Mr Market must have gotten up on the wrong side of the bed yesterday.

CNBC reports:

‘The Dow fell 395 points to 25,017. The S&P 500 dropped 1.7 percent to 2,690 as the technology sector pulled back 3.8 percent. The tech-heavy Nasdaq lagged, falling 3 percent to close at 7,028 as Amazon dropped 5.1 percent.

‘The popular FAANG trade, made up of Facebook, Amazon, Apple, Netflix and Alphabet, is now in a bear market, with each member down more than 20 percent from their one-year highs.

‘“It’s going to require a recovery in tech to make things happen,” said Greg Luken, the CEO of Luken Investment Analytics. “I think where we are in tech, we’re going to see tough sledding towards the end of the year. I think stocks that are down will see further selling pressure.”’

We have no way of knowing what will happen next. Fortunately, we don’t need to know. And we don’t need to duck when Mr Market starts throwing the silverware.

We’re not even in the room!

 

Expensive stocks

At Dow 25,000, stocks are too expensive. The Dow-to-gold ratio is now 21. In other words, it takes 21 ounces of gold to buy the Dow. That ratio has only been higher twice in the last 100 years. And each time was followed by an 85%-90% selloff.

The FAANG stocks are especially expensive. We buy a $60 bottle of wine from time to time. We stay at a $400-a-night hotel occasionally and eat in restaurants with real tablecloths once in a while.

But we don’t buy expensive stocks. What would be the point?

You don’t buy stocks for pleasure. You buy stocks to make money, not to get rid of it. The whole idea is to buy low and sell high. If you buy high, you’re starting off on the wrong foot.

Netflix, for example, trades on a price-to-earnings (P/E) ratio close to 100. The average P/E for the S&P 500 today is 21.

You invest $100…and you wait 100 years (at current levels) for the company to log that much in earnings. And a fat lot of good it does you anyway.

Netflix doesn’t pay out any of its earnings in dividends. It says it is focused on ‘growth.’ But you can’t pay your rent with growth. And if you buy for growth and hold on, you’re likely to find your growth going to someone else.

For every new technology there’s newer technology somewhere ahead. And it usually shows up while you’re waiting for your ‘growth’ tech stock to grow into a profit stock. Then, you end up with a Palm Pilot, Atari, Hitachi, Compaq, or…a Polaroid Land camera, while everybody else has an iPhone!

 

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River of no returns

Amazon is another big, Big Tech company that has never paid a dividend. Though fans insist it is ready to start making money any day now, its retailing model — cut prices to get market share — is still the ‘River of No Returns.’

And it probably always will be. Because it’s very hard to generate a profit when your business model depends on not having a profit margin.

Based on last year’s earnings, you’d have to wait 387 years to get your money back from AMZN. Earnings were scarce. The price was high.

Since things that are out of whack tend to go back into whack, eventually…and since it is extremely unlikely that earnings could rise enough to justify such a high valuation…the price will have to fall to a more reasonable multiple of earnings.

In other words, investors will lose money.

Even if the FAANGs’ technology survives, they probably won’t make much money for investors.

When a new tech company becomes a hot favourite, the stock price is bid up to levels that don’t really make much sense. The companies, even if they are successful, can never earn enough to give investors a good return on their money.

That is what happened with the Nifty Fifty stocks of the late 1960s and early 1970s. They were good companies — including Coca-Cola, Sears, and General Electric. They had leading technologies, too — Polaroid, Xerox, and Texas Instruments, for example.

Investors at the time felt that all you had to do to succeed in the stock market was buy these 50 leading stocks. It made investing easy. You just had ‘one decision’ to make, and you were set for life.

Naturally, the Nifty Fifty stocks went up…to twice the level of the S&P 500. At their peak, they traded for 42 times earnings, about the same as Alphabet (Google’s parent company) today.

But investors weren’t set for life. The Nifty Fifty stocks might have been good companies, but at 1972 prices, few of them turned out to be good investments. If you had bought them at their peak in 1972, by 1975 you’d have lost two-thirds of your money. By today, you would have lost much of the rest of it.

Only one of the Nifty Fifty stocks turned out to be a great investment — good ol’ reliable Philip Morris. Take out the smokes and the whole portfolio was a loser.

Will the same happen to the FAANG stocks? Will Facebook, Apple, Amazon, Netflix, and Google soon be ‘yesterday’s technologies?’

We don’t know. But at 2018 prices, there is probably far more downside than upside.

 

Regards,
Bill Bonner