Warning: This newsletter will scroll long, because of all the pictures. It's also the most monetarily valuable newsletter we've ever written (it contains about $70M of art), so scroll with care.
Doges were originally the elected leaders of Italian city-states during the Medieval/Renaissance eras. This note is not about them. Being an April newsletter, we're going slightly off the rails here. Not so much into our normal April tinfoil hat conspiracies, but most definitely into market absurdities. This time featuring delis and Shiba Inus.
Does Halloween lose a bit of magic because people have been wearing masks for 6 months already? Resoundingly, no. Sure, it may be more trick than treat this year, but Halloween itself is about the atmosphere - shorter days, cooler evenings, foggy mornings, zombies...yes, the zombies. We are in the middle of a zombie apocalypse - you see them every day and probably have no idea until they collapse and die right in front of you. One of the more recent ones to be decapitated and burned (take your pick of favored zombie disposal methods) is...Hertz.
That’s right, we’re talking about zombie companies! Zombie companies are those that should have gone out of business a long time ago, but have been reanimated through the Fed’s zero interest rate policies. Without going on another rant about how the Fed has destroyed the notion of productive capital allocation, here’s how zombie companies form:
The upshot of last month's webinar, for those of you that missed it, was that the Fed is turning the stock market into a house of cards, but you might as well make yourself comfortable in it. Recently, we've been having a number of conversations that suggest we need to elucidate that point a little further than can be accomplished in a 40-minute Zoom. So here we go:
What is investing?
Are you "investing in companies" when you buy into the stock market?
99% of the time you are not investing in a company. The only ways you can actually invest in a company are: public stock offerings (usually IPOs); public debt offerings; private equity or debt deals. Last year, there were a low-200's number of IPOs that raised around $62B total. Through the first half of 2020, there have been 64 IPOs that raised $22.3B. The total value of the US stock market is right around $30T with a "T". So in any given year, about 0.2% of the stock market is actual "I want to invest in your company" money.
You've seen a record $1.2T in new bond issuance (more on this in a bit) year-to-date in a $40T bond market. Private markets are up to about $6.5T total and have added $370B or so a year (including performance). So recently, in any given year, you could reasonably expect about $1.6T in real "give this company my money" investment. In a combined stock/bond/private marketplace in the US of $77T or so. That's 2%.
Okay, sorry, we were wrong: 98% of the time you are not investing in a company (though really, most of that 2% is limited to a very select few, so in our defense it is likely closer to 99%).
So what are you investing in? When you buy your shares of Apple or Tesla or Aurora Cannabis, you aren't giving your money to the company for them to do amazing world-changing things with. You're not giving your money to the company at all. That's why the stock market is a "secondary" market - you're giving it to the person you bought the shares from.
Happy Holidays, dear readers! Believe it or not, the vast majority of the newsletters we write are not, in fact, for our own entertainment. A couple of them definitely are - notably the April Tin Foil Hat series and the October Halloween series - but apart from those semiannual gems, most of the time we are trying to educate, inform, amuse, explain, entertain, and/or deobfuscate.
This one, however, will likely turn out to be none of that. If you’ve been paying attention to those trade confirmations that hit your inbox at the stroke of midnight, you’ll have noticed that we’ve been busy headed into year-end. The following is a glimpse into what we’re thinking, and why. Fair warning, it may feel a bit like climbing up an Escher staircase. But like we said, this one’s for us.
If last month was Roger Moore as 007, then we’re closing out this summer series with Michael Bay. That’s right - it’s time for stock valuation, replete with explosions, special effects, and very confusing cuts in the action sequences.
Stocks, also referred to as “equity”, are shares of ownership in a company. These used to be issued as actual stock certificates (really decorative pieces of paper), but now it’s just digital 1’s and 0’s. Kind of like the cash in your bank account. When you buy a stock, you expect to make money in two ways. One is by collecting a dividend (which right now averages just under 2% for the S&P 500). The other is by the stock price going up.
Unlike bonds, there is no intrinsic starting point for stock valuation. There is neither a maturity date nor a future value, which makes them more or less impossible to actually value. Not kidding - there are textbooks upon textbooks upon college courses upon certifications all trying to impart some standardization to stock valuation. But that uncertainty is also where the fireworks come in, and why stocks swing they way they do.
Bonds, unfortunately, are nowhere near as exciting as the actual 007. Or at least, they’re not supposed to be. Maybe a Roger Moore 007 though, those were all pretty boring. A bond is an IOU - a promise to give your money back in the future with periodic fixed interest payments in the meantime. They used to be issued as actual certificates, with little coupons that you would clip off every six months and turn in to receive your interest payment, but alas, those days are gone.
So, if you get your money back (let’s call that amount “100”) at some point in the future and in the meantime are collecting interest payments, how much is that bond worth? 100? 102? 96?
Last month we started big - economic theory big. Now we’re going to look at stocks and bonds. More specifically, what are they and how do you know what they’re worth?
Apparently Santa came early this year! Or at least that’s what we’re telling ourselves given that top of our Christmas list every year is “less government”. So we’re going to choose to look at this Christmas, with about ¼ of the government shut down, as a happy little present and just ostrich out all the nonsense about why we’re actually in a partial government shutdown and how much of 2019-2020 will also be spent in a partial shutdown…
For the equity markets, however, it has been an absolute bear of a holiday season. Quite literally:
This summer, like every summer for the last 600 years, saw the annual Running of the Bulls festival in Pamplona, Spain. This summer, like every other summer for the last 10 years, saw the continuation of this current bull market for stocks (“current” assuming no unmitigated disaster between writing and press time). In point of fact, August marked the longest ever bull market in the US - our very own running of the bulls.
The annual Running of the Bulls was held in Pamplona last month, in a tradition that dates back to at least 300 years before the signing of the Buttonwood Agreement (the precursor to the New York Stock Exchange). Not to be outdone, Wednesday of last week saw a celebration of sorts for our own “running of the bulls” - the longest bull market in history for stocks, at 3,453 days and counting.
Bull markets are, somewhat ironically, defined more by what they aren’t than what they are. As long as stocks don’t drop more than 20% from a peak, the bull market keeps running. If they drop more than 20%, the bull market gets posthumously dated to the last peak and all of a sudden you’re in the middle of a bear market. Or they don’t get backdated and you have to wrap your head around having lived through a Schrodinger’s cat-esque market that was technically both bull and bear since the last market peak. Not to worry though! As of this writing the S&P 500 has surpassed the January 26th levels to reach a brand new all-time high, so this bull market still has legs. Probably.
We have carved out some time in between World Cup group stage matches this month to bring you part two in our Price is Right series - how to value stocks. Those of you wanting a refresher on the time value of money and bond valuation before we move on can find yourselves suitably refreshed here.
Facetiously, stocks are worth what someone is willing to pay for them. Unlike bonds, there is no intrinsic starting point for valuing stocks. With bonds, you get your money back at maturity (hopefully), so it’s fairly straightforward to use that as an anchoring point and work backwards to a reasonable valuation. Stocks, on the other hand, have neither a maturity date nor an expected future price, which makes them more or less impossible to actually value. Not really kidding about that. There are textbooks upon textbooks upon college courses upon certifications all trying to impart some standardization to stock valuations. If you want to make the big bucks on Wall Street, you go work for an investment bank and spend all your time trying to figure out how much companies are worth.
But saying “whatever, it’s all made up anyway” two paragraphs into a note isn’t particularly satisfying. So let’s take a look at common methods of valuation, and then we’ll see if we can learn anything about what those methods have to say about current stock market valuations.
If you’ve never spent a Sunday watching Antiques Roadshow on PBS, your life is missing something. Especially the British version of Antiques Roadshow. The gist of the show is that a bunch of appraisers travel around and set up shop in various small towns here and there, and then people bring all of the stuff that has been lying around their attic for the last 25 years to see if it’s worth anything.
It has even spawned its own hilarious meme. At its core, Antiques Roadshow works for two reasons: one, it’s a big play-along treasure hunt so that everybody can be a couch Ray Dalio (fun fact: not only does Ray Dalio run the world's largest hedge fund, his submarine just found a $17B shipwreck treasure); two, it answers the age-old question of “that’s worth how much?” that has also fueled such long-running classics as The Price is Right and House Hunters.
In this month’s note, we are going to try and answer the question of “that’s worth how much?” with regard to stocks and bonds, a long running soap opera that’s on from 9:30am to 4pm daily (weekdays, anyway. That aren’t federal holidays.)
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