New Vol Regime

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September 2, 2020: All-time highest VIX on a day with the S&P 500 touching the highest level ever.

Equity Market Volatility Divergence

Strange times indeed. This week we observed two spectacular divergences. First, single-name equity option activity relative to indices was near all-time, historic extremes. Second, Nasdaq volatility (VXN) traded at a multi-year premium to the CBOE VIX. What is going on here? This post is from August 28, the latest update is here. 

Nasdaq Volatility Trading Very Rich to the S&P 500
With the Nasdaq QQQs up close to 40% this year, there are lots of gains to protect.  Nasdaq vol has been trading very expensive relative to the VIX. Investors are paying up for protection.

Climax Points

Think of bull and bear market capitulation climax points. At the end of a bear’s mauling, dozens if not hundreds of rallies have failed. Long, exhaustive bear markets break the hope and spirit of more and more investors – until the point of maximum capitulation. There is NO one left to sell, think March 2009. Each failed rally delivers deeper losses to the market participants and every one of the “fast money” tourists have run for the hills. All that’s left is an empty meadow, the genesis of a new bull market is born.

Now, let us think of the beast inside a great bull. Dozens if not hundreds of dips have been bought. With each victory, fast money rookies share their battle stories with more and more friends at cocktail parties. Tourists arrive, busload after busload empty into the market, it’s all good, “this is easy.” With each triumphant buy of the dip, investor confidence turns into a dark shade of hubris and more and more capital pours in. Why not, the mad mob is playing with the house’s money. Now think of 100 hedge funds, all up 3% for the month. Why not take 1% of those gains and buy calls on the largest, highest momentum equities. Worst case you end up 2% for the month, best case you deliver 5%, after all, you take home at least 20% of the profits. One conclusion, month-end (Aug 31) / quarter-end (Sept 30) is about to get very interesting.

August 2020

The first 20-ish days of the month were the quietest in a long time. If we look at ten-day, realized equity market volatility, it plunged to nearly 6 vol, 2020’s nadir. On the other hand, this week as month-end drew closer – we experienced two, 1% trading range days with close to forty handle swings in the S&P 500. For sure, someone is monetizing gains.

VIX Up – S&P Up
On Wednesday and Thursday this week, the  Chicago Board Options Exchange’s CBOE Volatility Index (VIX) was more than 5% higher each day, with the S&P 500 up both of those days. How rare is this? Very. We could only find ten days in the last decade with the S&P up 1% with the VIX closing higher. This is especially rare with the market at all-time highs. In a healthy bull market at its best levels, the VIX should be in the low teens, NOT the lows 20s. 

Two Month vs. 8 Month VIX Futures Contracts
One of our 21 Lehman Systemic Risk Indicators are found in the trading spread between the two and 8-month VIX futures options contracts. To keep this as simple as possible, all we are doing here is measuring the cost of protection. How much more expensive is buying short term vs. long term insurance? The above data is mindblowing. This week, the cost to buy the two-month VIX future reached nearly 5 handles more than the eight-month contract. Elephants leave footprints. When large hedge funds need or want to pay-up for short term protection from a market crash that is one thing, BUT the price they are paying this week is VERY extreme with a market at all-time highs. As you can see above, the 2-8 spread is wider today than nearly every financial panic in the last five years. In a healthy, “risk-on” (where risk is being put on) bull market – this spread should be in “contango” – the two-month VIX futures contract should be ALOT cheaper than the 8-month variety. 

 Paying Up for Upside Risk

Over the past few weeks, there has been a massive buyer in the market of Technology upside calls and call spreads across a basket of names including ADBE, AMZN, FB, CRM, MSFT, GOOGL, and NFLX. Our friends at Citadel calculate, over $1 BILLION of premium spent and upwards of $20B in notional through strike – this is arguably some of the largest single stock-flow we’ve seen in years, they noted. We agree someone is playing with House Money, and they’re rolling large.

“The average daily options contracts traded in NDX stocks to rise from ~4mm/day average in April to ~5.5mm/day average in August (a 38% jump in volume).  Given this group of 7 stocks accounts for a ~40% weighting in the NDX, the outsized volatility buying in the single names is having an impact at the Index level.  So why are Vols moving yesterday/today when this call buying has been taking place for weeks?  Yesterday CRM, one of the names we have seen outsized flow, rallied 26% on earnings – a less than ideal outcome for those short volatility from all the call buying.  As the street got trapped being short vol, other names in the basket saw 3-4 standard deviation moves higher as well – yesterday FB rallied 8% (a 3 standard deviation move), NFLX rallied 11% (a 4 standard deviation move), and ADBE rallied 9% (a 3 standard deviation move).  The most natural place to hedge being short single name Tech volatility is through buying NDX volatility.  As such, there has been a flood of NDX volatility buyers with NDX vols up about 4 vol points in 2 trading days. And if NDX volatility is going up, SPX volatility/VIX will eventually go up too.” Citadel

What are the conclusions? What does this tell us about the path forward? What other instances of this occurrence have we seen historically? Email tatiana@thebeartrapsreport.com for our full report. 

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High Impact in the Gulf

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*MARCO ‘ S CENTER MOVING THROUGH THE YUCATAN CHANNEL :NHC
*LAURA STRENGTHENS NEAR PUERTO RICO :NHC

Gulf Disruption, Where is the Trade?

“Over the last decade, at certain inflection points each year we listen to our best relationships in the advanced weather forecasting space and believe a hyperactive hurricane season is on the
way. A possible 18-22 “named” storms/hurricanes compared to the 30-year average of a 13 storm season. The primary reason? Significantly warmer-than-normal Atlantic surface temperatures are with us. This balmy water is pure lighter fluid, propelling storms all the way from the African Sahel toward the Caribbean and beyond. Hurricanes often cause immense property damage; loss of human life and we hope none of these events transpire. However, for market participants, we offer three scenarios and strategies to hedge against encroaching hurricane risk. Should a hurricane enter the Gulf of Mexico, we believe a strategy of long refiners and short (re)insurers presents the best hedge. However, if the beast aims for the Eastern Seaboard, a combination of long natural gas and short (re)insurers provides the best plan of action.”

Bear Traps Report, August 19, 2020, institutional investors, FAs, RIAs, CIOs, and investment professionals, email tatiana@thebeartrapsreport.com for a copy of the investment thesis and the FULL report.

Here Comes the Story of the Hurricane
“The models are showing something unprecedented this morning, two storms make landfall within 24 to 36 hours in essentially the same spot.”

Aaron Carmichael, a meteorologist with the commercial forecaster Maxar.

The Fujiwhara Effect

If both cyclones perform an elegant dance and slip around each other. They would orbit a common center, with Laura likely propelled west-northwest while Marco’s northward progress could be slowed. – WP


 

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The $400B Front Run with the Index Funds Holding the Bag – Part III

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Inclusion Games Chapter III

On Friday, Telsa shares climbed very close to $2100 and a $400B market cap – right on the doorstep of passing Johnson & Johnson JNJ. This would put TSLA just behind Buffett’s Berkshire Hathaway at the #8 spot based on equity market capitalization. We’re looking at one colossal whale for the S&P inclusion team to swallow. An unprecedented amount of selling will be required to make room for this monstrosity.

Looking back at major index inclusions in the last decade, especially with a keen eye on the last 12 months of S&P announcements on constituent changes, we think it’s most likely that the S&P will include Tesla TSLA in the upcoming rebalance in the third week of September. If not, the December rebalance would be the next opportunity for S&P to include TSLA.  Most of the smaller S&P inclusions/exclusions coincide with a corporate event. This could be the completion of a takeover or bankruptcy that frees up space for another constituent. However, the larger constituent inclusions are done with a quarterly rebalance. For example, the Teledyne TDY inclusion in June was done with the June rebalance and the Live Nation LYV inclusion in December with the quarter-end rebalance which occurred that month. Note that one of the biggest additions of the last 10 years was Facebook FB, which was announced on December 11, 2013, for the inclusion on December 20, 2013, coinciding with the quarterly rebalance.

Is this a Scam or a Con game? It Smells to High Heaven
We believe it is likely that the Inclusion Committee at S&P waits until mid-September to announce the inclusion of Tesla in the S&P 500. This would coincide with the quarterly rebalance (Sep 21).

Free Float and Influence

Buying pressure from S&P inclusion: There is approximately $3.9T of pure index capital following the S&P 500. These are mostly index funds, including ETFs and mutual funds that mimic the S&P. TSLA market cap is $400B but Musk owns 18.4% of the stock. The free-float market cap is therefore $326B. Musk’s net worth is getting up there, near $90B, nearly $11B more than Warren Buffett, not bad for the car and battery maker. Keep in mind, at his death in 1947, Henry Ford was worth close to $200B in today’s dollars.

We have over 450 buy-side institutional investors on our live Bloomberg Chat, with more than 50 contributors across nearly all asset classes. If you know a portfolio manager that we should add to our live chat, please let us know tatiana@thebeartrapsreport.com .

Why the Big Move this Week?

The recent runup in TSLA stock was more likely to be related to the 5-for-1 stock split. The split takes effect on August 31 for each shareholder of record on Aug. 21. Market participants were likely clamoring into the stock to be shareholders of record for the split.

The S&P index inclusion has been another source of fuel behind the recent squeeze higher in the TSLA stock. According to our estimates, S&P is likely to assign a 1% weight for TSLA in the S&P. That means passive investors, who track the S&P 500, would need to buy $33.8B of TSLA stock. But every $100 increase in TSLA stock, would force another $1.6B of index tracking capital into the stock. This provides all the elements of a potential squeeze, whereby astute speculators front-run the index inclusion announcement, after which passive capital must buy the stock in a relatively short period of time before the rebalance.

Selling Stock In the Hole

For decades, the convertible bond market has been known on Wall St. as the “last saloon.” You know, the one bar opened until 3 or 4am, where patrons desperate for a late-night cocktail can find refuge. Our research shows, frequent visitors to this arena – where borrowing terms are certainly NOT as friendly as others – have gone on to file bankruptcy a very high percentage of the time.

Less than 18 months ago, Tesla sold TSLA stock on the cheap (near $200 in May 2019 vs. $2100 this month), in a desperation convertible bond offering. Which begs the question,  if you sold shares in size at $200, why wouldn´t you do the same at $2100? We think Elon will, he is NO dummy.

Serial Convertible Bond Issuers

SunEdison*
Chesapeake Energy*
Molycorp*
Lehman*
iStar Financial*
Calpine*
Fannie Freddie**
Enron*
Tyco*
Adelphia*
Six Flags*
eToys*
Avaya*
Worldcom*
Tesla

*Went bankrupt. File under ominous. Tesla is one of the very few, VERY few companies that have come “hat in hand” – in desperate need of capital, multiple times to the convertible bond market, and NOT file bankruptcy. 
**conservatorship

“Tesla should fill all orders with an offering that is announced on the inclusion day. It’s been done before. $15BN equity offering MOC pricing should do it. Every bank; $GS, $C, $JPM, and the buyers themselves are way way ahead of you. They are already talking.”

Andy Constan

Buffett’s Ideas to Avoid Disruption

In prescient from, back in 1999, Warren Buffett observed that the growth of indexation would eventually run into sustainability problems in need of solutions.  Buffett made the point if a very large company were to be added to the S&P 500 it could be extremely disruptive. “If you shorted the companies after inclusion into the index you would be surprised at the (good) returns.” After the market distortions, unnatural demand for shares created by the addition to the index is very disruptive. Buffett came up with two solutions. Option #1, Tesla could offer a large number of shares for sale in a secondary offering which would offset the $34B of index demand. Look out below, $TSLA stock would lose 40-50% in our view in this scenario. Option #2, S&P scales the entry in, say 10bps a month or quarter. To us, this is the MOST likely solution. The index funds don’t swallow Tesla in one bite but a dozen nibbles over 12-24 months.

For perspective, Buffett entered the S&P 500 in 2010. Back then Berkshire and was the 21st largest stock in the Index vs. #9 for $TSLA. More of a shocker, BRK/B was valued at just $170B vs. $390B valuation for Tesla on Friday. In terms of inclusion demand for shares: $14B vs. $35B*. The run-up into inclusion was 26% for Buffett v. 822% for Musk.

*Amount passive indexes MUST buy, WSJ Reuters data.

Lessons from Yahoo
Yahoo was added to the S&P 5000 on December 7, 1999. Its market cap was nearly $92B – then it spent the next 15 years between $5B and $50B valuation. 

We have over 450 buy-side institutional investors on our live Bloomberg Chat, with more than 50 contributors across nearly all asset classes. If you know a portfolio manager that we should add to our live chat, please let us know tatiana@thebeartrapsreport.com .

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Fed Balance Sheet Games, Fed´s MTA Bailout takes shape

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August 19: New York’s MTA Becomes Second to Tap Fed as Banks Demand Higher Yields

Now that the trains are half full, the Federal Reserve took down nearly $500m of the troubled rail´s bonds. Interest costs were 1.92%, nearly 1% LESS than their cost in the private market. This is one COLOSSAL bailout in the works, billions $$$ more bond buys to come in the near future. 

How does the Fed decide 1.92%? When the cost of capital is decided by unelected committees (and NOT the free market), who picks the winners and losers?

In our institutional client chat, live on Bloomberg we received this question today:

Q: “Why has the Feds balance sheet shrunk over the last 6 weeks if they supposed to be doing over $100B a week of QE? I don’t get why there´s almost no one is talking about this?”

Keep an Eye on the S&P 500 and the Fed Balance Sheet
A: We keep hearing this is in relation to liquidity vs. securities held. So “securities held” are up LARGE (mortgage-backed securities, treasuries, corporate bonds, municipal bonds), but liquidity measures, swap – repo facilities are down a lot. So, the total balance sheet has come down from $7.169T on June 10, to $6.957T today. Above all, roll off of repos and $ swaps from CBs has been a drain on asset side fed balance sheet. These two things have largely happened in tandem as Fed has restored markets to a plethora of liquidity. Fed 84 day swap lines got up to $400b, that number is coming down a lot, and the same is the case for repo. The market can now handle both. As these things come out, Fed balance sheet will start moving higher again as the +$80b a month of UST purchases becomes a marginal driver. For now, PDCF, $ swap lines, repo etc. all the emergency measures that aren’t getting rolled in full and coming off b/s are taking the wind out of the growth of Fed asset side. The bottom line, real liquidity is being pulled from the system. Keep in mind, as the Fed expanded their balance sheet from September to February, we were lectured by Wall St., “don´t fight the Fed.” And then stocks dropped nearly 40%. 

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Dollar Plunge, Copper Supply Crisis, Shipping Costs Soar, file under NOT Deflationary

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Dollar, Now through the Lows

August 18, 2020

Dollar Weakness on Road to a Crisis

The US dollar has declined vs most major currencies, while gold, silver and other commodities have rallied. While last week’s 0.6% rise in core CPI could be an adjustment from the shutdown, the rise in commodities and decline in the dollar is something that could become more meaningful over time, although this process could take months or years.  One major difference with previous periods is the impact of China. Beginning with its 50% currency devaluation in 1994, China has been one of the major forces dampening US inflation – i.e. Greenspan’s conundrum. If production begins moving back to the US, inflation may begin assuming more historically normal patterns. We may even see the rebirth of the Phillips curve. With Arthur Bass, Wedbush.

Never Listen to the Mad Mob

The unintended consequences coming out of the multi-trillion dollar, fiscal – monetary policy cocktail are ripping around the planet. Coupled with pandemic side effects – shipping costs are telling us bond yields should be much higher. Copper prices are singing the same tune.

The mad mob ONLY wanted to talk copper demand in April and May, now everyone is waking up to the supply reality. London Metal Exchange’s global warehouse network is holding the least copper since 2008. See our bullish metals report here. 

Copper Supply Crisis-hits a New Level
The London Metal Exchange’s global warehouse network is holding the least copper since 2008 in the latest sign of an economic recovery. The decline in inventories over the past few months coincides with record-breaking shipments of copper into China, where demand for the metal in the manufacturing sector has surged since lockdown restrictions were eased. Inventories tracked by the LME now stand at 110,000 tons, down 61% from this year’s peak, per Bloomberg.

The Largest Shipper on the Planet – Maersk
The last time MAERSK equity was near 9000, German bund yields were 20 to 60bps higher. As one of the world´s top exporters, German bond yields have maintained a strong correlation to shipping costs, until now.

The Cobra Effect, comes with Surging Unintended Consequences 
Capacity constraints have driven up rates for international shipments this year whether by sea, air or land, further complicating matters for supply-chain managers dealing with the effects of Covid-19 on their businesses. The cost of moving goods by ship has climbed 12% in 2020 to the highest since February 2015, according to the Drewry World Container Index. Ocean-liner rates have benefited from the industry being more disciplined with idle capacity, coupled with support from general rate increases and peak-season surcharges, per Bloomberg Intelligence. Must see our Cobra Effect post, over 1 million views. 

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Consumer Prices, will the Real CPI Please Stand Up

“As the Fed expanded its balance sheet to unprecedented levels from December 2008 to December 2011, precious metals and precious metal miners widely outperformed equity markets. Historically, in the most extreme precious metal bull markets, silver widely outperforms gold. Today, silver trades at multi-decade cheap levels relative to gold. We remain bullish on both, but as we alerted clients last week, silver remains our highest conviction buy over the next 12 – 18 months. We’re long a full 3/3 position in the portfolio.”

Bear Traps Report, April 3, 2020


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Cross Asset Signals are Surging

After almost a decade in hibernation, gold bugs are roaming the earth again. A fast drop in the dollar’s real yield and the uptick of a favored gauge of inflation expectations have sent the metal on a wild ride.

CPI vs. CPI Food
When CPI food makes a 2-3 standard deviation move, it´is hard to ignore.  For weeks there was meaningful divergence. Commodities were screaming higher while bond yields were looking the other way, no cares. That all changed this week. 

Q2 Agriculture Equities

Mosaic MOS +49%
Bunge BG +22%
Nutrien NTR +15%

Food Stagflation

This week Bloomberg Opinion noted, skeptics might say there isn’t enough evidence of rising prices to warrant a neck-breaking run in gold, traditionally seen as a hedge against inflation. (Maybe all that lockdown isolation had bond traders imagining things.) In July, U.S. consumer prices rose 1% from a year earlier, well below the Federal Reserve’s 2% target. Meanwhile, at 2.7%, the headline figure in China remained in check, even as pork and fresh vegetable prices soared. But here’s a thought: What if our governments aren’t measuring consumer prices correctly? Is it possible that inflation is actually a lot higher?

Covid-19 has overhauled our spending patterns entirely, not least because of social distancing rules. We’re laying out less on transportation, restaurants and hotels, and splurging on food, because — like it or not — we’re all home chefs now. This sudden change can introduce significant biases in the consumer price index, according to a new study from Harvard Business School. Statistics bureaus in most countries update their CPI expenditure baskets only once a year, often using lagged data. The U.S. Bureau of Labor Statistics, for instance, revised its weightings last December using information collected a year earlier. As a result, the indexes don’t reflect Covid-19.

Soft Commodities and Bond Prices
What is interesting is – in Q2 2020, hard commodities led this move higher, and “softs” (agriculture plays) really started to play catch up in recent weeks – THAT woke up the bond market this week. 

Pass-Through Inflation Risk

In the official gauge, for instance, groceries receive a weight of less than 8%, whereas transportation gets about 15%. But recent data collected from consumers’ credit and debit card transactions show that a more appropriate weighting would be around 11% and 6%, the study’s author, Alberto Cavallo, found.

As gnarled distribution makes food more expensive, and groceries take up a bigger share of our daily budgets, the inflation we’re feeling is quite a bit higher than the numbers suggest. Meanwhile, cheaper transportation hardly matters, because we’re all staying home.

China Floods are a Problem – Listen to SOIL
There are reports of up to 30% of China´s agricultural output could be at risk. China facing food shortage after months of flooding, infestations.  Xi’s description of food waste as ‘shocking and distressing’ could portend looming food shortage. Per Asian news outlets, this is the second time that Xi has given instructions on China’s grains within a month, raising eyebrows among China watchers as a sign of a possible food crisis. 

State Secrets

The bias in China is harder to measure because the CPI weighting is a state secret. What we do know is that the National Bureau of Statistics tweaks it every year. Bloomberg Intelligence gives us their best estimates: Food may be getting a 20% weight, while transportation and communication has about 14.5%.  Nonetheless, China’s downward bias is likely even more pronounced. Say food returns to its 30% weight from five years ago, a back-of-the-envelope calculation shows that consumer inflation would have hit 4% in July, well above the central bank’s 3% comfort zone. Food prices jumped by 13.2% last month, versus a 4.6% rise in the U.S., because a severe flood disrupted the supply chain.

This perhaps explains why, even though the dollar has become a less attractive investment vehicle thanks to the U.S. government’s chaotic virus-containment policies, investors aren’t crowding into high-yield emerging-market currencies but opting for gold instead. Nominal rates are falling everywhere, while inflation is ticking up, and who knows what the real interest rates in various nations are. Gold, as we’ve argued, serves as a useful hedge in these extraordinary times. Working with Bloomberg Opinion and Shuli Ren.


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Reflation vs. Stay At Home, a Large Rotation

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The Once Certain has become FAR Less Certain

The Cobra Effect is all about the certainty of unintended consequences. That means the ten-year valuation of future cash flows coming out of Big Tech companies is now worth far less as the certainty of deflation is FAR less certain. Let’s explore.

Month over Month

Our “Re-Flation – Re-Open” Basket

Mosaic $MOS +50%
Alcoa $AA: +37%
Metals ETF $XME: +19%
Berkshire $BRK: +17%
General Motors $GM: +15%

The “Stay – At – Home” Basket

Microsoft $MSFT: -3%
Cloud Software ETF: -5%
Netflix $NFLX: -11%

Bloomberg data

The Purchasing Power Problem, 2020 Style

Let’s say you’re a newly minted billionaire in Saudi Arabia. You just spent the last 20 years taking care of the family, especially Dad. Unfortunately, he passes on leaves you $1B in US 10 year Treasuries. After running around San Tropez for a couple of months, you sit down with your financial advisors and they give you the blood-curdling news. Real bond yields are -1.10%, so you’re burning through $11m year in negative carry. That’s right, inflation expectations > income. After lightening up on all the extra help around the Bayt al-Razzaz, you turn on the 108-inch flat screen and the first thing you see is a large collection of junkies in Washington running up a $5T bill, a 24-7 pork-athon with no end in sight. Next, your advisors point to gold’s 36% year over year return, but you become distracted by the insanity going on in silver, up nearly 90% over the last 3 months. Frustrated that you missed those boats – you’re instructed to turn around, “focus on agricultural commodity plays Sir.” You turn on CNBC and Mosaic MOS is on the screen – up 50% month over month, “‘uwh la!” Then comes the worst news of all. Someone whispers, “the US dollar is off 7% over the last three months.” So, your $1B has lost another $60m of global purchasing power. “Sell the yikht!”

Asset Flows out of Tech
Cloud and SaaS (software as a service) equities widely underperformed value equities such as Berkshire Hathaway this week. In our view, investors continue to realize they are not positioned correctly being overweight technology with rising inflation expectations. From the Tea “Austerity” Party in 2010 to an MMT fueled, junkie-juiced fiscal spending overdose in 2020? We’ve come a long way baby. Hard to process a $4 to $5 trillion Federal deficit under a Republican Administration without concluding that either inflation is around the corner or the dollar is going to substantially weaken or most likely both. The current inflation picture (August 2020) is meaningless. Markets are starting to price in the 5-10 year forward path. You DO NOT need current inflation today to change the models and valuations, you simply need to dramatically alter the certainty of deflation.

What is “Terminal” Value? Think Stay at Home vs. Re-Open
The GM vs. Netflix debate is the ULTIMATE “Stay at Home” vs. “Re-Open” conversation. Think of Netflix, no free cash flow, or real earnings. The company simply takes all incoming cash and builds a Capex funded content war chest. It’s a cash-burning inferno. Terminal Value (TV) is the present value of all future cash flows, with the assumption of perpetual stable growth in some cases. Terminal value is used in various financial tools such as the Gordon Growth Model, the discounted cash flow, and residual earnings computation. However, it is mostly used in discounted cash flow analyses. Any hint of inflation can DRAMATICALLY alter the company’s valuation built on a high terminal value element. If all the company’s value is found in the projected, long-term (5-10 year) future cash flows, and the probability of inflation rises 3-5 years out, those FUTURE cash flows are WORTH far LESS! To us, this is what’s shaking tech at its core, large tremors (capital outflows into stagflation resilient sectors) are forming. Some LARGE, clever investors are leaving the party early – while the “high-kites” want to rock-on, hang around for the sunrise.

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