Omicron is a Scapegoat for Sickly Financial Markets
Markets tumbled due to weakness in markets, not COVID.
The 2.27% drop in the stock market on Friday, November 26, 2021 could go down as a footnote in the smallest font in the appendix of the most irrelevant market reference. It could be recorded that way, as a long-forgotten market day of little importance.
The sell-off could also be considered the tipping point for the longest bear market in the United States since the 1970s. I’m not predicting anything.
According to Twitter and the financial media, the sell-off was due to Omicron, the latest variant of COVID.
Already, the fears over Omicron appear to be abating among some, while others appear to be just learning about it. The argument is that the new virus might be more transmissible, but less dangerous than the original.1 This is pure speculation. The major vaccine distributors promise a vaccine update in as little as 100 days.2 It’s too early to form an opinion, but that doesn’t stop us, as humans from trying to figure it out.
One thing is for sure. This story was waiting to be told. A new variant has always been around the corner and most likely we will see another variant or two. It’s to be expected. Therefore, Omicron is merely the scapegoat for last Friday’s sell-off. It’s not the true cause.
What else is going on?
On Thursday, economists from Goldman Sachs said that they expect the Federal Reserve to kick off faster tapering and wind down bond buying by mid-March.3 By the end of the trading day, everyone seemed to be discounting this news as ‘bad timing’ due to the news of Omicron, which was expected to keep things in status quo (no tapering, more helicopter money, and record low interest rates.)
In fact, while the markets were dropping, names like Peloton (PTON) traded up 5.67% on the day, where investors expected the ‘good news’ of future lockdowns to force their customers, who already own one exercise bike with an iPad to buy more exercise bikes with iPads.
Markets are confused. They still view bad news as good news. They are not seeing the looming inflation problem for what it is. It’s a problem that could outweigh all policy responses that came before it. The following are a few examples of how our financial markets are sick. The system is imbalanced and a massive correction is due.
A Quick View of Peloton
Since I mentioned Peloton, I decided to check the valuation. The company isn’t currently profitable and doesn’t look particularly healthy. From June 2021 to September 2021, the company’s total cash position dropped 42%. Inventories increased 35%. Over a three-month period, this is a tremendously bad trend.
Meanwhile, the income statement shows a year over year comparison. They increased marketing expenses by 148% to generate 6% sales gains. Gross margins are dropping and General and Administrative expenses increased by 121%.
Looking further at the 10K, one will see the same trend for gross margins (declining), negative operating cash flows, and some curious notes from the auditors about recalls and revenue recognition in their audit opinion. As an accountant, I remember when these types of issues caused investors to panic.4
Peloton appears to be following a mantra of “growth at any cost.” Since the company doesn’t earn anything, the best valuation measure might be price to sales. The current P/S ratio is 3.21 and the long-term historic median S&P 500 P/S is about 1.52. In my view, Peloton must drop about 53% to be considered fairly valued, but that is only if they can stop hemorrhaging cash. On Friday, investors appeared to be thinking that the company would return to the ‘good times’ of the early COVID lockdowns.
How about Tesla?
There is a copy of a leaked email from Elon Musk related to Tesla (TSLA) circulating on Twitter (which is the new version of PR Newswire, apparently).
Elon Musk appears to be admitting that Tesla will miss their sales targets for the quarter and suggests that the company take the most efficient route for production, including managing costs. If you are checking the date on your palm pilot, you will notice that we haven’t finished November yet. So, this is awfully early to be guiding investors to expect a sales miss.
This is especially troubling since the CEO just began divesting sizable chunks of his holdings. He has the earliest view of sales, out of anyone. Thus, even the most avid Tesla fans have to admit his stock sales came at the best possible valuation for Elon Musk and the worst possible time for shareholders.
This admission of a possible sales miss may be a big big deal for Tesla. The company ranks 30th out of 33 manufacturers in initial build quality.5 All other major car manufacturers have an EV offering that competes. Some, like Ford, have even beaten Tesla to the market with offerings like the F150 Lightning. Tesla has failed to deliver the promised Cybertruck. Tesla doesn’t have a first mover advantage or a quality advantage. They have hype.
The Tesla valuation ratios don’t make any sense with a P/E of 351 and P/S of 26. The lofty valuations are driven by sales growth and zero interest rate policy. The P/S ratio itself is 17 times higher than the median historic P/S of the S&P 500. If sales miss, the fallout is going to be tremendous. The current market cap for the company is $1.09 trillion. A full $1 trillion could come off of Tesla’s market cap if sales slip. To put that in perspective, the market cap of Lehman Brothers was $60 billion and the company had $600 billion in assets on the balance sheet. Tesla is a massive bubble all by itself and if sales disappoint at the same time that Fed tapering and interest rate hikes are coming, it will be an implosion for Tesla share prices.
What about Crypto?
A piece about weak financial markets and bubbles is not complete without touching on crypto.
I once asked a crypto ‘investor’ why they think any cryptocurrency has value since the shares can never pay dividends and don’t have cash flow. Call me a fool, but I didn’t realize they had an answer for that with something called “staking.”
What is Crypto Staking?
I immediately went to Google and asked “what is crypto staking?” and got a myriad of results. Let me summarize as concisely as I can. People who buy some cryptocurrencies have an option to engage in staking. By staking “they pledge their coins to the cryptocurrency protocol.” All this means is they lock in their coins as a long-term holding, rather than trading them. As they continue to hold, they may be issued additional coins, minted on the blockchain. There is no effort required and no investment in hardware for mining. 6
What I find interesting about this is how similar this is to receiving a stock dividend. The big difference here is that stock dividends are shares of equity. Equity is an actual asset with value. Issuing new shares doesn’t affect the overall amount of equity on a balance sheet. In fact, adding shares through a stock dividend actually dilutes book value per share. In many cases, stock dividends add little value for shareholders and minimal amounts of dilution.
Cryptocurrency has no equity backing. It has only theoretical value. So, dilution doesn’t happen. There’s nothing to dilute. The coins have value because the current and new holders are willing to buy them. Staking is meaningless, except that a greater fool may be willing to buy those newly minted coins at some point in the future. The bigger concept here is that cryptocurrency holders believe they are earning a return for holding their shares, even though the staking process gives them coins that have no intrinsic value.
Among the risks of staking include:
Lock-up Period - During this period, holders are unable to do anything with their cryptocurrency including selling it.
Changeover Delays - When you decided that you want to unstake your crypto, the unstaking period could last a week or longer.
This is a very interesting way to run a ponzi scheme. If you can convince enough people that they are earning a return, then you have a large number of bagholders to take the losses when the cryptocurrency collapses. Anyone choosing to stake their crypto to earn a return will be unable to get out when it collapses.
Speaking of that, last week, Bitcoin dropped 8% during the market rout. At that same time, crypto exchanges simply stopped working. Ponzi buyers could not sell into the panic.
If you believe cryptocurrency is a giant ponzi scheme, then you may be concerned to know that this ponzi scheme has now captured $3 trillion in real value.7
Concluding Thoughts?
Markets are sick with greed, laziness, and lofty valuations. Raise cash.
Rampant Covid variant spreads to UK, Germany and Italy, https://www.cnbc.com/2021/11/27/the-world-is-on-alert-as-the-uk-reports-cases-of-omicron-covid-variant.html
Pfizer said an updated version of its COVID-19 vaccine will be 'ready in 100 days' if the new Omicron variant is resistant to its current vaccine, https://www.businessinsider.com/pfizer-vaccine-update-100-days-omicron-variant-resistant-2021-11
Fed to kick off faster tapering plan from January: Goldman S, http://timesofindia.indiatimes.com/articleshow/87915200.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
Twitter, https: //twitter.com/bgrahamdisciple/status/1464693458237636612
Peloton 10K, https://investor.onepeloton.com/static-files/d84f3085-8c04-45d0-b6ab-0550de50c7ad
JD Power, https://www.jdpower.com/business/press-releases/2021-us-initial-quality-study-iqs
What Is Staking in Crypto?, https://www.fool.com/investing/stock-market/market-sectors/financials/cryptocurrency-stocks/what-is-staking/
Crypto World Hits $3 Trillion Market Cap as Ether, Bitcoin Gain, https://www.bloomberg.com/news/articles/2021-11-08/crypto-world-hits-3-trillion-market-cap-as-ether-bitcoin-gain