Market Notes

Eagle, CO

A few weeks ago, my favorite fundamental analyst of all time came out of a self-imposed silence and provided his first thoughts on the markets after around six months off.

It was so good to read that I wanted to share it with you, in its entirety. This is worth your time. I promise. If you read it all and think otherwise – lunch is on me next time we meet!

With that, I turn it over to the one and only, Porter Stansberry.

April 26, 2019
Baltimore, Maryland

Here it comes...

After a 10-year economic expansion... a humongous expansion of debt (far in excess of GDP growth)... and after stocks have gone higher and higher and higher for what seems like forever... the stage is set for what my colleague Steve Sjuggerud calls the "Melt Up."

Stocks hit new highs this week (April 26, 2019)... And all signs point to more and more advances, just like Sjug predicted last fall. Congratulations to the investors who were bold enough to follow his advice and continued to hold aggressive growth stocks.

Today, I (Porter Stansberry) want to show you a few things that tell me this current rally won't last for long. And I want to explain why the coming bust might not only be a lot worse than the last tech bust (in 2000)... This could be "The Bust."

My personal favorite two measures of how stupid things are getting in the stock market are...

1. The value of stocks relative to GDP.

We're close to matching the insane levels we last saw in 2000...

2. The number of unprofitable companies successfully selling shares to the public.

Back in 2000, more than 600 companies sold shares to the public. Only 14% of them were profitable at the time of their initial public offering ("IPO"). And almost none ended up being the Amazon (AMZN) they claimed they would become.

We're back to those same levels today... And this time, the size of the losses is vastly bigger. (There's a reason private investment firms have held onto their "unicorns" for so long, which I'll explain in a minute...)

In some cases, these companies' losses are as large as – or even larger than – their revenues...

For example, Snap (SNAP) – a young-adult-focused social network – recently reported losing $310 million on revenue of $320 million. But why worry about that? Its total number of users increased 2%!

You can imagine a path that would lead Snap to eventually reach profitability. I'm not saying that will happen... I'm only pointing out that the economics of social networks can create tremendous cash flows if they reach a big enough scale.

But those economics don't carry over into most businesses – like real estate or transportation, for example.

So, it's much harder to make sense of WeWork, a real estate business that rents commercial office space and then sublets it to individual users and small firms. WeWork reports that its revenues more than doubled last year to $1.8 billion. However, its losses also grew... to $1.9 billion.

It's easy to understand why WeWork's losses grew as fast as – or a little faster than – its revenues...

WeWork doesn't own any commercial office space. It has to lease it, and then re-sell it to others. But office space is a competitive business. It's not easy to capture profit by simply re-leasing space... especially when your business also provides free beer to your tenants (no kidding).

Why would anyone be willing to own a real estate company whose losses exceed its revenues... and whose "secret" to success is something as dumb as free beer at work?

That's a good question.

I don't think I'd want to own that business at any price. I don't see anything proprietary in what it is doing. Nor do I see any value in its brand or in the offices it has leased. If there is some value here, it isn't much – not with such huge losses.

So why did Masayoshi Son, the head of international conglomerate SoftBank, invest $2 billion in WeWork at a $47 billion valuation?

How will WeWork ever produce profits to justify even a tenth of that valuation? The more office space it gobbles up, the more money it loses.

Likewise, it's hard to imagine how using ride-hailing software will transform the taxi business so that Lyft (LYFT) – with losses of $1 billion last year – or Uber – with losses of more than $1 billion last quarter – will ever come close to justifying their almost $25 billion and $75 billion valuations, respectively.

Whether or not you believe those cars will soon drive themselves – as Tesla (TSLA) CEO Elon Musk claims – local transportation is a ridiculously competitive business with zero fundamental barriers to entry. Nobody will care whether the car they're riding in for 10 blocks says "Lyft" or "Uber" on it.

This is a non-scalable business with significant marginal costs. Going forward, winning market share for these businesses will almost certainly lead to losses because there's no way to gain a fundamental advantage, no barrier to competition, and free price comparisons are available instantly for every consumer.

Investors will soon discover a painful lesson they should've learned in the tech crash of 2000...

Recklessly buying huge amounts of revenue growth with other people's money doesn't usually lead to a good outcome... not unless you're the guy selling those shares to the public.

Just think about that for a minute...

Why on Earth would wealthy and sophisticated investors – like private-equity firms and venture-capital firms – allow the companies they own to generate losses like this... losses that are completely unsustainable? Who in their right mind would run a company this way?

The answer, of course, is: no one who actually plans to keep them.

These companies aren't being managed to last. They're being managed to sell. Their founders are young and handsome. They have long hair and wear T-shirts. They're rock stars, not real business builders. They're out there to capture media attention and generate unbelievable growth stats that "prove" they're the next Jeff Bezos.

But how many Amazons will emerge? Not many.

Do you wonder why so many of these 'unicorns' with huge revenues and huge losses have been private for so long?

Why didn't the private investors cash out a lot sooner?

I suspect it's because index-based funds now dominate the public markets. And most of these indexes are based on the market value of the company.

By building Uber's valuation to more than $50 billion, the firm's private investors are guaranteeing that lots of index-based funds will have to buy the shares. Using market caps to weight index funds – where the most expensive stocks receive the most allocation – has to be one of the dumbest ideas in the history of capitalism.

Why does Masayoshi Son want to "prove" WeWork is worth so much money, when in reality, it probably isn't worth anything? So the investment bankers working on his behalf can make index funds buy it.

Private tech investors are about to exploit index funds in a memorable way. I can't say that I blame them. If you're going to be a moron in a poker game, your chips won't last long.

You'll see more and more of this in the years ahead...

As interest rates have gone lower and lower and our economy becomes more dominated by debt, more of this kind of financial engineering will happen. That's because it's the only way to create growth.

Remember, this huge wave of liquidity wasn't provided by actual savings. It's not as though the global economy has been through a long period of delayed gratification with large economies saving more than they consume and investing conservatively in new means of production. No, not at all.

As a result, we've seen little increase to productivity and no pent-up demand. Thus, the "growth" we see today is only where you also see massive amounts of financial engineering.

I call this the "financialization" of America.

A quick example... Corporate earnings haven't grown nearly as much as stock prices during this bull market. What has grown? Corporate debt. Those debts have been used to fuel share buybacks. That has produced upward momentum for the stock market, so the valuation of stocks has gone up, too.

Thus, we have fewer shares trading at higher multiples of earnings... but no real meaningful improvement in the productivity or profits of our country's biggest businesses.

Where does that lead? Not to real increases in wealth. It leads to slower growth (as the debt burden builds) and a lot more volatility as this financial mirage eventually falls apart.

Sadly, the financialization of America won't merely cause a lot more volatility in the stock and bond markets... What's even worse than all of the money that public investors will lose on these new IPOs is how much time and capital have been wasted on business ideas that simply don't make any sense – like WeWork.

Meanwhile, businesses building real products for real customers and earning real profits... those businesses can't get funding.

Last week, I had a troubling discussion with a venture capitalist...

As you may know, in addition to my core business (Stansberry Research), I've also been heavily involved in another half dozen or so private-equity deals. Some of these deals have been large – in the tens of millions of dollars.

In the financial area, I've bought other research firms and software companies – like Casey Research, InvestorPlace Media, and TradeSmith. I've also invested in venture projects, partnering with legendary investors like Peter Churchouse and Whitney Tilson, to create new brands – like Empire Financial Research. These deals are attractive to me for obvious reasons... Having spent 25 years working in the industry, I know it well.

But I've also done a fair amount of private-equity investing in areas where I don't have any special insights – most notably, in real estate.

I'm an investor in a private-equity group that buys older apartment buildings in mid-tier cities around the country. The group then refurbishes the buildings to increase the rental yields. More recently, I found a new partner who has figured out how to make buying older hotels in certain markets work in a similar way.

Finally, I've spent a good amount of time developing a new luxury consumer brand...

Of course, regular Digest readers know I'm talking about OneBlade, the men's razor company. Hopefully, you've seen our ads and have tried our product.

We've gotten great feedback from our users. And the business is doing well. Our customer base grew 43% last year, while our subscriber base (folks who've signed up for our subscription blade service) grew 73%.

Most important to me, we saw our repeat-customer revenue grow even faster (96%) than our new-customer revenue. It's a good sign when your existing customers are buying more and more from you. It means folks aren't merely trying your new products... They're adopting them.

As I know from my other subscription-model businesses, folks who renew their subscriptions tend to stay with your business for a long time. This repeat revenue is incredibly valuable to a business because it accrues without additional marketing expenses.

I have a good friend who went to Stanford...

He knows several people in the Silicon Valley private-equity community. My friend has been watching OneBlade grow, and he recommended that I talk with some private-equity firms about whether it might be time to bring in outside investors to ramp up OneBlade's marketing efforts.

A phone call was set up. I was skeptical...

There are always "strings" attached with institutional investors. And they have different investment goals than I do. Private-equity firms need companies to go public or be sold to a new majority owner within seven years so that they can cash out, return the capital to their investors, and go on to the next deal.

But I'm not building OneBlade to sell... I have the opposite strategy. I'm building OneBlade because there's been almost no real innovation in wet shaving in 100 years. With better materials and much more sophisticated design, I know tremendous improvements are possible in razor performance. With innovations in manufacturing, truly personalized razors can be built at an affordable price.

There's a development path for us to continue to grow the "moat" around OneBlade – by consistently building better and better razors over many years. This strategy won't require hundreds of millions of dollars in capital. Nor will it likely produce billions in revenue in only a few years. But it's also surely not going to produce billions in losses!

My conversation with the venture capitalist was sadly ironic...

We went over the details of OneBlade quickly. He wasn't curious about the product. He wasn't interested at all about the size of our repeat-customer revenue or our subscriber growth. Instead, after hearing about our current revenue growth rate, he immediately told us he wasn't interested in the company.

That didn't surprise me... Companies that are being conservatively managed don't produce triple-digit growth rates. Doing so requires spending far too much on marketing and losing a lot of money – something that has never made sense to me.

But I was curious to know what venture-capital firms are expecting in this market. So I asked what he's looking for in consumer-product start-ups... He said he wants to see annual revenues in excess of total capital invested in the business.

So if you've spent $10 million building your new product, developing inventory, hiring staff, and buying advertising, he expects your company to be producing at least $10 million in sales per year.

I can tell you from experience, that's almost impossible unless your cost of goods is near zero and unless you're spending so much on marketing and advertising that you're willing to run your company at a significant loss.

In other words, he's looking for a company that's investing almost all of its capital in advertising and sales, while selling extremely cheap goods.

So if you're building a company with great, innovative products that are built to last... if you're building a dedicated, loyal, and lucrative user base with a conservative marketing budget so that you can continue to invest in research and development... and if you're partnering with high-tech manufacturers in America, who hire lots of expensive engineers, designers, and programmers...

You won't find many private-equity firms that want to invest.

But instead, if you build really cheap sneakers that are just like everyone else's and are manufactured in Asia (like Allbirds)... and you also spend $50 million on marketing, generating a huge marketing loss... then you're worth $1 billion.

Where do you think that kind of investing is going to lead our economy and our country?

Today, America is beset with unsustainable, debt-fueled companies and institutions...

It's to the point where almost nothing works – nothing – without huge amounts of additional debt.

Just look at college lending... Student loans have gone [all-in], with more than 44 million people owing $1.5 trillion in debt that can't be discharged in bankruptcy.

Look at home prices and mortgage lending.

Look at automobile prices and subprime auto loans... for used cars.

Look at the incredible growth in the number and scope of publicly traded companies that can't afford their interest payments.

Look at the number of businesses – like Netflix (NFLX) and Tesla (TSLA) – that only exist because of huge amounts of debt that are constantly being added to their balance sheets.

Look at our annual federal deficit, not to mention the size of our unfunded social-welfare obligations.

Nothing works in our economy without more and more debt. This is a recipe for social unrest, radical politics, addiction, despair, and desperation.

Yep, that's about what we've got.

It also means that nothing will be built to last. Because the clock is ticking. Not just on this current bull market, but on this entire system.

Enjoy those hot IPOs while they last!

Porter Stansberry
Baltimore, Maryland
April 26, 2019