Llevo 31 años subido al andamio de la industria financiera, los últimos 25 gestionando patrimonios. He vivido en Nueva York y en Londres, donde he tenido la gran suerte de conocer y trabajar con algunos de los mejores inversores de nuestro tiempo. A ellos y a mis socios les estaré siempre agradecido por la formación que he recibido.
Recent news on the success of clinical trials for COVID vaccines is lifting most spirits and giving a boost to Recovery stocks. Twenty-one years ago, the world was bracing itself for another dangerous bug. Well, perhaps not the entire world, but most business managers and government officials were holding their breath ahead of the turn of the millennium because of a very serious computer programming glitch. This was a combination of early programmers’ economy with expensive and scarce memory, and the spectacular lack of long-term foresight that drives most human endeavours. For a more recent example, look no further than post-Brexit planning in the UK. The fear at the time was that, left unchecked, the Y2K bug might have rendered most of the world’s computer software dangerously useless, as most computer languages would not recognize dates beyond December 31, 1999.
This B-movie like tail risk was the final problem that Chairman Greenspan faced in his long quest to tighten monetary policy since his “Irrational Exuberance” speech in December 1996. In the interim, his hands were tied by a long series of crises starting in Asia in the summer of 1997, and culminating with the demise of Long Term Capital Management and Russia’s devaluation and default in 1998 just ahead of the introduction of the euro and Y2K in 1999. When, he finally raised the Federal Funds rate by 25bps in early 2000, irrational exuberance all but disappeared overnight. Few would have guessed that US Treasury would become one of the best investments for a while as the NASDAQ fell 80% and the S&P500 45% to their nadirs.
Yet, just a few months prior to this collapse and following the markets’ correction in the fall of 1998, the NASDAQ had followed an exhilarating parabolic rise turbocharged by fear of missing out the Internet Revolution. At the peak in March 2000, Cisco Systems was the second largest company in the world by market capitalization behind Microsoft. Cisco provided the plumbing of the fast growing Internet, which could not do without its routers. Trading at 28x Enterprise Value to Revenues and nearly 100x Enterprise Value to EBITDA, the Cisco of 2000 was an excellent company and a good story, but as it turned out, it was not a good investment. Shareholders have lost 11.6% of their money since. In fact, the total shareholder returns to date for the 10 largest TMT companies at the peak of the market in March 2000 have been very disappointing with the exception of Microsoft, which is up 600%. The worst performers in that select group have lost between 75% and 100% for shareholders.
A cursory review of the companies that completed the Global Top 10 of March 2000 should give you some room for thought. These Internet Big Bang proxies were largely represented by Telecom Operators and Telecom Equipment Manufacturers such as NTT Docomo, Vodafone, Nokia, MCI, and Ericsson. There was a also a data base company Oracle, as well as old economy companies such as General Electric, Walmart, Pfizer, and Exxon. The next 10 largest companies also included many successful TMT companies, successful up to that time in any case. The list included Sun Microsystems (acquired by Oracle in 2010), Nortel Networks (which filed for bankruptcy in 2009), AT&T, Texas Instruments, EMC Corporation (acquired by DELL in 2015), and WorldCom (which filed for bankruptcy in 2002), as well as a few one hundred year old business models such as BP, Citigroup, Toyota Motor, or Merck which are still around.
The first thing that comes to mind when reviewing this ranking from the turn of the millennium is the formidable presence of EU companies among the World’s Top 20. There are only two of them today, and both are old economy businesses: LVMH and Roche. The EU is the seat to one of the largest pools of savings in the world, but its capital markets, outside the UK, have yet to develop fully. An oversize financial system continues to play a very big role in the intermediation of savings, perhaps too big a role given the meagre returns of that industry and the difficulties that many companies encounter to raise equity or debt.
At the turn of the new millennium, there was certainly pride and elation around these EU champions, it turned to be quite misguided. Everybody made money from Telecom Operators except for their shareholders. Governments through spectrum auctions, bankers thanks to an M&A wave and large debt issuance to pay for wanton acquisitions, and later by raising equity to repay that debt, and finally management because compensation is determined more often than not by company size rather than by the performance of the stock. Both investors and management failed to see that Telecommunications is not an industry that scales well. As it turns out, Telcos are pedestrian largely consumer services companies that year in and year out churn out very low returns on invested capital because they constantly have to give their customers more for less. All you need to do to confirm this thesis is to look at your current bill and compare it to your bill(s) from 2000. Secondly, there were high hopes, unfounded as it turns out, that the apparent lead Nokia and Ericsson seemed to enjoy in mobile networks equipment and handsets would become a permanent competitive advantage. Alas, they failed to see that without a dominant Operating System (OS) they would not remain relevant in the smartphone centric industry that was soon to emerge. Symbian was no match to iOS or Android.
According to Bloomberg data, the best performing stocks of companies that were public in 2000, since then, among the current Top 50 Global companies (ranked by equity market value) are: Apple Inc. (129x), Wuliangye Yibi Co. Ltd (82x), NVIDIA Corp. (78x), UnitedHealth (67x), Nike Inc. (51x), Amazon (46x), Union Pacific (31x), Starbucks (27x), Next Etra Energy (26x), and Adobe (22x). Interestingly enough, they almost all of them were well-known at the time. While Apple and Amazon have reinvented themselves with new products and business lines, and might be thought off as disruptive, all the other companies continue to do what they did well back then. The billion-dollar question is how easy were these opportunities to spot? Moreover, how much did investors have to pay for all the subsequent growth they bought? The answer to the first question is that except for the Chinese spirits company, most of the other companies were well known and widely followed. Valuation was in many cases very reasonable Next Etra Energy, Union Pacific, and UnitedHealth traded at 10x, 11x, and 15 trailing earnings respectively. Whereas the growth companies traded in a range of Enterprise Value to Revenues going from 1.2x for Apple Inc. to 16.5x for Amazon (which revenues had surged 130% the previous year).
Are we seeing a similar situation to that of March 2000 soon? We will offer some naïve unrequited observations. Firstly, that valuation did matter in the past. Secondly, companies with highflying stocks will look to put some revenues under their market capitalization by emulating the AOL-Time Warner merger of 1999, raise equity to make up for cash flow generation, or put themselves on the block. A newswire article this week suggested a Tesla-Daimler AG tie up. We fear that while Elon Musk has been able to raise billions through equity and convertible bond offerings effortlessly over the years, including $5billion recently, raising $100 billion to make an unsolicited cash offer for Daimler may be a showstopper. Even if the IPO market today is very liquid, it may not be quite that liquid. While 2020 is indeed a banner year for US IPOs, recording the highest volumes since 1999, the total amount raised year to date is just $150 billion. Elon Musk could try a merger, but he may find that perhaps Stellantis, the presumptive result of Peugeot and FCA’s never quite closing merger, may be the sole interested party for a friendly tie-up. In any case, everybody should know by now that, Tesla is not just about making cars, it is so much more.
In this nearly thirteen year-long bull market, many investors especially in Tech-un-savvy Europe shunned investing in the best companies in the world because of concerns over valuation. They have been catastrophically wrong thus far. As was the case from the crash of 1987 to the early 2000s, the revenues and earnings for many leading Tech companies have grown at a pace that has more than justified the multiples at which these companies traded for years. However, this may have changed in the most recent rally. Indeed, the valuation for some software and Electric Vehicle companies is very demanding, as is the valuations for some recent IPOs, including DoorDash and Airbnb this week.
Obviously financial repression is the elephant in the room separating these two periods. As you all know, nominal interest rates in the US and the euro zone have never been lower, and real rates have seldom been lower either. (Nevertheless, as the marginal growth for all these companies well into the future should come from emerging and frontier markets, developed markets’ yield curves alone may not be the best-suited benchmarks for terminal values). There is so much liquidity that after an initial pull back on the vaccines’ news; the Work from Home basket is rallying again, even as the Recovery basket stocks are on a tear, at least for now. This is a breach of the law of the excluded middle brought to you by the collusion of expansionary fiscal and monetary policies. While it would appear that we could have our cake and eat it too, we wonder whether another very old law will not assert itself once again, indeed, when something is too good to be true, it generally is.
The Internet stocks explosion of 1999-2000 was very costly to the careers of some of the best hedge fund managers of prior decades. Their brick and mortars longs were plummeting as their Internet shorts kept rising unstoppably. Some lost their businesses, others their jobs. Until it all came to an abrupt halt with Greenspan’s modest rate hike. From its March 2000, peak of 5132 the NASDAQ Composite Index fell 78.4% to a low of 1108 in October 2002. While fundamental investors got their heads handed to them in the brutal rally, many momentum investors were wiped up in its aftermath. As far as we can remember, only a few people shone in that environment.
What could make today’s market swoon? Certainly not an unexpected rate hike. More equity supply is in the cards, as many companies that have raised large amounts of debt to weather the pandemic will have to reduce leverage sooner or later. They are all waiting for their stock prices to rerate, by then it may be too late for some. Nevertheless, even this may not be enough. There are other pockets of problems around the world that under normal circumstances would raise serious concerns. These include a no-deal Brexit, the rise in Government and private sector debt, especially in the euro periphery; a slew of corporate defaults and other funding issues in China and elsewhere. The reality is that many crises come from out of left field for many investors who did not anticipate the issue. Sometimes, these are known unknowns, sometimes they are unknown unknowns. We believe that it is not impossible that his time around the jitters will come from inflation prints not seen for many moons. We shall see what gives then.