"Well she got her daddy's car
And she cruised through the hamburger stand now
Seems she forgot all about the library
Like she told her old man now
And with the radio blasting
Goes cruising just as fast as she can now
And she'll have fun fun fun
'Til her daddy takes the T-bird away"
-- Beach Boys, "Fun Fun Fun"
As I have noted, the market's complexion has been changing for weeks/months.
Slowly at first and now more rapidly, market sectors are falling from the ranks of superior relative performers. Importantly, the attitude of market participants appears to have begun to grow more demanding.
Even FANG has become vulnerable to the aforementioned stock price weakness. For example, the world's most popular stock (despite protestations from holders and business media commentators), Amazon.com Inc. (AMZN) , is trading at $945 (down $135 a share from its 2017 high of $1,080), and Alphabet Inc. (GOOGL) is trading more than $75 lower than its top price this year.
To me, Mr. Market might be experiencing a Beach Boys Moment.
One of the most memorable Beach Boys songs was "Fun, Fun, Fun." A key lyric from the song (above) is... "til her daddy takes the T-bird away."
That may be happening in the last two weeks for AMZN and recently for Netflix Inc. (NFLX) . In this case, daddy is Mother Market and the T-bird is the free checking account given to both firms to spend without the demand of an economic profit. In my opinion this market behavior may be coming to an end. If I am right, it will have profound consequences for these two of the four components of FANG and, possibly, for the broader market.
Back in late 1999/early 2000, I was bearish on the dot.com stock market boom, making cautionary speeches at CFA (chartered financial analyst) societies around the country and writing not only cautionary comments on TheStreet but also in editorials and numerous interviews in The Financial Times and Barron's ("Kids Today") and elsewhere. (I was not yet appearing regularly on Bloomberg and CNBC back then, so my cautionary market and economic remarks in the TV business media had to wait for the next period of overvaluation and excessive speculation in 2006-07!)
I was in the minority; indeed, at times I felt like the standard bearer of the bearish argument and for investment sanity.
In the late 1990s, many investment managers commonly employed "tracking error" to control risk. Tracking error is the statistical deviation from an index. At that point, tech was benchmarked close to 40% of indices. Tracking error told investment managers that their portfolios were less risky than the index if they underweighted tech to, say, "only" 35% compared to the benchmark of 40%. That may have been true statistically, but when that 40% benchmark tech weighting went down by nearly 80% in the next few years, clients were unhappy and fired many of those managers. Indeed, most of the portfolio managers and the analysts who recommended tech stocks lost their jobs quickly.
It was a win for investment common sense and for the bears.
History Will Decide
Flash forward to early 2017, when tech arguably has entered into a bubble again.
Only history will decide.
I recently have argued that Amazon and Netflix are bubbly because, in part, they have never generated cash in excess of their spending. For years the markets have ignored this phenomenon, but that may be changing.
A week ago Amazon announced post the Whole Foods Market Inc. (WFM) acquisition that it would cut prices, and competitive stocks spiraled lower. Amazon initially traded higher on the announcement of the Whole Foods deal, but over the last month the shares have fallen by $125.
Amazon's strategy is not new. Here we need some history.
In the late 1960s, Charles "Charlie" Bludhorn ran a conglomerate called Gulf and Western Industries. It was an early proponent of what is now called financial engineering. G&W used a high multiple stock to buy low multiple businesses. This led to an increase in earnings and, for a fairly long time, a vibrant stock price. However, Bludhorn and his successors lacked competence to manage these businesses correctly, and cycles and high rates caught up with them and the feel-good story as well as the stock's salad days ended.
Now, back to 2017.
All Good Things Must Come to an End, Even For Amazon
"Don't cry because it's over, smile because it happened."
--Kass Diary, "All Good Things Must Come to an End, Even for Amazon"
Amazon has purchased Whole Foods.
In my career, food retailing never has been a high-multiple business. Amazon has used its bank account, fortified by a 35 times multiple on 12-month trailing EBITD, to buy into an eight- to 10-times multiple business. Of late, WFM has had issues (largely competition) and some might interpret the deal as dressing up a pig.
AMZN conducted no conference call on the deal and its strategy was unveiled last week after Federal Trade Commission approval, with the deal closing several days later. In a move that surprised no one, Amazon cut some prices on items with pretty inelastic demand -- if bananas are 50% lower in price, how many more will you eat? But, Amazon's share price did not continue to rise.
Undoubtedly, AMZN will increase its estimate of revenues with WFM in its barn and widen its estimates of operating losses. However, this may lead to a down stock price. Time will tell, but the technical action of the stock is not encouraging.
Perhaps the market has had enough. Certainly with the White House sheltering its present occupant, it easily may be concluded a change in the political winds is happening. I now wonder if competitors of Whole Foods, such as Walmart Stores Inc. (WMT) , Costco Wholesale Corp. (COST) and Kroger Co. (KR) , easily can be bought. I do not think this is the end for any of them, but it could be a new beginning. Best Buy Co. (BBY) clearly has learned how to deal with Amazon. It is not an impossible skill, and it may get easier if AMZN has a big correction.
And then there is Netflix with its blank check to buy content. However, some, such as Walt Disney Co. (DIS) , no longer want to sell to it and new competitors as content buyers are entering the arena. This usually pressures the stock price of the incumbent. Competitors such as Alphabet, Facebook Inc. (FB) and Amazon have big checkbooks, and the supply of producers of good content is not infinite. The price of content will go up. Netflix does not have a stellar record at producing content. Sure, there were winners, but who can name the Adam Sandler NFLX comedies that have been released so far?
At last look, Adam Sandler eats before the shareholders. By the way, NFLX sells at 100 times 12-month trailing EBITD. Other content manufacturers sell at 10 times or so. Is the NFLX distribution network -- which the last time I looked was the Internet with no entry barriers, unlike cable in the good old days -- irreplaceable? Is the Internet worth the multiple premium for Netflix's alleged superior growth based on an unproven power to raise prices? Does NFLX have bad accounting, as Barron's recently suggested?
The markets will decide.
And here is my analysis on why I would avoid (but not short) Netflix.
I remain short Amazon and would sell Netflix.
Reasonable people may differ.
(This commentary originally appeared on Real Money Pro at 8:30 a.m. ET on Aug. 28. Click here to learn about this dynamic market information service for active traders.)