By Michael Lewitt at Money Morning
If it looks like a bubble, smells like a bubble and walks like a bubble, it is a bubble.
There are few certainties in this world, but one of them is that bubbles pop.
And like all previous bubbles, this bubble will pop too.
One of the key signs of a bubble is when investors and the analysts that cheer them over the cliff refuse to acknowledge facts that contradict their bullishness.
The Evidence Is Irrefutable
Exhibit "A" is Tesla Motors, Inc. (NASDAQ: TSLA). At the beginning of the year, analysts were forecasting that the company would earn $2.78 per share and had an average price target on the company's stock of $269 per share – $49 per share higher than where it was trading at the time. Since then, a series of setbacks have led analysts to radically lower their earningsestimates to a mere $0.53 per share – a reduction of 80%.
But instead of lowering their price target on the stock by a commensurate amount, analysts have only lowered it by $19 per share to $251 – a reduction of a mere 7.1%.
That is bubble thinking. The psychological term for that is denial. The Wall Street term for that is careerism.
Exhibit "B" is Amazon.com Inc. (NASDAQ: AMZN). In the first quarter of the year, the company once again managed to spend every penny it took in – and it took in a lot of pennies.
Revenues for the quarter increased 15.1% from a year earlier to $21.7 billion, but the company managed to spend every penny and more, leaving it with a $57 million net loss.
The big news, however, was that the company disclosed for the first time some financial details about its secretive cloud computing business, Amazon Web Services (AWS). AWS's revenue for the first quarter was $1.57 billion and its operating income was $265 million; analysts had been projecting annual revenue of $6 to $9 billion, so this met expectations.
Amazon has been competing fiercely with Google, Inc. (NASDAQ: GOOG), Microsoft Corp.(NASDAQ: MSFT) and International Business Machines Corp. (NYSE: IBM) to provide cloud computing services to startups and other companies such as Netflix, Inc. (NASDAQ: NFLX).
Investors are now fantasizing about an Amazon Web Services spin-off and the possibility that AWS could someday be larger than the Mother Ship at Amazon.
For its part, Amazon promised further losses of between $50 million and $500 million in the second quarter. The result – investors bid up the company's stock by $55.11 per share (14.13%) to $445.10 per share, where it is trading at an even more infinite multiple of its non-existent earnings.
That is bubble thinking.
Investors were so enamored with AWS, in fact, that they bid up cloud competitor Microsoft's stock by 10.45% – the biggest move in that behemoth in years.
Microsoft saw its stock rise by $4.53 per share to $47.87 just a couple of days after announcing earnings that failed to inspire the market (in fact it inspired Goldman Sachs Group Inc.'s (NYSE: GS) analyst to reiterate his "Sell" recommendation on the company).
What happened, of course, was that investors extrapolated Amazon's success at AWS to Microsoft's growing cloud business to add $37 billion to the software giant's market cap.
Once again, bubble thinking.
Bubble thinking also requires a total lack of memory. Investors seem to think that cloud storage is something that has never existed before, but it is merely a new version of the Internet hosting business that crashed and burned 15 years ago.
"Creative Destruction" May Not Be Enough This Time
Amazon and its competitors are already engaged in a vicious price war that is driving down the cost of cloud storage and obliterating margins and profits in this business.
The history of technology is filled with case studies of creative destruction, which is why even with its current success Microsoft's current market cap of $393 billion is 31.6% lower than what it was in 2000.
Other tech giants tell the same story…
Cisco Systems Inc.'s (NASDAQ: CSCO)'s market cap is $147 billion today compared to $466 billion then; Intel Corp. (NASDAQ: INTC) is worth $152 billion versus $401 in 2000; andOracle Corp. (NYSE: ORCL) is worth $188 billion today compared with $232 billion during the Internet Bubble.
While all of these companies have made enormous business and technological strides over the past decade-and-a-half, they have moved backwards in market terms.
Where Bubble Thinking Takes Us From Here
Investors holding Amazon and Tesla stock should run out and sell it as quickly as possible. Those capable of taking the risk should be shorting these stocks using options to limit their downside.
The other stocks on this list – MSFT, CSCO, INTC and ORCL – have survived the tech wars and are more reasonably valued; their stocks are primarily subject to the risk of an overall market decline, which means these holdings should be hedged with the market moving into increasingly overvalued territory.
All of this – and there is much more, believe me – led the NASDAQ to rally by 3.25% or 160.27 points to close at a new record high of 5092.98 last week. Of course, bubble-heads will remind us that this is only a nominal high and that the index has much higher to go since in inflation-adjusted terms the equivalent level to its 2000 peak would be 6,900.
The Dow Jones Industrial Average (INDEX:.DJI) added 1.44% or 254 points while the S&P 500 (INDEX:.INX) gained 37 points or 1.37% to close at 2117.69. Both were new highs. All of these gains ignored another slew of negative economic reports, weak corporate earnings, and continuing dollar strength – all factors that should be suppressing the animal spirits driving stock prices upward.
Economists are now beginning to lower their forecasts for second quarter growth. The most disturbing news was a terrible March durable goods report, which showed the 7thconsecutive decline that coincides with the strengthening of the dollar.
Dollar strength is likely in its early stages and could run for several more years barring a radical change in monetary policy in the United States compared to those in Europe and Japan.
The feckless Fed meets again this week and will likely further torture the markets by giving little guidance on when it might raise interest rates. The time is long past when it should have done so.
It is becoming increasingly clear that just as the consensus (which includes both the policymakers promulgating policy and the financial media reporting on it) was wrong in thinking that lower rates would stimulate economic growth and higher spending – it has done just the opposite – it is likely to prove wrong in thinking about the impact of modestly higher rates.
Higher rates would promote economic growth by promoting investment discipline, taming speculation and creating lending incentives.
Consensus economic thinking is upside-down and until it gets right-side-up, we are doomed to massive mal-investment and all of the bad consequences that flow from that.