Wednesday, August 22, 2018

Commentary: Just One FAANG Bankruptcy Away from Recession

By Aaron Clarey
Recessions are a perpetual guarantee in economics.  They do happen, they will happen, and they are going to happen.  The issue is being able to figure out when.  Predicting recessions is an impossible task, but usually they need a trigger or some kind of spark to ignite the recession fuel that has been building up over the years.

In the Dotcom days it was a spate of bad earnings reports that triggered that recession.
In the housing bubble it was a spate of subprime mortgages that went into default.

But the problem today is there's no apparent spark that will set the economy aflame.

Yes, stocks are overvalued.  Yes, housing is back to being overvalued, but I would contend this is the result of flooding the market with QE money, not bad lending practices or a classic tulip bulb bubble like the dotcoms were.  Additionally, the federal government is so far up banks' asses its very unlikely we will see a housing crash like we did a decade ago.  Still, the PE ratio for the stock market is 40% higher than it's historical average, dividends are paying a laughable 1.8%, and I'm sure US property is back to all time "price to rents" highs.  It's merely a question of what is going to prick this bubble?

So it is here I'd like to speculate on what that catalyst could be - one of the FAANG's going bankrupt or severely missing earnings.

The "FAANG" companies are Facebook, Amazon, Apple, Netflix and Google.  However, I would also consider companies that are merely "popular" today like these FAANG companies are.  Twitter, Tesla, Uber, Lyft etc.  And while the traditional FAANG companies are all profitable (Amazon finally achieved profitability this past year), a lot of today's popular companies are not.  Twitter, Tesla, Uber, and Lyft all run losses, but ironically have market valuations in the billions.

We've seen this before.  In 1998 it was fashionable among low IQ people to use "price to sales" as a valuation metric because none of the dotcoms were profitable.  People were in love with the IDEA of some of these companies, even though they had no profits.  And while it certainly is an investment strategy to buy into a money-losing company in the hopes it will become profitable later, inevitably, sooner or later investors are going to want their money back.  Alas hobbies like Tesla are simply that - hobbies - not legitimate business concerns.

The problem I fear though is this past generation has been flooded with so much money that they no longer understand the concept and importance of having a profit.  Be it student loans, QE, borrowing money for a house, or borrowing money for a car, the concept of spending less than you make I think has been completely purged out of today's generations.  For example Patreon. 

I never understood why somebody would donate to somebody's Patreon when you get nothing for it in return.  Especially in light of Amazon's affiliate program where you spend the money you were going to spend anyway, but make the affiliate marketer a nice 7% commission through your purchases.  Still, Patreon's success I think is more due to a non-profit mentality that is widespread amongst millennials and Gen X'ers because they lack the concept of profit.  And this lacking concept also affects the way they invest in that they truly don't care if a company is profitable, long as it sounds cool, virtue signals, and has a "small carbon footprint."

Inevitably though, you can't have a company running perpetual losses forever.  If Uber or Twitter has to go back to their financiers for more money those investment bankers will not be taking such a nice, naive and non-profit approach to a second round of funding.  They are going to want their money back, and likely won't fund these companies.  This means one of these FAANG/FAANG-like companies is going to go bankrupt when it can't get financing to continue losing money.  And when that happens I think that may be the spark that catches the economy on fire with recession.

I don't see it being a big recession, but I do see it providing a rude awakening for these "neo-nonprofit investors."  Yes, I know you think Chipolte is great because they're green - did they meet earnings?  Yes, I know you think Lyft is great because they have an initiative to raise awareness about sapiosexuals - did they meet earnings?  And yes, I know Elon Musk is very popular, but his little over priced sparky cars cost more to make than he can sell them for - they have no earnings to speak of.  And when one or two of these perennial money-losers goes bankrupt, it's going to cause worry and concern about the valuation of the other FANNG-esque companies as people realize it's not popularity, but profit that has value.

Still, I won't be holding my breath.  Most investors today seem to think investing is a hobby, not a serious endeavor.


Editor's note: This article was originally published at Captain Capitalism and has been rerun with permission.

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