Thursday, March 19, 2020

Notes on the Bubble

I have not written as much the past few years, outside of contributing to the Oddball Stocks Newsletter, because there has been so little to write about. Just an overvalued bubble market that kept rising, and a lot of people engaged in crazy behavior, some of which I chronicled in the Links. I also managed to read hundreds of books over this time period. Plus I managed to "tread water" and preserve capital for better opportunities to come. (And which I do not think are here yet.)

For posterity, I will recap some of the behavior that stands out as I think back on the past decade's economic crescendo. One example is the cryptocurrency bubble. These never made any economic sense to me. While the supply of most cryptocurrencies, like bitcoin, was fixed, the supply of cryptocurrencies was not. More than 5,000 of them have been created. How many people were dedicated to this and how much illusory wealth did it represent? The combined value of the cryptocurrencies peaked at a combined valuation of $825 billion in January 2018.

The Horizon Kinetics guys once raised the interesting point that a $400 billion for bitcoin is small in relation to the world's other garbage currencies like pesos, which are collectively worth ten times as much. But perhaps the peso or the ruble are better currencies than bitcoin. People use them, and very importantly there are liabilities denominated in them. Who is ever going to borrow, or lend, on the basis of a wildly fluctuating cryptocurrency? Plus, traditional currencies are more energy efficient!

In the startup bubble, business valuation had almost ceased to mean anything as perpetually unprofitable yet ostensibly disruptive businesses had ~$100 billion valuations. A prime example of this was WeWork, which would have been foisted on retail investors but for a negative mood at the moment that its prospectus was published, which resulted in appropriate scrutiny. Others in this category would be Uber, or Tesla. Those three alone represent $300 billion of paper valuation for businesses with zero cumulative profit. Another example of was Airbnb, which could not make money as a pure middleman, and was probably also close to $100 billion of paper valuation. 

It is also noteworthy how expensive stock indexes and bonds were at the peak. The Shiller PE was at levels only exceeded during the 1929 and 2000 bubbles. Bond yields were at all time lows, reinforcing the equity bubble. Right as deficits are set to get a lot biger.

Finally in the three months ending at the market peak in February we had unrestrained mania. Yes, I'm talking about this. A $150 billion enterprise value for Tesla was the highest valuation in history for a business that had never had a profitable year. Both the price blowoff as well as the retail involvement - via Robinhood shares and also the r/wallstreetbets buying of call options - were astounding.

Now we have had what you might call the "indexing crash". Swifter and sharper than any crash before - perhaps because so much money was invested passively, and the passively invested money had paid so much more than the value investor bid for shares of businesses. It might also be sharper because the pin that popped the bubble - the WuFlu - had such immediate and dramatic implications.

The WuFlu is exposing the deep rot of U.S. institutions. This includes the federal and state governments, which are unable to get an extensive WuFlu testing system set up. Without that, there is no good data on the severity of the disease. Have a lot of people already been exposed and had mild or asymptomatic cases? Inability to test also makes it impossible to suppress the epidemic. The more competent east Asian nations that beat this with very few deaths (Taiwan, Hong Kong, Singapore) used contact tracing and suppression strategies.

We still don't see many people in the U.S. wearing masks even though this would probably be very helpful. The government chose to lie about the usefulness of masks because this country, which doesn't produce them, doesn't have enough. The result is that individuals stockpiled them during February panic buying, but aren't wearing them, while healthcare workers are short of them.

Other institutions like hospitals are in tough shape too. I was just looking at the annual report of a non-profit health system with 50,000 employees that has about $8 billion in revenue. They foolishly invested $2 billion in stocks but have no personal protective equipment in reserve. Extra supplies of stuff like masks and gowns would have kept their employees and patients safer - but no exciting 20% annual gains.

For baby boomers, no equity valuation was ever too high. A bubble made retrospective returns look higher, and by boomer logic where the past equals the future, it made prospective returns seem higher as well.

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