There’s a lot of excitement about the building IPO docket for the year. Let’s take a look of the lay of the land …
There is said to be more than 220 companies planning to go public in 2019.
On Friday, Lyft filed an S1 with the SEC (a prospectus like document) in preparation for an IPO. This will be the first Silicon Valley darling to go public this year.
Lyft is the second largest ride-sharing company — owns about a third of the U.S. market, with Uber owning the rest. Uber is expected to go public this year. The other big ones coming: Airbnb, WeWork and Palantir.
We’ve clearly had a boom cycle in Silicon Valley over the past decade. But are these IPOs coming late the party?
Remember, we have an administration in Washington that has tightened the regulatory screws on the dominant publicly-traded tech giants (Facebook, Amazon, Google). The regulatory tailwinds (or lack thereof) that they enjoyed along the path of their disruptive growth, have now turned into headwinds. And the stocks have all been hit, as a result.
Keep in mind, the private market valuations were pumped-up in these IPO candidates when public equity markets were offering little optimism about future returns. With that, pension money was flowing into the coffers of Silicon Valley private equity firms. And private equity fund managers were throwing money at things — and companies have been burning through that money, ramping staff, buying fancy offices and inundating us with blitz advertising campaigns.
Safe to say there has been an overhyping of the term “disrupters.” In many cases, we’re looking at startups trying to underprice and outspend (with our pension money) in a traditional business, without having the hurdle of making money (maybe ever). Not surprisingly, there have been market share wins.
But public companies tend to be held to a standard: profitability. We’ll see how they do with the shifting market environment (i.e. late cycle Silicon Valley).
Lyft will be an early indicator. Its last private investment valued the company at $15.1 billion. For that, in their filing, they revealed a company doing a little over $2 billion in revenue, while losing almost a billion dollars last year. Revenue growth has been slowing, losses have been widening as the private equity investors attempt to cash out in the public markets.
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The tech giants continued to get hammered today. We’ve talked about the prospects for an unraveling of the tech giants for much of the past year.
Despite the clear warning shots that were fired by regulators/lawmakers (and the President) along the way, these stocks kept going up — until they didn’t.
As I said back on September 4th, when Amazon crossed the trillion-dollar valuation threshold, “at 161 times earnings, the market seems to be betting on the Amazon monopoly being left to corner all of the world’s industries. That’s a bad bet. Much like China undercut the compeition on price and cornered the world’s export market, Amazon has undercut the retail industry on price, and cornered the world’s retail business. That tipping point (on retail) has well passed. And as sales growth accelerates for Amazon, so does the speed at which competition is being destroyed. But Amazon is now moving aggressively into almost every industry. This company has to be/will be broken up.”
A day later, Facebook and Twitter executives visited Capitol Hill for a Congressional grilling. Here’s an excerpt from my note that day: “If you listened to Zuckerberg‘s Congressional testimony in April, and today’s grilling of Jack Dorsey (Twitter) and Sheryl Sandberg (Facebook), it’s clear that they have created monsters that they can’t manage. These tech giants have gotten too big, too powerful and too dangerous to the economy (and society).”
Here we are, a little more than two months later, and the sentiment on tech has dramatically changed. Amazon topped the day it reached the trillion-dollar valuation and has lost a quarter of a trillion dollars in value since (down 26%). Facebook is down 39% since the record highs in July.
So it appears that we are finally seeing the “monopoly scenario” priced out of the tech giants. And with that, we should see money moving back into those stocks that have been left for dead in industries like media, retail, shipping (to name a few). This is the Dow/Nasdaq convergence we’ve been looking for for much of this year — and we’re getting it. At one point this summer the Nasdaq was up close to 15% on the year, while the Dow was flat. Now both are up just over 1% year-to-date. I suspect that Dow outperformance will continue.
We have G20 tomorrow, where the world will be watching for some movement on the U.S./China trade negotiations. Any hint at a deal should get this Dow trade moving aggressively higher.
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If you are a regular reader of my daily notes, you’ll know I’ve suspected we are seeing an end to the “wild west” days in Silicon Valley.
I think we’ve finally seen it play out in the stock market in the past month.
The media has spent the past month pontificating about big macro economic stories and how these risks have driven this correction stocks. But the intermarket correlations don’t support it. Despite the sharp slide in stocks, money hasn’t fled to the safety of bonds. The currency market has shown little to no stress. And gold has been relatively quiet. This is all antithetical to what you would find in a world shaken from elevated global risks.
Ultimately, this correction has been about repricing the tech giants. And one of the power players in Silicon Valley said about as much this week.
Peter Theil, founder of PayPal and the first investor in Facebook said he doesn’t expect to see another innovative breakthrough consumer internet company. I agree (for a number of reasons).
With that, I want to revisit my note from March of 2017, as Trump was just getting his feet wet as President:
TUESDAY, MARCH 7, 2017 “A big component to the rise of Internet 2.0 was the election of Barack Obama.
With a change in administration as a catalyst, the question is: Is this chapter of the boom in Silicon Valley over?
Without question, the Obama administration was very friendly to the new emerging technology industry. One of the cofounders of Facebook became the manager of Obama’s online campaign in early 2007, before Obama announced his run for president, and just as Facebook was taking off after moving to and raising money in Silicon Valley (with ten million users). Facebook was an app for college students and had just been opened up to high school students in the months prior to Obama’s run and the hiring of the former Facebook cofounder. There was already a more successful version of Facebook at the time called MySpace. But clearly the election catapulted Facebook over MySpace with a very influential Facebook insider at work. And Facebook continued to get heavy endorsements throughout the administration’s eight years.
In 2008, the DNC convention in Denver gave birth to Airbnb. There was nothing new about advertising rentals online. But four years later, after the 2008 Obama win, Airbnb was a company with a $1 billion private market valuation, through funding from Silicon Valley venture capitalists. CNN called it the billion dollar startup born out of the DNC.
Where did the money come from that flowed so heavily into Silicon Valley? By 2009, the nearly $800 billion stimulus package included $100 billion worth of funding and grants for the ‘the discovery, development and implementation of various technologies.’ In June 2009, the government loaned Tesla $465 million to build the model S.
When institutional investors see that kind of money flowing somewhere, they chase it. And valuations start exploding from there as there becomes insatiable demand for these new ‘could be’ unicorns (i.e. billion dollar startups).
Who would throw money at a startup business that was intended to take down the deeply entrenched, highly regulated and defended taxi business? You only invest when you know you have an administration behind it. That’s the only way you put cars on the street in NYC to compete with the cab mafia and expect to win when the fight breaks out. And they did. In 2014, Uber hired David Plouffe, a senior advisor to President Obama and his former campaign manager to fight regulation. Uber is valued at $60 billion. That’s more than three times the size of Avis, Hertz and Enterprise combined.
Will money keep chasing these companies without the wind any longer at their backs?“
Again, this note above was from about 18 months ago. And administration change has indeed become a problem for these emerging monopolies.
Trump’s scrutiny has come, and so has the regulatory scrutiny. But admittedly is has taken longer than I expected.
Still, it has become clear now to lawmakers (in the U.S. and abroad) that the lack of regulatory oversight of these companies (if not regulatory favor) has created a “winner takes all” environment. And the power transfer into so few hands has quickly become a big threat.
Now these companies look forward to the next decade of regulatory purgatory. But given the maturity of these tech giants, higher regulation only strengthens their moat. That means there will never be a competition to Facebook emerging from a dorm room or garage. The compliance costs will be too high.
But regulation on the tech giants also creates the prospects for those “old-economy” competitors that have survived, to bounce back.
On Friday we talked about the opportunity presented by this recent dip in the broad stock market.
We’re beginning to see more clearly today the rotation out of tech and into value. That is translating into a continued slide in the Nasdaq, while the Dow is rising.
Now, even though this looks like a re-pricing of the high-flying tech stocks, as we often see the “baby gets thrown out with the bathwater.” In this case, because the big tech giants have been so widely held, when they crack, everything has cracked. That’s an opportunity to buy broader stocks on sale. And stocks are indeed cheap.
Take a look at historic valuations (P/E on the S&P 500) …
From a valuation perspective, Wall Street is estimating stocks on next year’s estimated earnings to be as cheap as we’ve seen only two times in the past 26 years.
You can see where stocks were valued on the S&P going into 2012. Stocks finished up 16% that year. The other year was 1995 (a P/E of 14.89). Stocks finished that year up 37.6%.
Still, many have continued to harp on valuation, always pointing to the long run average P/E on stocks, which is around 16. That’s a long history. If we look back at the past twenty years, the average valuation is MUCH, MUCH higher. It’s 23 times earnings!
If we take Wall Street’s estimate on S&P 500 earnings of $176 and multiply it by 23, we get and S&P at 4,048. That’s 47% higher than Friday’s close.
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The market is typically pretty good at pricing in what is known. And it has been pretty clear that Trump has seen trade imbalances as a key piece of his structural reform plan. And the strategy on correcting those imbalances has been to fight trade barriers with trade barriers.
While it has created plenty of fodder for political and economic debates, the markets seem to like it.
As we’ve discussed, any movement on trade, from a U.S. perspective, is success. He has said as much with this statement on China:
Given the position of U.S. stocks (at or near record highs) relative to global trading partner stock markets (largely, negative on the year), the market seems to be fairly comfortably betting that movement will occur, given the position of strength from which Trump is negotiating (i.e. the biggest and most powerful economy behind him).
Now, this is the effort to level the playing field internationally. We’ve also talked about the ‘domestic’ leveling of the playing field on the Trump agenda. And that has everything to do with the tech giants. And it has most to do with Amazon.
With that, we’ve talked about the case for breaking up Amazon. As I’ve said
“At 161 times earnings, the market seems to be betting on the Amazon monopoly being left to corner all of the world’s industries. That’s a bad bet. Much like China undercut the competition on price and cornered the world’s export market, Amazon has undercut the retail industry on price, and cornered the world’s retail business. That tipping point (on retail) has well passed. And as sales growth accelerates for Amazon, so does the speed at which competition is being destroyed. But Amazon is now moving aggressively into almost every industry. This company has to be/will be broken up.”
Amazon was a big loser on the day today. Why? Break-up speculation.
A Citibank internet analyst today called for the split of Amazon’s ecommerce and cloud computing business (AWS). But the analyst recommended the company split itself to avoid regulators doing it for them. That sounds like a recommendation for a pre-emptive strike in an effort to maintain the euphoric investor sentiment in the stock.
When we look back, the trillion-dollar valuation threshold in Amazon may have been curse. On September 4th, it hit a trillion dollars. And that has been the dead top.
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Yesterday we talked about the case for breaking up Amazon, on the day it crossed the trillion-dollar valuation threshold. Today the stock was down 2%.
Also today, Facebook and Twitter executives visited Capitol Hill for a Congressional grilling.
If you listened to Zuckerberg’s Congressional testimony in April, and today’s grilling of Jack Dorsey (Twitter) and Sheryl Sandberg (Facebook), it’s clear that they have created monsters that they can’t manage. These tech giants have gotten too big, too powerful, and too dangerous to the economy (and society).
All have emerged and dominated, thanks in large part to regulatory advantage – operating under the guise of an “internet business.” And it all went unchecked for too long. These are monopolies in the making. But, as we know, Trump is on it.
As we discussed yesterday, Amazon has to, and will be, broken up. As for Facebook, Google, Twitter, Uber: the regulatory screws are tightening. Those businesses won’t look the same when it’s over. But it’s complicated. The higher the cost of compliance, the smaller the chances that there will ever be another Facebook or challenger. That goes for many of the tech giants.
With that in mind, regulation actually strengthens the moat for these companies.
That would argue that they may ultimately go the way of public utilities (in the case of Facebook, Google and Twitter).
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As we end the week, let’s take a look at a few charts ….
We had the first look at Q2 GDP today. Here’s an updated look at the chart of the average four-quarter annualized growth rate we looked at
yesterday ….
This number will be formally revised two more times, but the “advance” number came in at 4.1%. Yesterday we talked about the prospects for the highest four-quarter annualized growth rate since 2006. We just missed it, in this first reading. But the Q1 number was revised UP to 2.2%, so adding in today’s Q2 number, and we get 3.1% four-quarter average annualized growth. Only for a moment, in 2010, was it better (at 3.15%).
I suspect we will see a bigger number in the coming Q2 revisions. And if sentiment on trade indeed bottomed out on Wednesday, with the EU concessions, we will likely have a big Q3 growth number coming.
That steadily rising trend, since the election, in the four-quarter average growth rate is a big deal. With that, I would call the above chart, the most important chart of the week…
Let’s look at the second most important chart of the week ….
I’ve been making the case that the massive Nasdaq outperformance, relative to the Dow, would begin correcting. In the chart above, you can see that it’s starting (Dow moving up, Nasdaq moving down). And it’s being led by strength in the blue chips following strong Q2 earnings, and weakness in two of the big tech giants (Netflix and Facebook) following big misses. With that, Facebook has quickly revisited levels of early May (which should give us all perspective on how aggressive this run in the tech giants has been over the past two months).
The question: Is it “peak Zuck?”
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On Friday, we talked about the building momentum in the economy. We’ve already had huge positive surprises in corporate earnings for the first quarter. And we’re probably just beginning to see the positive surprises on economic data roll in.
Remember, despite the execution success on Trumponomics over the past year (deregulation, repatriation, tax cuts and $400 billion in new government spending approved), the Fed is still expecting growth to come in well below trend (3%), at 2.7%. That’s just 20 basis points higher than they projected prior to the execution of massive tax cuts in late December.
The good news: Positive surprises are fuel for confidence and fuel for stocks.
Remember, we’ve yet to have a return of ‘animal spirits’–a level of trust and confidence in the economy that fuels more aggressive hiring, spending and investing. We should see this reflected in wage growth. Wage growth has been the missing piece of the economic recovery puzzle.
On that note, we’re now near the best wage growth in nine years, and that tax rate cut is still in the early stages of working through the economy.
Don’t underestimate the value of confidence in the outlook (and the return of “animal spirits”) to drive economic growth higher than the number crunchers in Washington can imagine. Remember, these are the same experts that couldn’t project the credit bubble, and didn’t project the sluggish ten years that have followed.
Remember, while we’re in the second longest post-War economic expansion, we’ve yet to have the aggressive bounceback in growth that is characteristic of post-recession recoveries. We now have the pieces in place to finally get it.
So, as we’ve discussed throughout the year, the backdrop continues to get better and better for stocks.
At the end of last week, I said “it looks like the all-clear signal has been given to stocks.”
Well, we had some more discomfort to deal with this week, but that statement probably has more validity today than it did last Friday.
With that, let’s review the events and conditions of the past two weeks, that build the case for that all-clear signal.
As of last Friday, more than half of first quarter corporate earnings were in, with record level positive surprises in both earnings and revenues (that has continued). And we got our first look at first quarter GDP, which came in at 2.3%, better than expected, and putting the economy on a 2.875% pace over the past three quarters.
What about interest rates? After all, the hot wage growth number back in February kicked the stock market correction into gear. The move in the 10-year yield above 3% last week started validating the fears that rising interest rates could quicken and maybe choke off the recovery. But last week, we also heard from the ECB and BOJ, both of which committed to QE, which serves as an anchor on global rates (i.e. keeps our rates in check).
Fast forward a few days, and we’ve now heard from the last but most important tech giant: Apple. Like the other FAANG stocks, Apple also beat on earnings and on revenues.
Still, stocks have continued to trade counter to the fundamentals. And we’ve been waiting for the bounce and recovery to pick up the pace. What else can we check off the list on this correction timeline? How about another test of the 200-day moving average, just to shake out the weak hands? We got that yesterday.
Yesterday, in the true form of a market that is bottoming, we had a sharp slide in stocks, through the 200-day moving average, and then a very aggressive bounce to finish in positive territory, and on the highs of the day. That took us to this morning, where we had another jobs report. Perhaps this makes a nice bookend to the February jobs report. This time, no big surprises. The wage growth number was tame. And stocks continued to soar, following through on yesterday’s big reversal off the 200-day moving average.
With all of this, it looks like “the all-clear signal has been given to stocks.”
Yields continue to grind higher toward 3%. That has put some pressure on stocks, despite what continues to be a phenomenal earnings season. This creates another dip to buy.
Yesterday, we talked about a reason that people feel less good about stocks, with yields heading toward 3%. [Concern #1] It conjures up memories of the “taper tantrum” of 2013-2014. Yields soared, and stocks had a series of slides.
My rebuttal: The domestic and global economies are fundamentally stronger and much more stable. But maybe most importantly, the economy (still) isn’t left to stand on its own two feet, to survive (or die) in a normalizing interest rate environment. We have fiscal stimulus doing a lot of heavy lifting.
Let’s look at a couple of other reasons people are concerned about stocks as yields climb:
[Concern #2] Maybe this is the beginning of a sharp run higher in market interest rates — like 3% quickly becomes 4%?
My Rebuttal: Very unlikely given the global inflation picture, but more unlikely with the Bank of Japan still buying up global assets in unlimited amounts (Treasuries among them, through a variety of instruments). They can/and are controlling the pace, for the benefit of stimulating their own economy and for the benefit of stimulating and maintaining stability in, the global economy.
[Concern #3] I hear the chatter about how a 3% 10-year note suddenly creates a high appetite for Treasuries over stocks at this point, especially from a risk-reward perspective (i.e. people are selling stocks in favor of capturing that scrumptious 3% yield).
My Rebuttal: In this post-crisis environment, a rise toward 3% promotes the exact opposite behavior. If you are willing to lend for 10-years locked in at a paltry rate, you are forgoing what is almost certainly going to be a higher rate decade than the past decade. If you need to exit, you’re going to find the price of your bonds (very likely) dramatically lower down the road. Coming out of a zero-interest rate world, bond prices are going lower/not higher.
Remember this chart …
The bond market has become a high risk-low reward investment. Meanwhile, with earnings set to grow more than 20% this year, and stock prices already down 7% from the highs of the year, we have a P/E on stocks that continues to slide lower and lower, making stocks cheaper and cheaper. That makes stocks a far superior risk/reward investment, relative to bonds – especially with the prospects of the first big bounce back in economic growth we’ve seen since the Great Recession.
