AM Brew, May 24th 2022

Back to anti-risk today: equities are off 1% across the board, the pound & yen are dropping again, Bitcoin down 3% to $29,300, but the most important indicator, Cruide Oil is flat in AM trading.

SNAP's disappointing outlook is weighing on the markets, but not all is negative. In a true bear market, takeovers of Twitter and VMWare would not be happening. Really, not all is bad. This morning, ZOOM reported good results and is trading up 6% premarket. Similarly, NTES reported and is trading up 2.5%. AutoZone (AZO) reported a surprise increase in same store sales and is trading up 3.5% pre-market. BestBuy reported negative comps but is trading up 8.5% pre-market. Despite the presence of a decent amount of good news, the earnings picture doesn't look good. Inflation is almost always bad for near-term earnings. Longer term, companies catch up and stock prices go higher, but it takes a couple of years for companies to adjust and fully pass along higher cost structures.

It seems like there are 2 markets out there: (i) the overvalued markets that are dangerous (think SNAP) and (ii) strong franchises trading 30% cheaper and are ok right now (think JPM). Check out our recent post highlighting a DeMark signal on JPM.

SNAP is a good illustration of why shorting has been more difficult than it was in the last bubble. Back in 2017, we shorted numerous tranches of SNAP Call Options back when the stock was in the low $20s, with all of the calls profitably expiring worthless. Our price target of $12 was achieved, although valuation is always difficult when a company has never generated cash. SNAP even got as low as $6. By last year, SNAP had finally generated a massive $223 million of free cash flow. It appears that SNAP can generate $500 million in free cash flow, so maybe that is worth 25X or $9-ish dollars after adjusting for the strong balance sheet. This is today's tech market: SNAP is down 30% pre-market to $16 but its only worth $9.

Those with longer term time horizons really have to start over-weighting the sharecount issue in tech stocks. Its a massive issue and nobody really seems to care. Look at SNAP's share count over time:

SNAP has 1.56 BILLION shares outstanding, a cool 250 million share increase from when they went public. You can count on these guys increasing the share count 4% or more every year.

NVR is one of the few stocks that has done better than AMZN ($41 to $4200). Why? Look at its share count. NVR just keeps using cash flow to buy back shares:

Over 25 years, NVR's share count has dropped from 13 million shares to under 4 million shares. Investors need to be looking at balance sheets, share count trends, free cash flows, growth rates, margins, and valuation. You can find good companies in this market - NVR is back down close to pre-pandemic levels, which is pretty good for a homebuilder that can easily sell every house they can construct for a huge price.

Inflation is still a huge problem, but the insane spikes are partially rectified. Look at Nickel prices:

Copper and other building materials are also down recently. Unfortunately, Bloomberg is reporting that Europe has a major electricity problem. European utilities buy power many months ahead in forward markets to lock in costs for consumers. Unfortunately, look at the one-year German forward power contract below. Inflation is not looking good anywhere in Europe right now:

The USA, the world's largest fossil fuel producer is somewhat shielded from the Russian situation, but in Europe, things are very difficult right now. Bridgewater, speaking at Davos, is saying that markets are still scary & not properly discounting the inflation/stagflation picture. Goldman & BofA are telling clients that the Fed is the likely catalyst for a turnaround and that further pain the capital markets are likely needed to trigger any Fed Put. Right now, keeping a lid on aggregate demand to control inflation is more important that the capital markets.

The next 6 months should create some epic buying opportunities. Stay tuned.