Equity markets are being dragged north by large tech and social media companies. It is dangerously reminiscent of 1999-2001 period. But this time the Federal Reserve is standing in the capital markets as the buyer of last resort. We believe that this selling to the next idiot is working because the next idiot is the Fed. What happens when the Fed can no longer buy up assets or insert insane liquidity into the market? Discrete valuation adjustments. Also, any market that is so disproportionately focused on so few entities is not a market that is sustainable or capable of truly representing future economic stability or growth. The risks within this market are extraordinary. During a pandemic that resulted in government ordered economic destruction, social unrest not seen in 60 years, and liquidity and fiscal insertions that pervert asset values this market seems to be indicating that all is well. It simply defies logic. We once again preach patience. The expected return to risk tradeoff will improve as will the corresponding investment opportunities. Fear of missing out (FOMO) is not an investment discipline but rather a psychological phenomenon that will prove short lived.
Returning to the market leaders. Many of these entities (Google-Alphabet, Facebook, etc.) rely heavily on ad revenue. During the current environment many potential consumers have been forced to spend far more time accessing the internet and relying on social media and technology to maintain human interactivity and in some cases survival. As such, these entities, along with Amazon and Netflix, have predictably done well. Ad revenue, online shopping, and streaming take personal income to sustain themselves. Once the fiscal handouts end, will these patterns of consuming continue? Unlikely. Consumer spending dynamics will have to change to meet the economic realities that many will find themselves in. Consumer spending requires gainful employment and despite the highly dubious employment data released last week too many individuals and small businesses will be unable to spend without continued fiscal largesse. Profligate government intervention is shorter lived than FOMO and results in compounding economic austerity. So here again, the solution is worse than the problem. Organic growth takes time.
Eventually, as these spending dynamics change and largely end, their will be fewer entities to spend on marketing and advertising. Ad revenue will decline as will valuations of these ad dependent tech companies. Moreover, as social interactivity returns to actual human interaction streaming and social media will suffer as well. Ultimately, their valuations will reflect the fundamental realities facing the global economy. Slower economic growth is unavoidable and fiscal insanity can not artificially sustain it; nor in our opinion can it bridge it to some economic nirvana like that currently being priced into asset values. Again, patience is required here.
Even if our risk assessment is slightly off, we firmly believe that investment opportunities over the coming quarters will improve meaningfully. As the return distribution shifts and changes shape we will be better able to evaluate asset valuations. Note, however, that this changing risk distribution can abruptly and violently change within the environment we are operating in. We have a market that has exclusively reacted to exogenous interventions and completely ignore fundamentals. It is also a presidential election year where we have perhaps the most vitriolic political atmosphere in our lifetime. The level of sheer hate can lead to some highly dubious policy decisions. Moreover, states and municipalities have yet to fully quantify the impact of lockdown policies on their budgets. Risk is simply far to stochastic and unpredictable currently. Again, patience will be rewarded.
Eyeballs alone only don’t drive income for marketing budgets. Back in 1999 analysts bragged that “fundamentals don’t matter anymore..it’s all about the clicks.” This market seems to have a very similar milieu. Eventually, government handouts end, spending will decrease dramatically; ultimately ad revenue will not be sustained, and these current market leaders will have to be revalued based on fundamentals. With over 40 million additional unemployed our economy will suffer dramatically. No government insertion can prevent that from happening. Eventually, this nihilist upward equity trend will end. It is best to be prepared and understand the risks inherent in equity market activities. We are prepared and patient; we will wait for the opportunities to present themselves.