A Phenomenal Rise
Since March 2009, the longest equity bull market in US history was underpinned by one particular sector, technology, with companies commanding quasi-monopolies taking the lead and delivering performances in multiples of where they started.
Winner-takes-all says the logic of these business model and many of them have become supranational businesses with billions of clients around the world and a political reach beyond the imagination.
Facebook, Google, Twitter, Amazon, Netflix, Uber, Deliveroo cater for clients across the globe, collect data on a massive scale, analyse human behaviour and use Artificial Intelligence to predict global and individual trends while storing personal data in their digital vaults.
Apple and Google master the App and operating systems businesses, Apple and Microsoft the software businesses , Google the search engines , Facebook and Twitter the social media communication, Microsoft and Zoom the video conferencing platforms, AMD and NVIDIA the chips used in video games and Netflix the streaming entertainment platforms.
These companies have build phenomenal and highly profitable franchises over the years, gained a massive lead in technology, acquired most of their potential competitors and command unprecedented market share.
Rightly so, their stock prices have sky-rocketed between 2009 and 2019, and even more so when the 2020 pandemic locked down entire swathes of populations forcing people to work, play, shop and view series from home.
APPLE Inc. shares soared from $2.79 ( adjusted for stock splits) on 29 Jan 2009 to US$ 145 yesterday, a 51x increase over the past 12 years.
MICROSOFT rose from $14.87 on 6 March 2009 to $ 280 yesterday, a 18.8x increase in value
ALPHABET ( Google ) rose from $141.5 on 23 January 2009 to $ 2545 yesterday, a 17.9x appreciation
FACEBOOK rose from 17.55 on 28 Sep 2021, after its IPO, to $ 358 yesterday a 20.4x increase.
AMAZON rose from $47.6 on 30 January 2009 to $3734 yesterday, making Jeff Bezos the richest man on the planet, a 78x increase in value
NETFLIX rose from $4.11 on 30 January 2009 to $ 593 on 29 January 2021, a 144x increase in value
ADVANCED MICRO DEVICES rose from a low of $ 1.61 to $ 99.23 on 15 January 2021 a 61x appreciation since then
NVIDIA rose from $7.08 on 23 January 2009 to $835 yesterday, a 118x increase.
These spectacular performances underpinned the entire 2009-2021 secular bull market taking the SP500 from a low of 666 on 30 June 2009 to an all time high of 4361 yesterday, a 6.54x increase, and the tech heavy Nasdaq from 1265 on 13 March 2009 to its all-time high of 14 755 yesterday an 11.66x increase.
By the same token, their share in the corresponding indexes rose to an unprecedented 28 % of the SP500, a unique level of concentration.
Today all these companies have market caps in the hundreds of billions of US Dollars with Apple and Microsoft above 2 trillion, the GDP of Italy, Amazon at 1.8 Trillion, Google at 1.6 Trillion, Facebook flirted with the 1 trillion mark, Nvidia at 500 Billion, Netflix at 250Billion and AMD at 110 Billion.
However, most of the appreciation of these shares, and of the overall market for that matter, did not come from an equivalent increase in their annual earnings per share, but from an unprecedented VALUATION EXPANSION phenomenon.
As a matter of illustration, the Price/earnings ratio of the SP500 has trebled from 11x to 33x between 2009 and 2021 and its Price to book ratio – there again across industries has risen from 1.45x to 4.62x.
Massive monetary stimulus over the past 12 years, and especially last year, coupled with a countercyclical tax cut in 2018 and massive fiscal stimulus – helicopter money – in 2020 found its way into assets taking their valuations to extremes exceeding both the 1999 peak and the 1928 peak.
Investors today are more invested, more bullish and more speculative than ever, and what is true for the global market is even truer for the leaders of the market; the US Mega caps.
In 2018, we called the END OF TECH
In our various papers on the theme, as early as February 2018, we built our bearish case on two tenets :
. Valuations then had already reached levels that were rationally and historically unsustainable for the future,
. The might and global reach of the US Mega-tech had reached a point where nations and Governments would ultimately act to contain their rise and break them up.
Boy, were we early …
In January 2018, the Donald Trump tax cuts provided corporations with the free money to buy back their already over expensive shares, and
In December 2018, the Trump appointed new Chairman of the FED, Jerome Powell, under political pressure, reversed the course of Monetary policy, lowering rates again and triggering one of the best equity rally on records in 2019 with the SP500 rising by 29 % and the Nasdaq +37 % despite relatively subdued economic and earnings growth.
In 2020, as the COVID-19 pandemic hit the world, Central banks did even more, going all-in on free money and Governments on handouts, feeding multiple investment bubbles across the financial and commodity spheres, sending cryptos, meme stocks, IPOs, space, real estate and art, including non-fungible tokens through the roof.
We even had the privilege of our post calling the top of the crypto world on April 13 2021 being tokenised for prosperity.
Today, some of the most prominent money managers are forecasting the mother of all crashes as an event waiting to happen. Only to name a few, Micheal Burry, Jeremy Grantham, Leon Cooperman, Stanley Druckenmiller, Jeffrey Gundlach, Kevin O’Leary, Robert Kiyosaki or Gary Shilling are ALL warning investors that, at best, returns will be very poor in the future, and at worst, the markets are ready to crash in the coming months.
WE, OURSELVES, HAVE WARNED OUR READERS ABOUT THE COMING CRASH IN US TECH – See Get Ready for the Coming Crash.
So let’s revisit the two tenets that make us believe that many of the companies outlined above could lose anything between 60 and 90 % of their value in the coming two years..
INVESTING IN OVERVALUED STOCKS IS A RECIPE FOR DISASTER
As we highlighted above, the spectacular performances of the US mega tech stocks have come primarily from valuation expansion and investors infatuation with their stories.
The phenomenon has been compounded by passive investment or indexation which today represents more than 50 % of all the money invested and compounds the buying pressure on these overvalued companies because of their unprecedented weighting in the indexes.
To illustrate the point, let’s take the case of Apple Inc‘s 51 x increase in share price.
In 2009, Apple’s earnings per share stood at $0.32. They rose to US$ 5.1 expected in 2021, a 16x increase only – or only one third of the share price increase.,
Its enterprise value ( Market CAP + debt – cash ), or the price actually paid for the company by investors rose from 130 Billion in 2009 to 2.3 trillion this year.
When brought back to annual profits, the EV/earnings ratio rose from 16x to 31x and its price to book from 3.3x to 33x over the same period. Some analysts will argue that Price to book ratios may not be the best valuation indicator to compare technology stocks to other industries, but in this particular case we are comparing apple with apple and the historical trading of its own Price to book ratio over time. This massive increase from 3.3 to 33x just reflects how much the company has been leveraged over the period, making it that much more dangerous if interest rates start rising.
We could do the same analysis and come to the same conclusion on each and every one of the above listed stocks, but it would be extremely fastidious to list them all.
The point we are making is that
Valuation expansion does come to a halt at some point and even reverses courses when the upward momentum of the stocks reverses.
This has been a hallmark of every financial asset, every cycle and every period in history.
When the speculative frenzy ends and policies normalise, valuation and rationality comes back to the fore and every period of valuation expansion is followed by a period of valuation contraction.
And this is where we are now…
Right now, a lot of tech stocks trading at insanely high valuations…
Valuations so high that even if these companies meet the aggressive growth assumptions that are constantly revised up by analysts as stocks are going up, pumping up expectations, the stocks won’t rise much over the next five years.
Moreover, expecting that valuation expansion will continue at the same pace is folly.
The future growth of these companies business is already priced in.
And if these companies see even one misstep or market downturn, the stocks will plummet.
Understanding a company’s valuation is the most important part of any investment.
Even the best companies with technologies that none of their competitors have are not good investments if they are trading at too high of a valuation.
Investing at an irrationally high valuation in a fantastic company will still lead to investment losses, and this is the point we are making here today.
The 1999 dot.com bubble example.
We can see the dangers of investing in overvalued technology companies by looking back at the dot- com bust.
Back then, companies were going public at absurd valuations with little more than a vague business plan and a “dot-com” in their name.
But some companies, as today’s tech giants, had phenomenal technologies, considerable edges, market share and financial fire power.
Sun Microsystems was one of those tech leaders
Sun Microsystems, Inc. was an American technology company that sold computers, computer components, software, and information technology services. It created the Java programming language, the Solaris operating system, ZFS, the Network File System, VirtualBox, and SPARC microprocessors.
As you can see in the chart below, Sun Microsystems peaked at $257 and plummeted 96% to $9.68.
The company’s fall didn’t happen because Sun Microsystems had bad technology. In fact, its Java programming language is still in use today. Sun was the leading provider of enterprise servers and mainframes.
It fell because the valuation was way too high to support its future growth expectations.
The founder and former CEO of Sun Microsystems, Scott McNealy, put it simply.
In an interview in 2000, when the stock traded at $64 he said:
“We are selling at 10 times revenues…
At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal.
And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate.
Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What are you thinking?”
As can be seen from the chart above, the stock kept on rising to $250 before plummeting back down to the low 20s.
And when that happened in 2001 and 2002, NOTHING had materially changed in the underlying business of Sun Microsystems. It still was the provider of choice of mainframes, servers and operating systems of most of the world’s banks and large corporations….
Now let’s take a look at the charts of our US Mega techs.
We have added TESLA for good measure of a bubble that has already started to burst.
Any resemblance between the above charts and the one of Sun Microsystems in 1999 ?
All the above companies have Price to Sales ratio of between 8x and 12x, P/E ratios in the 30s and Price to Book ratios also in the high 20s or above.
Our point here is that there is no upside left on these stocks, but massive downside potentially.
In the coming bear market, our price targets, based on reversion to the mean, for the above stocks are :
Apple Inc. $ 65 ( – 54 % )
Microsoft Inc. $ 135 ( – 51 % )
Google $ 1350 ( -46 % )
Facebook $ 200 ( -42 % )
Amazon $ 1800 ( -51 % )
Netflix $ 250 ( -53 % )
AMD $ 32 ( -64 % )
NVIDIA $ 300 ( -62% )
Based on valuation mean reversion our price targets are much lower, amounting to losses of anything between 60 and 90 %
The second tenet of our bearish case is the coming regulatory clamp down
Nations and Democracies are based on power… The power to enact Laws, the exclusive privilege of force, the exclusive management of public affairs and society and the privilege to levy taxes on citizens.
Systems differ around the world and through history, but the common thread is the control of populations, maintaining Law and order, the administration of justice and the regulation of the economies.
Power is communication, democracy is communication, theocracy is communication and dictatorship is communication…
The emergence of the US mega techs has become a political threat … The free-wheeling US capitalist system has allowed the emergence of forces that are much more powerful than nations, that talk to billions of people across the globe, that can influence consumption as well as political trends and that can manipulate news and perceptions of reality.
Private corporations like Facebook, Google, Amazon, Microsoft, Netflix, Twitter and the like have reached a stage where they illegally – in the pure sense of freedom – collect data on billions of people, with their consent, in exchange for the free access to their value added services, be they search engines, web browser navigation, buying trends, travel and vacationing or even sexual preferences through pornographic websites….
Artificial intelligence (AI) and machine learning take their power even further by giving them a leading edge in predictive analysis and mapping.
They can track criminal activities, political ideas and movements, rebellious talks, seditious plans, plotting terrorism and illegal payments through cryptos or else.
But they can also spread fake news, destroy reputations, influence voters or even, as was the case on January 6th 2021 , entice riots and endanger the institutions.
Moreover, their global reach and tax optimisation enables them to hoard cash and profits while minimising taxes by using the most efficient tax jurisdictions and corporate organisations.
Big tech has become a sovereignty issue and a threat to National Powers in exactly the same way decentralized and uncontrolled currencies are a threat to the privilege of currency issuance and money tracking.
What is currently happening in China with the significant clampdown on big tech and data collection is a sign of things to come in the USA. It is all about controlling Big Data, and in our days of technology, it is the core resource of Power and sovereignty.
As always, because of the different political system, China is much more reactive and proactive than the US and is using its power to rein in the development of data collection, data analysis and data usage by private corporations that have no guidelines and no global interest at stake, apart from making money.
The key issue there, in the word of Xi Jing Ping himself is that :
No Private Corporation should ever be allowed to have more data collection, analysis and usage than the Sovereign State..
And the tend is rapidly coming to the US and the rest of the world and it will end up in major break-ups of the business model of the US Mega tech companies.
Pressure is building up and has been quietly building up for years.
Despite the recent setback of the Department of Commerce and the various States involved in the anti-trust action against Facebook, political pressure is mounting to challenge the powers and de facto monopolies of these companies in exactly the same way pressure did build-up in 1920s against the railroads, oil and steel companies in the USA.
Administration and Justice departments are slow to adapt but they are relentless.
Big tech monopolies are now being attacked on the privilege of App stores, the fees they charge, preventing competition, integrating platforms and sharing the data in exactly the same way the old monopolies were attacked.
It is only a question of time before these administrations end up winning the legal battles and new laws be enacted.
The Biden administration just announced a far-reaching plan to revamp the anti-trust Laws and give more powers to the Departments of Commerce and Justice to break-up the big techs.
Congress has long been questioning the power of big Tech and is ready to enact far more stringent Laws.
The pressure is building internationally as well.
For the time being, these companies have been fined with considerably amounts in absolute terms, but very small amounts in relative terms when brought back to the monetary benefits they derive from their monopoly situation.
Google, Facebook, Apple and the like have all had to pay fines in Europe and in other countries such as Australia due to their abuse of monopolistic positions, and Australia or Nigeria went even further by restricting their services or shutting them down altogether.
The January 6th assault ion Congress was a defining moment in the change of perception of Big Tech and the threat they represent for society and institutions.
Legal actions are in process to determine to what extent Twitter, Facebook, WhatsApp and the like were instrumental in allowing the thugs to storm the Capitol.
The self-regulating logic of these corporations is no longer considered to be sufficient or efficient, despite their voluntary bans of Donald Trump’s accounts.
Ironically, the recent lawsuit brought by Donald Trump himself against Dorsey, Zuckerberg and else may have the opposite effect as judges will now be forced to delve into the powers of communication and influencing of these big techs and the nefarious effects they can have on society.
The Departments of Commerce and of Justice will immediately benefit from the probes and decisions of these judges to establish their cases for containing the services and powers of these companies and highlight the weakness of State regulation of their activities.
The recent agreement of 308 countries to impose a minimum 15 % tax on global corporations was directly targeting Big tech companies using tax loopholes and weak taxation juridictions to operate.
Once the political agreement will have been translated into National Laws and implemented, the business model and profitability of all these giants will be dented significantly.
New revenue and profit calculation definitions are being studied to capture revenue flows that have never been imagined by the lawmakers who wrote the existing tax codes.
In 2019, a new independent analysis pointed at the fact that six of Silicon Valley’s biggest companies had a combined “tax gap” of more than $100 billion in the previous decade.
Fair Tax Mark, a British organization that certifies businesses for good tax conduct, assessed global tax payments from Facebook, Apple, Amazon, Netflix, Google and Microsoft between 2010 and 2019.
The research analyzed their 10-K filings, which are financial forms submitted by businesses to the U.S. government.
It looked at tax provisions — the amount companies set aside in their financial reports to pay taxes — and compared those to the amounts that were actually handed over to the government, referred to as cash taxes. Over the decade, the gap between the Silicon Six’s provisions and the taxes they actually paid reached $100.2 billion, researchers found.
In 2018, it was reported that Apple held about $252 billion in profits offshore, where it can avoid paying U.S. taxes. That’s over 90% of the company’s total cash on hand. This profit is subject to the corporate income tax as soon as it’s “repatriated” back to the U.S.
Before the 2018 tax code overhaul, the company would’ve paid $78.6 billion in taxes if it brought the money home, according to the Institute on Taxation and Economic Policy. Apple didn’t want to pay this tax, so it let the cash sit offshore for years.
And the Trump reform of 2018 was all about enabling these companies to repatriate this cash without having to pay taxes.
According to CBS news, 60 profitable US Fortune 500 companies paid no taxes on a total of $79 billion of profits earned in 2018.
And the Trump Tax reform favored the phenomenon.
The companies, which include tech giants such as Amazon and Netflix, should have paid a collective $16.4 billion in federal income taxes based on the Tax Cuts and Jobs Act’s 21 percent corporate tax rate, according to the left-leaning Institute on Taxation and Economic Policy.
Instead, these corporations received a net tax rebate of $4.3 billion. The analysis is based on the corporations’ annual financial reports, which were filed earlier this year to report their 2018 results.
Clearly, all these tax savings flow directly into the profits of the Companies, inflating profitability, valuation and stock prices.
… and Clearly the Biden Administration is now going after these tax advantages
Timing the end of a bubble is an extremely difficult exercise as irrationality can prevail for much longer than we expect.
However, the point we are making is that the clouds are amassing on the Horizon for the US big tech and that the current situation of overvaluation, over ownership, over concentration and building regulatory pressure makes it probably the MOST DANGEROUS segment of the US equity market.
Investors should bail out now…
The risk-reward is way too negative to stay invested
As Rothschild used to say, always leave 10 % of the upside for the suckers who are bailing you out.. They are the ones who will take the big hit.
As far as we are concerned we are strategically short all these companies in our Model Portfolio and will manage the exposure to remain that way.
The main danger of the current environment is that investors do not realize how quickly things can turn sour and how sharp the bear market will be, leaving then with no time to bail out.
March 2020 and its 40 % fall in less than two months was a warning signal…
But this time round there will be no rebound….
And just for the record, at the time of writing
. Bitcoins are down 50 % since we called their top on April 13, 2021
. Gamestop is down 31 % since we shorted it at $ 71
. Lumber is down 51 % since we called its top on May 6th 2021
. Soybeans and Corn are down 20 % since we called to short soft commodities on the same date
. The US dollar and Bonds are up as we predicted
Timing the very top of the US Mega Tech is much harder because of their unique importance in the global markets, their handle on investors imagination and the massive impact of indexation, it is about timing the top of the core market altogether, and we are not sure that another last bout of strength is not possible in the second half of 2021,
But what we are sure of, is that at current levels, investors should not stay invested with such a negative risk/reward,
And that when things turn, the violence of the liquidation phenomenon will be such that it will be too late to exit and avoid losses.
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