Would you rather invest in cups of tea on Wall Street, a Chinese real estate market, or crystal tech stocks?
Three things made the 1980-2022 period one of the most profitable episodes in history for investors. Energy was cheap. Labor was cheap. Credit (borrowed money) was cheap.
And now ? Governments discourage investments in the traditional energy sector. The supply of Chinese peasants that had kept labor costs low since 1979 has run out. The credit cycle took a turn two years ago: interest rates have increased since then, with the help of the Fed.
In short, the situation has profoundly changed. Are the markets aware?
The thing that investors and the government cannot ignore is inflation. Consumer prices are rising and this angers voters. It also highlights the Fed’s false competence, which forces it to take unpleasant measures. Therefore, in an environment marked by unprecedented inflation for 40 years, the Fed is determined to raise rates until “the job is done”.
We doubt, however, that he has the courage to stay on course.
The Fed will raise rates until “something breaks,” as one of our colleagues said. Then it will stop and turn around.
Today we are interested in teacups.
“Funding is running out on Wall Street,” a headline said in Wall Street newspaper Monday.
The core of the story is simple enough. As long as Wall Street was fueled with the lowest funding rates in human history, it was hard to break anything. There were a lot of flimsy teapots and flimsy cups. But when they faltered, their owners could wrap them up with ever cheaper credit.
Result: The US private sector has $ 10,000 billion in debt, and most of this debt belongs to companies that don’t have the means to repay it. According to Wall Street newspaper :
“North American companies will need at least $ 200 billion in 2022 and 2023 to cover the increased interest expense …”
What is happening ?
Cathy Wood is a well-known fund manager specializing in speculative tech stocks. She rose to fame in 2020 when the value of her portfolio increased by more than 150%. It was then easy to attract new capital: people wanted their piece of the pie. Tech companies received absurd valuations, even many as fragile as porcelain.
The problem with tech startups is that they are often not profitable. For example, of the 25 largest positions Cathy Wood holds in her portfolio, 21 are companies that are losing money. Many of them have no chance of being profitable in the short term.
They can therefore only survive by borrowing money or by raising more and more capital. And it becomes more and more difficult. the WSJ “Mergers and acquisitions have fallen by 43% in recent months and IPOs have plummeted to their lowest level in over a decade.”
In October, the number of IPOs fell by 95% compared to the same period last year. “The financing of investment vehicles called structured bonds backed by bank loans has fallen by 97% compared to last year”, continues the WSJ.
The profitability? What profitability?
Of course, there are other sources of capital. There are private lenders and private equity firms. The problem is that the people who invest their money are often cheapskates. Valuations are generally much lower than those available on public markets, especially those of the times of speculative bubbles.
For example, your correspondent works with a listed company and an unlisted company. Both are very similar. But the stock of the listed company trades at a price-to-earnings ratio (PER) above 10, while the unlisted company, if it were to be sold, would expect a PER of around 5, or only half.
But what happens when there are no benefits to multiply? Here are some examples:
Shopify’s capitalization is worth 8.1 times its revenue. The company doesn’t make any money.
UPath’s capitalization is worth 5.7 times its revenue. The company doesn’t make any money.
Crisper (CSPR) is certainly “disruptive” in the field of gene editing. But the company has a price / sale ratio of 83.9 … even if it’s not profitable.
Roblox has seen its share price drop 48% since the start of the year. It should be much lower. The company has a price / sales ratio of 11.4 and a price / book ratio of 44. It is not profitable.
Nvidia (NVDA) is profitable but has a price / sales ratio of 12 and a price / performance ratio of 14.8.
Toast, a restaurant management software company, is unprofitable with a price / sales ratio of 3.9 and a price / performance ratio of 8.5.
Bill.com, a company that offers HR management software, is largely held in ETF Vanguard, but it is unprofitable and has a price / revenue ratio of 16.9.
Cloudflare is not profitable, but it has a price / revenue ratio of 16.2 and a price / price ratio of 23.1. The insider sell / buy ratio is 331. Executives sold $ 332 million in one year.
And the list goes on and on …
Many of these unprofitable tech companies will not find funding in public markets. They will thus be forced to retreat into the world of private financing. Maybe they will survive, maybe not. Private market scavengers will demand colossal discounts. Many businesses will not find a buyer, regardless of the asking price.
Companies large and small are struggling to pay off interest. Some are already facing interest expense above 10%, which is huge for a struggling company. Gradually, cracks will appear. And as they say about the elephant in a china shop, the market will bring everything down.
Then, when the market is nothing more than a collection of broke investors wandering among the fragments of fallen companies, Jerome Powell will rush to their bedside … with glue.