Bleed Out!

By David Nelson, CFA CMT

With 190k Russian troops poised to cross the Ukrainian border ready to launch the largest battle since World War II investors seem desperate for positive news that all out war can be avoided. Headlines suggesting Biden and Putin had agreed to a summit followed by Russia recognizing breakaway regions of the Ukraine speaks to the level of chaos on all sides. The only thing certain is that the news cycle is fluid and any real resolution is unlikely anytime soon. 

Echoes of the Cuban Missile Crisis

Whether it is payback for the Cuban Missile Crisis or fear of an extension of NATO by way of the Ukraine, Putin seems willing to risk massive economic sanctions that could eventually throw his country into recession. Echoing that sentiment, the Russia RTS was off close to 14% on Monday, a market holiday here in the U.S.

As we have seen in the past geopolitical and military conflicts markets are quick to react and even overreact on any scrap of information. The potential for any resolution is of course welcome but investors would do well to stay focused on what will drive markets well beyond the current news cycle.

Bleed Out

It is easy to be mesmerized by gunfire and military jets rushing overhead but for investors the bloodshed takes on a different form. Once popular Technology stocks valued on nothing but sales continue to bleed out erasing $Billions in market cap. One by one asset bubbles have been bursting leaving many of the pandemic darlings in ashes. Investors love to buy the dip and given the magnitude of the fall it begs the question have these stocks fallen enough to call the bottom?

While there is a debate on its origins Winston Churchill once wrote “Those that fail to learn from history are doomed to repeat it.” Throughout history asset bubbles have inflated and then destroyed capital. Tulip mania, the Japanese Real Estate market, and even the U.S. housing bubble are easy examples. Since it was my first bubble let’s use the Dot.Com bust to look for parallels of the recent carnage.

Similarities to Dot.Com Bust

It’s easy to produce examples of heroes caught in the stampede as investors rushed to the lifeboats. The fascination of technology related to the internet was at the top of the pyramid but the fear of Y2K and the desire to update any digital device not in position to manage the date January 1, 2000, drove an insane level of double ordering pulling forward demand as company after company struggled to turn over their computer fleet.

I remember sitting in my cubicle at Lehman Brothers in the winter of 99 watching technicians install dozens of computers daily. Planes falling out of the sky, trains coming to a halt and banks unable to dispense cash were all fears for any country unprepared for the Y2K apocalypse.

The pulling forward of demand showed up quickly as months later technology companies started missing earnings and at the same time lowering expectations about future demand.

What we can learn from Peloton!

Sound familiar? It should. It’s exactly what we heard from Peloton (PTON) when they said they had stopped producing their Bike+ through June relying on current inventory to fill orders.

Data by FactSet

On March 27, 2000, Cisco became the most valuable company on earth with a stock market capitalization $569 Billion. The unwind of the one of the most popular stocks in history took close to three years to bottom wiping out about 90% of the value.

Amazon (AMZN) much the same falling over 95% before hitting a bottom in late 2001.

Data by FadtSet

Regime Change

Data by FactSet as of 2/17/22

The withdrawal of liquidity by the Federal Reserve raising the cost of capital has enormous implications for U.S. equity markets well beyond any misery being inflicted by Russian Troops in Europe. When the risk-free rate is zero you can put any multiple you wish on long duration assets. All that ends at even the hint of change.

Data by FactSet as of 2/17/22

Markets and economies are self-correcting and some of the heavy lifting is already being done as investors price in this new regime. Revenue growth on its own is taking a back seat to earnings, cash flow and dividends. What a concept!

The eventual slowdown in the economy from both rates rising and the wealth effect abating may even let the Fed pause or slow down the drain off of liquidity. However, it won’t change the fact that the punch bowl is gone and it’s time for investors to sober up.

It’s the 7th or 8th inning

Data by FactSet

I guess given the CSCO and AMZN example we could make the case that PTON has bottomed. What about the Cloud. Twilio (TWLO) is off 65% from the highs and on a price/sales down from 37x to 10x. Still 7th or 8th inning for me.

Data by FactSet

I will feel a lot better when some of these companies actually start earning money and I mean on a GAAP basis. Not this stock option adjusted nonsense that we see in Non-GAAP earnings. They call it Generally Accepted Accounting Principles for a reason. TWLO will lose about $6 this year and will see negative GAAP as far as the eye can see.

Somewhere soon there is an oversold monster rally for these innovation darlings. However, the real bottom won’t be in place until we stop talking about it. At the bottom of the bust few were talking about the opportunities of going long CSCO and AMZN. When Cathie Woods the manager of the ARK Innovation Fund (ARKK) isn’t the most sought-after guest on your popular financial news channel, that’s when it will be over.

*At the time of this article some funds managed by David were long AMZN