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The Markets Finally Start To Look At Valuations

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We are firmly in earnings season and the market keeps getting disappointed.

Don’t look at earnings because they are heavily pumped up by the Trump tax change. And by a weak dollar.

What you should really focus on this earnings season is revenue growth.

Consider Google.  Google crushed earnings because of the Trump tax change. Their revenues grew 23% (after FX issues). It beat expectations but was inline with what they’ve been doing for a few years.
But Google had to spend a ton to get those users (traffic acquisition costs surged 40%+). That’s why the market dinged them. In fact, Google’s stock price hasn’t moved in 6 months.

The market is suddenly discovering valuations. Google has a forward P/E of 35.  But expected growth is ~20%.  So they have a pretty big premium baked into their price. And that’s including the surprise jump in earnings per share (EPS) from its tax benefits.

In fact, many tech stocks are trading with quite lofty valuations. The cost of capital is set to rise a lot faster this year (if they need to refinance their current debt. Or issue new debt). Hence the sell-off.

If we are finally returning to fundamentals… then the market needs to drop another 1% to be “fairly valued.”  If the S&P falls below 2600, I might be a buyer.

A lot depends on the macroeconomic data coming out. The key concern is inflation.  Too much and the Fed may hike rates more frequently. That would really spook the market. Be sure to keep an eye on inflation data coming out. It’s the metric the Fed’s look at.

On a separate note, we are seeing the volatility (just as I predicted a few months ago):

  1. Valuations: Stocks have to compete with bonds, which are becoming more valuable (as its yields rise). Plus higher interest rates squeeze margins, adding more stress to valuations.
  2. Rate hikes: The Fed is raising rates. That will slow the economy. It will slow housing. Buckle yourself in.

If you like options, this is definitely a time to play the game. Buying the VIX would also be a good play today.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

A No-Brainer Trade: Free Dating Sites Closed

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Free dating sites close down. Only paid sites remain.

You might not know this, but Congress just wiped out the casual dating scene in mid-March when they recently signed into law the Fight Online Sex Trafficking Act (FOSTA). This intent of this law is to hold websites accountable for any content on their site that may lead to illegal sex acts.

Previously, websites followed a Good Samaritan approach wherein they did their best to monitor content, block anything illegal, and report it. 

Suddenly, websites are 100% responsible for what their users post. If you consider the massive amount of postings on Craigslist and Reddit, this is an incredible burden. All it takes is one post to slip through and these websites face enormously costly fines.

The FOSTA’s primary concern is underage sex trafficking. There are no reliable statistics around the issue of whether or not the internet has increased these criminal acts, but it’s obvious that the internet makes it easier to do wrong things. It’s easier than ever to find an interested party. And it’s incredibly easy to make a post.

The targets for the law are websites where sex workers advertise. But casual dating sites are also targets because they provide excellent cover for sex workers. Rather than take any risk, Craigslist shut down their personals section. Reddit as well.

If you are single and want to meet someone, you just lost your biggest free options. With no other options for now, the millions of singles who like casual dating will turn to other sites like Match.com, OKCupid, PlentyofFish and, of course, Tinder.

And all of these sites are owned by one company: IAC.

That’s the trade. You could buy IAC outright. Or buy you could look at the 2019 calls as IAC will continue to dominate.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

New Q2 2018 Moneyball Trading Ideas

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New Investment Ideas

I don’t usually throw out standalone investment ideas, but these are some I am considering. Here’s my thesis.

  1. Short the Turkish Lira: Turkey has over extended itself.  The economy has grown on the back of significant debt and fiscal stimulus.  If that sounds like the U.S., it does. Except that Turkey lacks a strong central bank. And they have also been engaging in some costly military adventurism. Also, I think that the Turks have antagonized the U.S. and Germany to the point these countries would like to see Erdogan stumble.
  2. Long Vietnam: Vietnam is a growing economy. With an educated and low-wage workforce, they are picking up a lot of manufacturing work from Chinese companies. The China/US trade tiff will drive even more business their way. It gives the Chinese the political cover to tell Trump that they have curtailed exports to the US.  The trade here is long the Vietnam (ETF Ticker: VNM)
  3. Long Interactive (IAC):  IAC owns Tinder, Match.com, eHarmony and many other dating sites.  That matters because Congress has effectively shut down free dating sites.  Almost 3 weeks ago, a new law was passed (FOSTA) that is intended to stop online prostitution. But it was written in a way that forced Reddit, Backpage, and Craigslist to shut down their casual dating sections.  (In fact, Backpage was then shut down entirely this week.)  Single people now have no option other than paid sites. And IAC owns the best ones. The trade here is the January 2019 $160 calls.

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

Markets Happy As It Climbs “The Wall Of Worry”

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Update: March 2018

The market is very, very happy.

The fiscal stimulus and lack of major “inflation scare” is helping keep markets steady, yet trending higher on a positive note.

So here’s the wall of worry that is getting built.

  1.  Economic growth is again topping.
  2.  Inflation could run up faster than expected
  3.  Slowdown in Europe and China could drag down US production

Each of these is real in my opinion.

Inflation is the big one that worries the market. Interest rates are rising and the pace and degree would normally be affected by the pace of inflation. I say normally because the Fed isn’t about to turn hawkish. That is, they aren’t suddenly going to undo 10 years (yep – 2008 was 10 years ago) of policy because they suddenly want to get ahead of the inflation curve. Nope. The Fed is going to be led by the market. 

Right now, the market will accept three rate hikes.

That doesn’t mean the market won’t get nervous. For example, a sudden jump in inflation will scare traders into expecting more rate hikes.

The market should worry because inflation is already here.  Consider truck rates – 70% of all goods in the US are shipped by truck. This means trucking inflation affects everything.

Trucking price inflation just surged into the double digits on a contractual basis.  But on a spot price basis, they hit 25% year-over-year.

However, the market has mostly shrugged off the recent blow-off. It’s down just 3% from its recent top. Here’s another look at the revised SouthBay Fair Value Index.

The S&P is still a bit overbought, although the gap has closed a bit thanks to the blow-off in the S&P. There’s also been an improvement in conditions for the SouthBay Index.

Now look at the S&P y/y growth rate.

Pessimism was at its peak in early 2016 when market growth slowed to -5% (actually contracting on a year-over-year basis).

With Trump elected, it surged but it has been looking toppy ever since the underlying economic data (reflected in the SouthBay Fair Value Index) started to soften.

KEY TAKEAWAY: The market rebounded with Trump and the underlying economic growth supported the reflation. Fast forward to mid-2017 and the underlying growth started to soften, and so did the market’s growth. Indeed, the surge from the tax cut does not seem to be halting the slowdown in economic fundamentals.

In other words, the divergence won’t hold. I think the S&P will be lucky to see 10% growth by year end. But that’s still great growth

 

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics

Business Is Booming For This Industry

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Marijuana Goes Mainstream

In October 2015, Oregon legalized the sale of recreational marijuana. The following month I flew to Portland to gauge the market. I visited 5 stores and monitored foot traffic and sales.

The atmosphere was somewhere between furtive and matter-of-fact. The products were fairly limited: cannabis buds and smoking accessories.

Business was very hot. In a one hour period during the afternoon on week days, I counted roughly 25 visitors per hour per store, with a spend of at least $40 each. Nearly $1000 an hour, all cash.

And that was during the off-peak hours.

Two years later, in November of 2017, I again flew to Portland and visited the same shops.

The question I wanted to answer whether or not cannabis was a novelty. If so, then business would have dropped.

Instead, I saw the exact opposite: business was just as high as when it was first legalized. More interestingly, because it was close to the holidays, the stores were offering gift baskets.

The product lines had evolved: in addition to green buds, they offered oils and edibles. There were also more accessories, but of a higher quality.

Imagine a Starbucks gift basket, but for cannabis.

The gift baskets spoke to the mainstreaming of cannabis.

There were identical sample packs that offered a variety of buds (a smoke-of-the-day club experience), a mix of edibles, or a mix of different cannabis products (oils, edibles, buds). There were baskets that gifted both the cannabis and the means to imbibe. Everything was wrapped in the same happy rattan baskets.

How is this mainstream? First, ubiquity. Every store had them.

Second, visibility. These gifts of joy were being given openly, without concern that recipients or givers would be outed.

Third, price. Holiday gift giving tends to follow a price point. These were novelty items or “cheapies.” The minimum price was $50.

Fourth, popularity. Many of the baskets had been sold out.

This mainstreaming is important. At some point, high volume products like Doritos will likely add cannabis oil.

And it is that oil where the investing opportunity sits. As demand for cannabis expands, it will drive up the use of oils. The facilities that convert marijuana bud into oil will be highly profitable.

KEY TAKEAWAY: The cannabis industry is booming. More states are heading towards full legalization. Companies that convert marijuana buds into oil will be huge winners in this industry. I’ll keep a lookout for the winners and report back.

 

Sincerely,

Andrew Zatlin

Editor of Moneyball Economics