All that we see or seem is but a dream within a dream.
Edgar Allan Poe
All things are subject to interpretation. Whichever interpretation prevails at a given time is a function of power not truth.
I was walking down the street wearing glasses when the prescription ran out.
I think one of the hardest things to learn as an investor is that your opinion isn’t worth all that much. You can believe anything you want but the market doesn’t care. The only thing that matters at any given moment is what the majority believes and is willing to bet their hard earned dollars on. You can think the “Chinese stock bubble” doesn’t matter and you can believe that the “Greek debt crisis” doesn’t matter but if everyone else thinks those things matter then you are going to have to accept that and the market volatility that comes with it. People believe what they want to believe, see what they want to see and at times it seems as if everyone you pass is wearing Steven Wright’s glasses. But that’s the way things are, the reality in which we have to operate and you might as well get used to it.
I don’t know whether the “Chinese stock market bubble” was a bubble or not or whether it was important to the global economy or markets. My logical side says probably not on the latter but I don’t think most people would agree with that perception and as the Chinese market stabilized last week, US stocks found a bid, up over 2% on the week. Considering the lengths to which the Chinese government went to stanch the bleeding, I am pretty sure they thought it was important but if the original sin was allowing the bubble to form then stopping its fall surely hasn’t solved the problem. But then that likely doesn’t matter any more than whether it was a bubble in the first place. If people believe it was a problem and that it has been solved, then it is solved until proven different and markets will act accordingly. Interestingly, what probably does matter – the condition of the real Chinese economy – doesn’t seem to get much attention these days – except maybe in Canada where the Loonie is doing a swan dive and the central bank just cut rates.
Or maybe it wasn’t the stabilizing Chinese stock market that pushed US stocks higher last week. Maybe it was the resolution of the “Greek crisis” that gave people confidence to buy stocks. After all the widely held belief that Greece would exit the Euro and that that was bad – although an explanation for why it was bad was rarely offered – had pushed stocks lower in previous weeks. Or at least that’s what I read in the Wall Street Journal and on lots of blogs.
All I’m fairly certain of is that keeping Greece in the Euro turned out to be negative for the value of the Euro, something which ought to give pause to the folks pushing so hard to keep them in the fold. That the terms offered and accepted by Greece are ones that will likely prevent the country from ever growing enough to pay off the debt is, for now, irrelevant. The Greek problem is solved and off the table. And again what really does matter, the condition of the European economy, gets favorable coverage just for seeming to be getting better. I saw an article earlier this week praising the fact that European exports were up 5% in the first five months of this year versus last year. Not mentioned in the article is that the Euro is worth about 20% less than it was a year ago.
Earnings season is also upon us and maybe that was the source of last week’s strength. Netflix and Google both beat the earnings guesses of Wall Street analysts and were rewarded with big gains in their market value. Of course, estimates for both had been falling – and in the case of Netflix continue to do so – so beating those estimates wasn’t all that heroic but a beat is a beat. A close reading of Google’s report reveals that the price of their main product – paid clicks – is dropping like a stone but that doesn’t matter either. What matters is that Google is working on all kinds of cool things in secret and that their new CFO was able to restrain expense growth to a paltry 13%. Yes, Google sells for 33 times trailing earnings and is growing at about 15% but still it made perfect sense for the company to gain $67 billion in market cap in one day based on that stellar performance. As for Netflix, with its 300 forward P/E, the only metric I could find in the report that was also triple digits was their cash flow. Unfortunately, it is negative and grew more so by a factor of 3. Yeah, yeah, I know. I’m old and don’t get it, yada, yada, yada, it’s different this time, yada, yada, yada.
The biotech sector also merited attention last week as the M&A cycle shifted into high gear. Celgene continued its spending spree paying $7 billion for a company whose main drug – or more accurately their best hope for a main drug – just performed pretty well in Phase II trials that proved absolutely nothing. Another thing the majority believes is that biotech companies are just becoming more scarce by the day. How else to explain the prices being fetched for anything with bio in the name and a drug in the dream phase? The dream phase is that testing period between crude idea and actual lab work. It consists of making up wild guesses about future revenue based on speculative estimates of potential patient pools and going IPO before Phase I trials have a chance to disappoint. It was about a year ago that Janet Yellen of all people, ventured the opinion that small cap biotech stocks were a might overvalued. One can’t help but wonder what she thinks now.
The power, if not necessarily the Truth, resides primarily with the bulls right now or at least it does in certain parts of the market. The NASDAQ broke out last week to new highs but the S&P 500 and even the more speculative Russell 2000 did not. The market’s advance continues to narrow, to concentrate among fewer and fewer names. Bulls will tell you that this is just a pause and the advance will broaden out. And if enough people believe that and there isn’t any convincing reason to sell, they might be right for a while. But at some point the rose colored glasses will come off and someone might wonder aloud why Celgene paid $7 billion for a company with trailing 12 month revenue of $4.5 million. Someone might wonder why Netflix is worth $48 billion and CBS is only worth $27 billion with more than twice the revenue, better margins, a higher ROE and the ability to produce positive cash flow. Until then it’s just a dream within a dream and somebody keeps hitting snooze on the alarm clock.
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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: [email protected] or 786-249-3773. You can also book an appointment using our contact form.
Disclaimer: Alhambra and/or its clients have positions in GOOGL and CELG.