S&P 500."

Some have pointed to the recent surge in Netflix and AAPL"s blow off to new all time highs on Tuesday after earnings as confirmation that the shorts are right to stay away, others have said that the move in the company - whose growth rate is a mere shadow of what it used to be, and which has now posted declining Chinese sales for 6 quarters - was so acute precisely due to another batch of shorts throwing in the towel and covering, or as BBG puts it, "tech bears shedding their fur has pushed the stocks higher."

And while the lack of shorts may suggest smooth sailing for the group over the near immediate future, over the long term, a lack of skeptics could be bad. Gendel points out why:

The dearth of short interest suggests an enthusiasm for the shares that could be quickly popped if things turn south. And the falling short interest is odd given that the FANG stocks have risen an average of 37 percent this year, potentially setting them up for a fall, or at least a slip. Amazon, after all, trades at nearly 93 times its expected earnings for this year. Netflix"s unending cash bonfire has burned through $2.1 billion in free cash flow in the past 12 months. The expectations for sales of Apple"s coming iPhone are stratospheric even though the price of one model may top $1,000. Any of these situations would seemingly make for a good short bet, if anyone was willing to make it.

For now, almost nobody is, as most traders remain "paralyzed" (or perhaps complacent) and instead chose the comfort of the passive-investing, ETF, CTA herd which continues to grind stocks ever higher with less volatility than the bond market. Then again, with all the FANG bears having thrown the towel, this may be just the right time to go short... again. Judging by the recent price performance of the group, others may have gotten the same idea.

Household Spending Growth Expectations Crash To Cycle Lows

Despite record high stock prices, soaring consumer sentiment measures, and the constant Fed-spun narrative that incomes will rise amid "full-employment", the latest survey of Americans by The New York Fed signals hope is collapsing for a spending renaissance...

Median household spending growth expectations tumbled from 3.29% in March to 2.58% in April, lowest level in data going back to June 2013..

Still, as long as NFLX, AAPL, AMZN, and GOOG are rallying, this is nothing to worry about, right?

Facebook due for a Face-lift after Fake-News exposes Fakebook

Facebook (FB) is no doubt one of the most popular tech stocks out there. The market cap of Facebook as of this writing is 368 B - it"s nearly the size of Amazon.

But what does Facebook really do? This question has been asked of tech stocks since the .com bubble. But many tech stocks, for example Amazon (AMZN) perform a number of useful, tech services. In the case of Amazon they have hundreds of niche services many haven"t even heard of, such as Amazon Web Services (which is cloud computing, hosting, and related services), publication services for authors including a full life cycle publishing solution through Kindle, Shipping storing fulfillment and logistics services for small businesses; the list goes on and on and on.

This opinion about Facebook isn"t rare - there"s actually a huge movement of users who have deleted their profiles and refuse to ever use the service again. Here"s one power user, a Forbes contributor, who dumped Facebook, and explains reasons why:

It"s official. I"m off the Facebook FB -0.02% grid. Nobody offended me. I didn"t have a bad experience. While I"m not thrilled about the idea of Big Brother watching my every move, I"m not particularly paranoid about social media sharing. Therefore, I"m sharing why I"m dumping Facebook and committing to Twitter and Instagram. 1) Facebook sucks time from my life, and unlike money, time is a zero sum game 2) Most of my Facebook friends aren"t (actually friends).3) There are other (better) options for photo sharing.4) Facebook brings out the worst in people.5) I learn more on Twitter. 6) The presence of ads on Facebook is getting ridiculous. 7) Less is more. Goodbye, Facebook. Follow me on Twitter: @TimMaurer.

This is just one example. There"s actually a flood of people fleeing the platform, they"ve even created names for Facebook to describe their feelings, like "Fake Book" and others.

What is the straw that broke the camel"s back? It was the recent election news cycle. "Fake News" was blamed as having a part in shaping an online discussion about political issues. Sites that broadcast this alleged "Fake News" like Facebook (FB) are being investigated, and users are questioning their use of the sites:

For weeks, Facebook has been questioned about its role in spreading fake news. Now the company has mounted its most concerted effort to combat the problem.

Since the election drama, there"s all sorts of accusations both internally and from users as well:

Facebook has been in the eye of a postelection storm for the last few days, embroiled in accusations that it helped spread misinformation and fake news stories that influenced how the American electorate voted. The online conversation among Facebook"s executives on Tuesday, which was one of several private message threads that began among the company"s top ranks, showed that the social network was internally questioning what its responsibilities might be.

Even as Facebook has outwardly defended itself as a nonpartisan information source - Mark. Zuckerberg, chairman and chief executive, said at a conference on Thursday that Facebook affecting the election was "a pretty crazy idea" - many company executives and employees have been asking one another if, or how, they shaped the minds, opinions and votes of Americans.

We need to take a step back and understand the origins of Facebook as have been revealed in the last years. Facebook isn"t just a startup, it has some interesting backers and partners. It was revealed recently that Facebook was part of a broad program to collect user information they publicly volunteered on social media platforms on behalf of the intelligence community. PRISM is just one program but the most bright example of how social media was used to collect intelligence - you can read more about PRISM here. Not only was the NSA and CIA seed stage investors in Facebook under NDA (Non-Disclosure Agreement) they were active customers. This data they extracted didn"t come free - they would pay for it, both with cash and favors. Favors that helped Facebook become the 368 B market cap behemoth that it has become.

All of this however, can potentially crumble. Not only is Facebook under investigation about manipulating public opinion with their "news algorithm" - it"s under scrutiny from potentially one of the most powerful people in the world, president-elect Trump.

Trump hasn"t put forth a plan to restructure the intelligence community explicitly; it"s been hinted at:

How Trump"s reported plans to restructure the intelligence agencies figure into this plan remains to be seen. This week, he selected former senator Dan Coats as his Director of National Intelligence, a position he reportedly considered abolishing earlier.

But case in point; Trump is in a quagmire due to his extensive international business units that can all pose a potential conflict of interest when he"s in office. As a President first and business owner second, he"s dealing with it. But from that perspective, would he perceive that it"s a conflict of interest for the intelligence community to directly invest, control, and partner with US tech companies on US soil - especially those such as the CIA that according to their mandate, only operate internationally? According to the CIA"s own website:

By law, the CIA is specifically prohibited from collecting foreign intelligence concerning the domestic activities of US citizens. Its mission is to collect information related to foreign intelligence and foreign counterintelligence. By direction of the president in Executive Order 12333 of 1981 and in accordance with procedures approved by the Attorney General, the CIA is restricted in the collection of intelligence information directed against US citizens. Collection is allowed only for an authorized intelligence purpose; for example, if there is a reason to believe that an individual is involved in espionage or international terrorist activities. The CIA"s procedures require senior approval for any such collection that is allowed, and, depending on the collection technique employed, the sanction of the Director of National Intelligence and Attorney General may be required. These restrictions on the CIA have been in effect since the 1970s.

That"s probably why InQTel makes their host clients sign NDAs! If Facebook can"t disclose them as an investor, it can never be proven they are involved in domestic intelligence even if indirectly, as the evidence could be thrown out of court due legal technicalities of how it entered the process of discovery (against the NDA). The author is not a lawyer to elaborate on how the NSA and CIA protect themselves from classified disclosures and lawsuits or worse, but they do have the best lawyers in America and even their own special court, called the FISA court, which is like a secret, classified court.

So if the NSA/CIA is "restructured" - would they look at InQTel and their affiliates? Is it a potential conflict of interest that the NSA/CIA has a vested interest in a company like Facebook that has been accused of shaping the election domestically? It"s unusual for the NSA/CIA to get involved in domestic politics. They have a history for fixing foreign elections, there are more than 100 countries where the NSA/CIA has either fixed the elections, or tried to, or tried to manipulate the local politics. But they"ve never done it domestically, at least to this extent. If they are investigated and restructured, and "de-politicized" - it can also lead to an investigation or restructuring in the least, of their public tech assets, companies like Facebook . This may sound like a big roundabout way to make a case; but consider that the NSA/CIA"s connection to Facebook is 1) not often talked about and 2) widely misinterpreted. In fact, they are a large part of the success of Facebook because well, they have really good connections!

Readers should note that, the CIA takes direction from the NSC, which is led by the President.

Facebook itself doesn"t develop technology or offer a "product" as does a company like IBM (IBM) or even Apple (AAPL). Facebook "s entire model is based on advertising, and now they have been buying companies that actually build and develop technology. But the core of Facebook is essentially, a house of cards built on the egos of its users and the illusionary world they allow people to create for themselves. This is not a stable business!

None of this is going to be reflected in the numbers, it"s hard to quantify. Even with a huge collapse Facebook is going to be around probably forever, but shareholders should take note of these major demographic trends that can cause a severe decline in the stock price as well as en-masse abandonment of the platform, at least from it"s US users. In foreign markets, it"s not clear if Facebook can be the dominating platform, as countries have their own platforms specific to their own culture, the best example being Russia"s VK which penetrates 99% of the market. Other countries have their own respective VK"s - so it"s not clear if Facebook could make up for the US issue with non-US business.

Finally, Facebook is littered with spam and fake accounts. Facebook claims to be aware of this issue, but it continues to be an ongoing problem. Local Police are even creating fake accounts for the purpose of monitoring local activity:

Police departments around the nation have taken predictive crime prevention to a new level by building fake user accounts, as well as posing as genuine people to gather information about local events, Tech.Mic reports.

Local agents put on a "digital mask" and pose as "members of the community," allowing them to gather personal information about suspects they consider a high risk of being involved in a future crime or have existing charges.

In a social media guide for law enforcement officialspublished by the Justice Department, the document details, officers create fraudulent profiles even though Facebook officially bans the practice.

That"s right - the Police have a guide on the creation of fake accounts in order to participate in the growing field of "pre-crime" published by the Department of Justice. You can download and read this manual by clicking here. From the introduction:

Police departments also have begun to explore the use of social media to obtain information, especially for tactical purposes, such as gathering information about threats of mob violence, riots, or isolated criminal activity during otherwiselawful mass demonstrations.

There"s even guides on how to create a fake account on sites like lifehacker.com - that"s not considering the companies that have made a business out of facebook-spam including but not limited to the US Military, via their Ntrepid software:

The U.S. Military is about to get into the business of lurking on forums and hanging around social media sites in a big way. Central Command (Centcom) is teaming up with a company called Ntrepid on software that will allow military users to create and manage multiple fake-but-convincing social media accounts, "replete with background, history, supporting details, and cyber presences that are technically, culturally and geographically consistent."

The military says these sockpuppet accounts will support "classified blogging activities on foreign-language websites to enable Centcom to counter violent extremist and enemy propaganda outside the US."

So here we have several cases of PUBLIC NOTIFICATIONS where organizations have stated PUBLICLY that they are creating fake accounts EN MASSE. That doesn"t consider the thousands or perhaps millions of companies that do this privately, as a business. Here"s just one example of a site that simply sells Facebook (FB) accounts, buyaccs.com and why not, they have a "bulk" discount for lazy spammers that don"t want to go through the trouble of creating their own army of fake accounts like the US military says they will do. Here"s an image of the site in case it gets taken down - you can see price per account, and how many accounts available per provider. If these are all "real" accounts - who would "sell" their Facebook account? And how would they possibly have so many in such large quantities?

Facebook and supporters of Facebook is in denial about how spammy Facebook has become. They are further blinded by the fact that ad-dollars have continued to roll into Facebook"s ad platform, which has put the issue of fake accounts on the back burner.

As an aside, Google (GOOG) has always had a problem with click fraud, but they developed highly sophisticated algorithms to detect click fraud, it"s not 100% accurate but works really well, according to advertisers and publishers. Legitimate publishers and advertisers both don"t want fraudulent clicks even if it"s as simple as a publisher clicking on his own ad (this is filtered by a simple IP algorithm). Google protects advertisers by finding invalid clicks (not genuine) and refunding the fees generated and in extreme cases, banning the publisher involved. It"s unknown how much Google invested in the development of this system, but it works.

Not only has Facebook not attempted to do something like this, they don"t even go after companies who have made a business out of hacking and spamming Facebook - they encourage it! They have changed their "real name policies" but that"s superficial, robots that create fake accounts have always used real names or names that sound real, i.e. Archimbaldo Ultsright, James Terefin, Haggo de Blazio, Horatio de Pulpa, if you aren"t creative here"s a fake name generator, similar to what all the robots use.

All of this information is of course, from the technical perspective of Facebook it says nothing about the earnings, the actual revenue Facebook has received and so on. Detractors of this Fakebook theory will claim this is all being dealt with. What they are failing to realize is how fragile the Facebook model is. Take a look at another example - many think Apple is overpriced. But Apple can"t be replicated in one weekend with a few million dollars - Facebook can, and has. There are thousands of competition social network sites that many have started using instead of Facebook . As isn"t sitting on a really unique technology / patent portfolio, the only thing keeping them at the top are their really high end connections, including but not limited to Silicon Valley and associated Billionaires, the NSA/CIA apparatus, and the marketing / advertising industry which has a vested interest to see Facebook be an "alternative" to the main stream media which is declining in relevance.

So, longs should be concerned about this and at the least, hedge your positions and in the most prudent, get out and find something with real value like Overstock.com (OSTK) as we have mentioned in a previous article. There"s hundreds of better tech plays out there that are real deep value plays. Facebook is due for a major face-lift, and the current management is not willing to face the facts: Facebook is Fake.

For a quick primer on the financial system checkout SPLITTING PENNIES - YOUR POCKET GUIDE TO MAKE YOU A FOREX GENIUS