Tales from a Late Stage Bull Market

An endearing quality of a late stage bull market is that it expands the universe of what’s possible.  Somehow, rising stock prices make the impossible, possible.  They also push the limits of the normal into the paranormal.

Last week, for instance, there was a Bigfoot sighting near Avocado Lake in Fresno County, California.  But it wasn’t just one Bigfoot.  According to a local farmer, there was a family of five or six Bigfoot running across his ranch in the middle of the night.  Paranormal expert Jeffery Gonzalez offered the following Bigfoot sighting anecdote:

“One of them, which was extremely tall, had a pig over its shoulder.  And the five scattered and the one with the pig was running so fast it didn’t see an irrigation pipe and it tripped, with the pig flying over.”

What to make of it?

Bigfoot sightings, no doubt, are pro-growth.  They’re bullish for stock prices.  So, too, are warnings from North Korea that nuclear war “may break out at any moment.”

How do we know these two unrelated events are bullish?  Because if you plot the S&P 500’s price movement since their occurrences, you’ll find that the market is up.  There is a direct – albeit false – correlation.

And these days a correlation of any kind is what matters.  No one cares that correlation does not imply causation.  Such a pesky detail doesn’t matter to Phillips Curve adherents.  Why should it matter for anything else?

Indeed, there are plenty of things that used to matter, which no longer matter.  For example, stock valuations don’t matter.  Profits don’t matter.  Most of all, deficits don’t matter.

The Greatest Fools of All

The point is an eight-year run of rising stock market indices has suspended, if not eradicated, the natural laws of the universe.  What was once considered rash or ridiculous is now shrewd and savvy.  Conversely, tried and true investment principles, including evaluating business fundamentals, are for losers who lack imagination.

The proof of the pudding is in the eating, goes the maxim.  Certainly, investors are lapping up this market like boysenberry funnel cakes at the county fair.  They can’t get enough of it.

They’ll stand in line in the hot sun for hours to buy Amazon stock at $1,000 per share at a price-to-earnings ratio above 250.  Because in this late stage bull market, growth and revenue are where it’s at.  That’s what today’s savvy market participants want.  They don’t care if, like farming, the attainment of growth and revenue comes at a loss.

To be fair, Amazon no longer operates at a loss.  Last year they booked $2.4 billion in net income.  Unfortunately, they had to bring in $136 billion in revenue – a net profit margin of 1.7 percent – to do so.  While some profit is better than no profit, in our book.  The Amazon folks sure did a lot of running around without much money left over to show for it.

So, what is it that attracts investors to Amazon?  Do they want to become part owners of a profit generating machine with an abundance of after tax income?  Is there a dividend they get paid for placing their money at risk?

To the contrary, Amazon investors receive no tangible income stream.  Instead, they make a bet that there will be a greater fool standing by to pay a premium when they’re ready to sell their shares.  In fact, those who bought at $1,000 per share may find that there are no greater fools left – yesterday’s close was $986.  Thus, if there are no greater fools left, by default, they’re the greatest fools of all.

Tales from a Late Stage Bull Market

Obviously, Amazon stock has been a fantastic speculation over the last 20 years.  Its stock price has risen from a split-adjusted $1.50 at its 1997 initial public offering to over $1,000.  That’s over a 60,000 percent increase.  Each dollar invested has transformed to $600.

But at this late stage in the bull market it is unlikely that Amazon will continue its trajectory into the upper stratosphere for much longer.  The fact is, Amazon’s profitability will never rise to its present market capitalization.  Those who bought shares of Amazon at $1,000 may not have the opportunity to sell at that price again until the year 2040, if ever.

From a broader perspective, the stock market is currently overvalued on 18 of 20 valuation metrics.  Naturally, timing the stock market’s ultimate crest is for wizards and palm readers.  However, anyone with half an inkling about anything knows the market’s much closer to its next top than its last bottom.

Hence, if you’re determined to buy stocks, you should take a moment to understand just what it is you’re buying.  Are you buying growth and revenue that’s pumped up by massive levels of debt?  Or are you buying a business that cranks out tangible after tax profits that are distributed to shareholders?

Knowing the difference is critically important.  Sure, high growth and revenue companies – pumped up by massive monetary intervention – were the hot lottery tickets over the last few years.  But when the dust settles following the next crash, and when Bigfoot sightings no longer serve as bullish indicators, boring old profitable businesses will be the prized holdings for investors.  Anything less will be detested.

Sincerely,

MN Gordon
for Economic Prism

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