Watching, waiting, and planning…

  • Cheap freight
  • Amazon.com profit slumps
  • Throwing caution to the wind
  • Mesmerised

Before we pat ourselves on the back, or get too carried away about an impending market crash, we glance with wide eyes at yesterday’s Financial Times:

Facebook climbed to a near-$500bn in market capitalisation after a better than expected second quarter, as the social network failed to dampen investors’ high spirits with a caution that growth could slow in the second half.

The social media company’s sheer size and advertising muscle has helped it fend off competition Snap, sending earnings and revenue soaring.

But the company warned that the number of advertisements it shows could peak in the second half of 2017. It will come up against a self-imposed barrier to the number of ads in news feed and may lose some news feed viewers as it pushes users to spend more time watching video. Efforts to compensate, such as the rollout of ads in Facebook Messenger, are in “early days”.

To say that Facebook Inc.’s [NASDAQ:FB] growth is amazing is an understatement.

First, remember that this is the same company that only a few years ago said it would never allow advertising in the newsfeed. Now, your Facebook newsfeed is chock-a-block with ads.

It’s clear to see what that has done to the company’s revenue. In 2010, Facebook generated US$1.9 billion in revenue. For the 2016 financial year, it generated US$27.6 billion in revenue.

And for the 2017 financial year, analysts forecast US$38.6 billion in revenue.

Crikey!

But, as is our wont, where there is the fire of excitement, standing nearby is your editor’s extinguisher of gloom. At the ready, we squeeze.

In particular, we note the opening paragraph of the FT article, ‘…as the social network failed to dampen investors’ high spirits.

Ah yes, high spirits indeed. In simple terms, the market refuses to believe what Facebook says. The company’s top brass says that ads could peak, and therefore further revenue growth may not occur.

But the market doesn’t care. Overnight, the Facebook share price gained 2.9%. This, if you’re a glass-half-empty kinda guy (or gal), is our crash-warning sign.

This is what causes markets to ‘melt-up’ before the crash. Companies record outsized revenue and profit growth. Some investors think the companies can keep repeating that growth.

So they keep buying. They keep extrapolating — ‘If they grew profit 71% this year, what would that mean if they grew it 71% next year?’ Buy, buy, buy.

Of course, the law of large numbers eventually comes into play. It’s hard for a multi-billion-dollar-revenue company to keep growing by big triple- or double-digit percentages.

Eventually, the growth must stop. And most of the time, when it does, it catches investors by surprise. That’s when you get a market crash.

We watch. We wait. We plan.

Markets

Overnight, the Dow Jones Industrial Average gained 85.54 points, or 0.39%.

The S&P 500 fell 2.41 points, or 0.1%.

In Europe, the Euro Stoxx 50 index closed up 1.95 points, or 0.06%. Meanwhile, the FTSE 100 lost 0.12%, and Germany’s DAX index fell 0.76%.

In Asian markets, Japan’s Nikkei 225 index is down 85.1 points, or 0.42%. China’s CSI 300 is up 0.32%.

In Australia, the S&P/ASX 200 is down 73.71 points, or 1.27%.

On the commodities markets, West Texas Intermediate crude oil is US$48.98 per barrel. Brent crude is US$51.41 per barrel.

Gold is trading for US$1,259.67 (AU$1,579.73) per troy ounce. Silver is US$16.57 (AU$20.78) per troy ounce.

The Aussie dollar is worth 79.74 US cents.

Cheap freight

To Bloomberg. It reports:

Consumers probably spent enough last quarter to help U.S. growth rebound from a tepid start to the year. The rest of the economy is giving less of a lift, and the pickup is unlikely to last.

Gross domestic product expanded at a 2.5 percent annualized rate from April to June, according to the median estimate in a Bloomberg survey ahead of figures due Friday. While that would be an improvement over the first quarter’s 1.4 percent, some of the upswing owes to the dissipation of temporary factors such as low heating bills, delayed tax refunds and volatility in inventories. Meanwhile, a gangbusters pace of business investment earlier in 2017 may have eased to a more sustainable rate.

Doesn’t sound overly positive to us.

And it doesn’t look overly positive when we consider it alongside one of our favourite charts — the Dow Jones Transportation Average.

Here it is:



chart image

Source: Bloomberg
Click to enlarge

The white line is the Transportation Average, whereas the orange line is the Dow Jones Industrial Average.

The Dow Jones Industrial has just hit another all-time record high. The Dow Transportation Average hasn’t.

In fact, while the Industrial was up overnight, the Transportation Average was down more than 3%.

We continue to see that as a small but important piece of information on the health of the market.

Now, we’re not saying that industrial and transport stocks should move in sync all the time. There will always be cases where one index lags the other.

Most of the time, you wouldn’t — and shouldn’t — think much of it. But, when stocks are eight years into a bull market rally, and when you start to possibly see the beginning of some significant divergence, then it is worth paying attention to.

That’s what we believe we’re seeing here. To be fair, it wouldn’t be the first time this has happened over the past year. In April this year, transport stocks began to fall, even while industrial stocks remained mostly steady.

Is that reflective of anything?

It could be. It could be that some investors are becoming wary about the future.

And they may have every right to be. Check out the following chart. It’s the Drewry East-West Air Freight Rates in US dollars per kilo (white line), overlaid with the Dow Jones Transportation Average (orange line):



chart image

Source: Google
Click to enlarge

Rates are dropping. We could, and we shall, contend that lower freight rates indicate price cutting by airfreight companies in an attempt to attract business…and because demand is falling.

If you look at the left side of the chart, rates were at a similar level in mid-2009, during the last US recession.

Rates then exploded higher, as demand picked up. They then fell over time. No doubt as new capacity and competition drove down costs.

But new capacity and competition doesn’t always explain falling costs. Lower demand and cost pressures can explain falling prices too.

We figure that’s more likely to be the case at the end of a boom than at the beginning or middle of a boom.

To us, it’s another reason to be cautious. But that’s not to say stocks won’t shoot higher first. Look at the Facebook result. The company says growth will peak in the second half of the year…and investors just don’t care.

Amazon.com profit slumps

He’s the richest man in the world: Jeff Bezos, the founder of Amazon.com Inc. [NASDAQ:AMZN]. The mighty Amazon…with not-so-mighty profits.

From Bloomberg:

Chief Financial Officer Brian Olsavsky said Amazon’s expenses would climb in the second half of the year as it hires workers and works out the kinks in new warehouses to prepare for the peak shopping season. That’s why Amazon projected operating income in the current period ranging from a loss of $400 million to a gain of $300 million. The last projected quarterly loss came in July 2015 for similar reasons.

The third quarter “is generally a high investment period for the holiday,” he said.

We say ‘bulldust’.

If the Facebook warning on peak advertising was a proverbial shot across the bows for the market, Amazon’s profit slump was a missile amidships.

Down she goes…to Davy Jones’ Locker.

Analysts had expected US$863.5 million in operating profit. The new Amazon guidance is clearly well below that.

The Amazon stock price fell 3% in after-hours trading.

In our view, investors will soon see that Amazon is a great big hype machine. On US$150 billion in revenue over the past 12 months, it has racked up a paltry US$1.9 billion in profits.

To say the margins are thin is an understatement. Since the bottom of the market in 2009, Amazon has generated revenue of US$573.9 billion in total.

It has recorded net profits of US$5.6 billion in total.

That is a total profit margin of less than 1%.

That, I remind you, is during a so-called boom period. We can only imagine what Amazon’s ‘profits’ will look like during the next bust. And we can likewise only imagine what the share price will look like too.

A US$1,000-plus share price is not part of that imagining.

Amazon.com is a retailer. Retailers don’t have fat margins. They don’t have high earnings multiples either. Woolworths Ltd [ASX:WOW] has a price-to-earnings ratio of 18.5-times trailing earnings.

Using the same multiple, Amazon.com stock should have a market capitalisation of US$35.5 billion. Its current market cap is US$500 billion.

To get to what we believe is its true value, the stock price needs to fall 92.9%. We believe that could happen.

To us, Amazon.com stock is a sell. A big sell.

Throwing caution to the wind

Throw caution to the wind, our colleague Sam Volkering would no doubt say. Certainly when it comes to cryptocurrencies.

He would point to this story from CNBC as evidence:

Investors are mesmerized with AMD’s impressive second quarter as cryptocurrency mining demand drove the company’s financial results above Wall Street’s expectations.

The chipmaker reported better-than-expected second-quarter earnings and guidance Tuesday. Its shares surged more than 10 percent in after-hours trading following the report and were up more than 9 percent in early regular trading Wednesday.

It’s all about the cryptos. You can find out why here.

Mesmerised

One final point. It’s worth noting that the origin of the word ‘mesmerise’ is 18th-century German physician Franz Mesmer.

He practiced what could be simply described as a kind of hypnotism. People who came under the influence of Mesmer were said to be ‘mesmerised’. Hence the term.

Were his techniques genuine, or just a trick of the mind?

We don’t know, but we certainly note that many people are mesmerised by the action in today’s markets. We can’t help but think that isn’t healthy.

Cheers,
Kris