Investments

Cold Turkey

By David Stockman  |  August 27, 2018

Of our elaborate plans, the end
Of everything that stands, the end

― The Doors, “The End” (1967)

The end is near.

As Reuters declared in a Sunday headline, “Turkey’s lira turmoil could herald a global financial crisis.” And they nail the proper villain, too: a decade of monetary central planning.

Turkey makes a nice focal point. But this madness is much broader, much deeper.

Wall Street has been reduced to the role of enabler. There is no “discounting the present value of future cash flows” taking place.

Consider Amazon.com (Nasdaq: AMZN). It’s been around for a quarter of a century. It’s not a startup.

During the last 19 months, Amazon has done nothing new. Oh, I’m aware it “disrupted” the grocery business with the Whole Foods acquisition. But even that’s just same old, same old.

Amazon cut those “Whole Paycheck” prices to goose sales. But it also vaporized Whole Foods’ already razor-thin operating margin. Now, it’s just another “growth” vertical that pukes red-ink.

On January 1, 2017, Amazon’s $350 billion market cap reflected a pretty frisky valuation of 37 times free cash flow.

Note that it had generated $9.5 billion of free cash flow in the 12 months prior.

Now, think about the fact that Amazon reported free cash flow for the 12 months ended June 30, 2018, of $8.8 billion.

Its market cap today is approaching $1 trillion. That means it’s trading at 106 times free cash flow. Let that sink in.

Indeed, “profitless predation” is Jeff Bezos’s business model.

When the market cap of a company grows by more than half a trillion dollars in less than two years on multiple expansion alone, you’re not in Kansas anymore.

There’s no capital market left. “Honest price discovery” is a relic of the past.

Amazon is not an outlier. It’s actually pretty run-of-the-mill in the FANGMAN era.

Multiple expansion has tripled 42-year-old Microsoft’s (Nasdaq: MSFT) market cap since 2012. That’s despite the fact that free cash flow has only grown 3.5% per year. Its current free cash flow multiple is nearly 26. That’s absurd.

And Netflix (Nasdaq: NFLX) actually does validate the “this time is different” idea. But I don’t mean that in a good way.

What’s “different” is that NFLX’s market cap has exploded by 10 times during the last five years – even as its free cash flow has headed straight south, reaching negative $1.8 billion for the 12 months ended June 30.

We have no need at this point to return to Elon Musk and his fanciful Tesla (Nasdaq: TSLA).

This peak is already even more ridiculous than the tech bubble in the spring of 2000. Back then, innovators and disrupters were vastly overvalued – but they had demonstrated highly profitable business models.

We have none of that now. Wall Street is nothing more than an enabler, easing the way for high-flyers without the capacity to produce profits to nosebleed valuations.

Talking heads gum more loudly than ever that “market internals” are strong. They point to 50-day, 100-day, and 200-day moving averages as bulwarks against another 2008-style selloff.

And those lines do hold true…Am

Until they don’t

On March 27, 2000, the Nasdaq 100 – 13% above its 50-day moving average – was pronounced impregnable by the Wall Street’s peddlers of the day.

Less than two weeks and 33% to the downside later, it had cut through that “support” like a hot knife through butter.

That was just the start of an 83% immolation of value over the next two years.
Central banks have fueled the most reckless, mindless scramble for yield the world has ever seen.

They took FANGMAN from a collective market cap of $1 trillion to $5.5 trillion in less than four years. They pumped $61 billion of air into Tesla.

And they facilitated Turkey’s accumulation of $500 billion of debt.

Turkey is not a one-off. Nor is it “contained.” Indeed, it’s going to be the biggest emerging-market default of all time.

But it is just a sign of the times.

And they’re going to get worse before they get better.

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR