Mad Hedge Technology Letter
April 18, 2018
Fiat Lux
Featured Trade:
(WHY YOU SHOULD STILL BE BUYING FACEBOOK ON THIS DIP),
(FB), (GOOGL), (AMZN), (NFLX)
Tag Archive for: (NFLX)
He did just enough.
He did 5% enough, but it should have been 10%.
That was the performance of the highly controversial data company Facebook (FB) in the wake of Mark Zuckerberg's (the aforementioned "he") testimony in front of politicians who failed to correctly pronounce his name let alone understand his business model.
But Zuckerberg did well.
Well enough that investors approved in droves.
Facebook shares tanked after the Cambridge Analytica scandal was disclosed, and the stock traded 16% below its February high.
The FANG stocks lost more than $200 billion in market value at one point when the headlines went viral.
Amazon (AMZN) and Netflix (NFLX) accounted for more than 30% of the S&P 500's 2018 gains in February, and their contribution has dipped to about 24% as of early April.
The leadership burden for large-cap tech is a resilient pillar propping up the equity market.
Let's get this straight - there has been no regulation as of yet but this moves forward any regulation that eventually was going to happen.
However, it could be a highly diluted version of any worst-case scenarios of which one could think.
The big question: Will earnings and guidance be sideswiped because of higher data costs?
And how many of the 2.2 billion MAU (Monthly Active Users) permanently deleted their Facebook accounts?
Facebook profile removals surged to 4,000 to 5,000 the first few days after the news hit and decreased to 2,000 per day in late March. The numbers further subsided to 1,000 at the start of April.
Deletions around the political testimony were clocking in between 1,000 to 2,000 per day.
To put this into perspective, the extirpation of accounts was only about 30% of the Snapchat rebellion where users quit in hoards because of a sub-optimal design refresh.
The media has done its best to sensationalize events and avoid the fact that hyper-targeting ad models has been around for years and has been used by various companies.
Facebook is not the only one.
Bottom line, there has been no material damage to user volume, and the testimony will empower tech because of Washington's botched question session.
Most of Facebook's profits come from less than 10% of user accounts.
Facebook is a one-trick pony with 98% of profits coming from ad revenue.
To add granularity, the bulk of revenue derives from developed nations mainly from North America, which make up more than 50%, and Europe at about 30% of total revenue.
Falling user engagement from the developed English speaking world would be a canary in the coal mine.
I am not talking about a few thousand profile deletions. However, a mass removal of 50,000 profiles or 100,000 profiles per day would throw Mark Zuckerberg into a tizzy.
If Facebook can convince users to stick around then Mark Zuckerberg is the ultimate winner.
With all the fearmongering, some facts get swept under the carpet. And it could be the case that many users are fine with Facebook possessing large swaths of their personal data.
In reality, users might prefer Facebook to Washington when it comes to possessing their personal information.
The performance of politicians lined up to interrogate Mark Zuckerberg was an unmitigated disaster for the political elite.
It is clear there is a competency issue with politicians. The generation bias has given us a fleet of politicians who have almost zero grasp of technology and its pervasive use in America's economy.
Many politicians showed a weak grasp of Facebook's profit engine.
Some politicians were more focused on Facebook's diversity policy than the real issue at hand.
Let's not forget Zuckerberg also controls 60% of voting rights through his accumulation of Facebook Class B shares and has an iron grip on any direction where the company traverses.
Any meaningful regulation costs will be passed onto the advertisers as a cost of doing business.
This is the key lever investors don't fully understand.
Facebook currently uses an auction-based system for ad pricing but could easily slip in stand-alone regulatory fees to compensate the extra costs.
The industries move from CPC (cost per click) to CPM (cost per impression) including duopoly playmate Alphabet (GOOGL) is a great strategy to pad profits.
The only real incurred cost to Facebook is the in-house DevOps team responsible for platform enhancement.
Facebook tried to experiment in 2016 by charging Facebook-owned smartphone messaging service WhatsApp users a $1 per year fee to use the messaging service.
It has done the groundwork to roll out a mass paid service.
Facebook later decided against this move as many users of WhatsApp are from undeveloped countries with no access to credit card payment services.
Zuckerberg is awkward. However, he has come a long way since his hoody days, even using smoke and mirrors to wriggle out of probing questions.
Half the "grilling" he received in Washington was met with the same vanilla answer saying that his team will get back to them.
The peak of evasiveness was Zuckerberg's response to a question about the willingness to change the business model in the interest of protecting individual privacy.
Zuckerberg stated he was "not sure what that means."
The hammering in Facebook shares was overdone.
It is obvious Washington is no match for large cap tech.
Facebook's upside trajectory has been sacrificed in the short term, but one could argue regulation was on the way - regardless of this data breach.
Regulation is a natural progression for an industry with almost no meaningful regulation.
Therefore, a little regulation for tech does not mean the end of tech.
Facebook is not going out of business. Not anytime soon.
Facebook earned revenue of $27.64 billion in 2016, on the back of $40.65 billion in 2017.
Facebook does not need to be "fixed" - it just needs a few bandages in place before it goes back onto the field.
These bandages will damage operating margins that are currently at 57% in Q4 2017, but their long-term fundamentals are still intact.
The wall of worry is unfounded and ad engagement is still solid.
Facebook is in store for record bottom- and top-line numbers when earnings come out. Ad revenue numbers and the guidance will be the key metric to digest.
Investors might want Zuckerberg to kitchen sink the quarter because most of the bad news is already priced into the stock and might as well dig out all the skeletons in the closet.
Regulation is positive for Facebook because Facebook and the rest of the FANGs are in the best position to confront the regulations. The worst case scenario is finding a backdoor way to navigate through the new rules just as the backdoor way of profiting through ad distribution.
The headline hysteria makes it seem like Facebook is about to go under and file Chapter 11.
The bar has been set so low for upcoming earnings that any reasonable guidance will be seen as a victory.
Advertisers have no choice but to pay for Facebook ads if they want to grow business - that has not changed.
Facebook is growing so fast that the CEO could not name the competition when he was asked at the hearing.
There is a huge short squeeze setting up for the next earnings report due out on April 25, 2018.
Lastly, WhatsApp recently surpassed 1.5 billion MAU with users sending more than 60 billion messages every day.
Remember that Mark Zuckerberg purchased WhatsApp when it had around 500 million MAU back in February 2014.
This service hasn't even started to monetize yet and was a genius piece of business for $19.3 billion in 2014.
The valuation is at least double to triple the price of purchase now but seemed ludicrously expensive when Facebook snapped it up at the time.
Facebook has bottomed out, and the added bonus is it is quite insulated from all the tariff chaos whipsawing the equity markets.
__________________________________________________________________________________________________
Quote of the Day
"I'm on the Facebook board now. Little did they know that I thought Facebook was really stupid when I first heard about it back in 2005."- said founder and CEO of Netflix Reed Hastings
Mad Hedge Technology Letter
April 11, 2018
Fiat Lux
Featured Trade:
(WHY YOU SHOULD BE BETTING THE RANCH ON TECHNOLOGY),
(AMZN), (NFLX), (FB), (Samsung), (Tencent)
Global IT spending is forecasted to surpass $3.7 trillion in 2018, a boost of 6.2% YOY, according to a report released by leading technology research firm Gartner, Inc. (IT).
This year is the best growth rate forecasted since 2007, and is a precursor to a period of flourishing IT growth.
IT budgetary resilience is oddly occurring in the face of a tech backlash engulfing Mark Zuckerberg as collateral damage during higher than normal volatility due to an unstable geo-political environment and nonstop chaos in the White House.
Zuckerberg's reputation has been torn to shreds by the media and politicians alike.
Tech has had better weeks and months, for instance as this past January when tech stocks went up every day. Facebook (FB) still had a great business model in January as well.
The biggest takeaway from the report was the outsized capital investments going into enterprise software, which spurs on exponential business formation.
Enterprise software will successfully record its highest spend rate increasing by 11.1% YOY to $391 billion. This is far and away an abnormally fast pace of increase, but is completely justified based on every brick and mortar migrating toward data harnessing.
The software industry will benefit immensely by the universal digitization of all facets of life as software acts as the tool that businessmen use to propel companies to stardom.
Application software spending will healthily rise into 2019, and infrastructure software also will continue to grow, boosted by the revamping of laggard architecture.
Data center systems are predicted to grow 3.7% in 2018, down from 6.3 percent growth in 2017. The longer-term outlook continues to have challenges, particularly for the storage segment.
The lower relative rate of spend is exacerbated by the chip shortage for memory components, and prices have shot up faster than previously expected.
The new Samsung Galaxy 9 cost an additional $45 in semiconductor chip costs because of the importunate costs that sabotage cost structures.
Exorbitant pricing was set to subside in the early part of 2018, but the dire shortage of chips is here to stay until the end of 2018.
Even though the supply side has ramped up 30%, demand is far outpacing supply, spoiling any chance for tech devices to be made on the cheap.
Global spend for digital devices will grow in 2018, reaching $706 billion, an increase of 6.6 percent from 2017. Not only will we see the standard characters such as phones and tablets, but new creative ways to produce devices in the micro-variety will soon populate our shores.
Amazon Alexa and Apple's HomePod are just the beginning and will spawn micro-devices that would fit nicely into a flashy James Bond film.
The demand for ultra-mobile premium smartphones will slow in 2018 as more consumers delay their upgrade and feel comfortable using older devices -- kind of like a smashed-up Volvo station wagon handed down from sibling to sibling.
In times of uncertainty, corporations hold back spending until the near-term variables can be flushed out, and unforeseen costs causing operational turbulence can be anticipated.
However, the industry has brushed aside the turmoil that has attempted to infiltrate the core growth story.
Investors cannot overlook that total tech spending growth for 2018 is the highest in the past 15 years.
Next quarter's earnings are now on tap, and investors will turn to fundamentals as a cheat sheet for what's in store.
It's undeniable that currently tech stocks aren't cheap anymore. They are also more expensive than they were at the beginning of the year barring Facebook and a few other stragglers.
The momentum has intensified with the five biggest tech firms accounting for more than 14% of the S&P 500 index's weighting.
Tech's relative performance has fended off the bears with PE multiples down a paltry 4.9% this year compared to the cratering of 11.4% in the general market.
And tech is still trading at a tiny fraction of the crisis of the dot-com era.
The outsized reinvestments back into business models don't tell the tale of an industry brought down to its knees begging for salvation.
Look no further than across the Pacific Ocean. Samsung Electronics Co. represents almost 25% in South Korea's Kospi index. At the same time, Asia's most valuable company, Tencent Holdings, makes up almost a 10% weighting in Hong Kong's Hang Seng Index.
Back stateside, about 90% of US tech firms beat revenue estimates in the last quarter of 2017, marking the best success rate for any industry.
The positive sentiment has continued into this year with wildly bullish expectations led by the FANG stocks.
The broader volatility is a gift to investors who hesitated and missed the monster rally that has graced tech the past few years.
Tech is vital to emerging markets. And this is the first year since 2004 that tech constitutes the biggest sector in the MSCI Emerging Markets Index blowing past financials.
Tech had a 28% weighting at the end of 2017, the weighting more than doubling from six years ago.
As it stands today, tech enjoys light regulation and by a long mile. Tech is actually the least regulated industry in America and has used this period of light regulation to stack up profits to the sky.
Banks are nine times more regulated than tech companies, and manufacturing companies are five times more regulated.
Legislation such as Dodd-Frank has done a lot to taper the excesses of the sub-prime frenzy that almost took down Wall Street.
The lean regulation has helped tech companies such as Facebook and Google build a gilt-edged competitive advantage that has been exploited to full effect.
After the Fed closed the curtains on its QE program, tech and its earnings are the sturdiest pillar of the nine-year bull market.
The Street is reliant on the big players to earn its crust of bread and show investors that tech isn't just a flash in the pan.
The two numbers acting as the de-facto indicators of the health of the overall economy are Netflix's subscriber growth numbers and Amazon's AWS Cloud revenue.
These two companies do not focus on profits and are the prototypical tech growth companies.
If they beat on these metrics, the rest of tech should follow suit.
The market is entirely dependent on big tech to drag investors through the time of transition. My bet is that tech will over-deliver booking stellar earnings.
__________________________________________________________________________________________________
Quote of the Day
"By giving the people the power to share, we're making the world more transparent." - said Facebook CEO Mark Zuckerberg
Mad Hedge Technology Letter
April 4, 2018
Fiat Lux
Featured Trade:
(SPOTIFY KILLS IT ON LISTING DAY),
(SPOT), (DBX), (GOOGL), (AAPL), (AMZN), (CRM), (NFLX), (FB)
The banner year for the cloud continues as Dropbox's (DBX) blowout IPO passed with flying colors.
Investors' voracity for anything connecting to big data continues unabated.
Big data shares are now fetching a big premium, and recent negative news has highlighted how important big data is to every business.
Let's face it, Spotify (SPOT) needs capital to reinvest into its platform to achieve the type of scale that deems margins healthy enough to profit, even though it says it doesn't.
Big data architecture takes time to cultivate, but more importantly it costs a huge chunk of money to construct a platform worthy enough to satisfy consumers.
The daunting proposition of competing with the FANGs for users only makes sense if there is a reservoir of funds to accompany the fight.
Spotify CEO Daniel Ek has milked the private market for funding, making himself a multibillionaire in the process. And as another avenue of capital raising, he might as well go to the public to fund the venture in the future.
Cloud and big data companies have identified the insatiable investor appetite for their services. Crystalizing this sentiment is Salesforce's (CRM) recent purchase of MuleSoft - integration software that connects apps, data, and devices - for 18% more than its original offer for $6.5 billion.
The price was so exorbitant, analysts speculated that a price war broke out, but Salesforce paid such a high price because it is convinced that MuleSoft will triple in size by 2021. That is another great trading opportunity missed by you and me.
An 18% premium to the original price will seem like peanuts in five years. The year 2018 is unequivocally a sellers' market from the chips up to the end product and everything in between on the supply chain.
Spotify cannot make money if it's not scaled to 150 million users, compared to its current 76 million. And 200 million and 300 million would give CEO Daniel Ek peace of mind, but it's a hard slog.
Pouring gas on the fire, Spotify is going public at the worst possible time as tech stocks have been the recipient of a regulatory witch hunt pounding the NASDAQ, sending it firmly into correction territory.
Next up was Spotify's day to shine in the sun directly listing its stock.
Existing investors and Spotify employees are free to unload shares all they want, or load up on the first day. In addition, no new shares are being issued. This is unprecedented in the history of new NYSE listings.
Spotify is betting on its brand recognition and massive desire for big data accumulation. It worked big time, with a first day's closing price of $149, verses initial low ball estimates of $49.
Cloud companies are the cream of the big data crop, but Spotify's data hoard will contain every miniscule music preference and detail a human can possibly exhibit for potentially 100 million-plus people.
Spotify's data will become the most valuable music data in the world and for that it is worth paying.
But at what price?
Spotify has no investment bankers, and circumnavigating the hair-raising fees a bank would earn is a bold statement for the entire tech industry.
Sidestepping the traditional process has ruffled some feathers in the financial industry.
The mere fact that Spotify has the gall to execute a direct listing is just the precursor to big banks being phased out of the profitable investment banking sector.
Goldman Sachs (GS) was the lead advisor on Dropbox's (DBX) traditional IPO, and it was a resounding success rocketing 40% a few days after going public.
IPOs are not cheap.
The numbers are a tad misleading because Spotify paid about $40 million in advisory to the big investment banks leading up to the big day.
This is about a $28 million less than when Snapchat (SNAP) went public last year.
Uber and Lyft almost certainly would consider this option if Spotify nails its IPO day.
Banks are being squeezed from all sides as nimble, unregulated tech firms have proved better adaptable in this quickly changing environment.
Spotify's business model is based on spectacular future growth, which may occur.
It is a loss-making company that produces no proprietary solutions but is overlooked for its valuable data.
The company is the market leader in paid subscribers at 76 million, far outpacing Apple Music at 39 million and Pandora at 5.5 million.
Total MAUs (Monthly Active Users) expect to reach more than 200 million users, and paid subscribers could hit the 96 million mark by the end of 2018.
Spotify's business model bets on transforming the free subscribers who use Spotify with ad-supported interfaces into paid subscribers that are ad-free. Converting a small amount would be highly positive.
Gross margin is a number that sheds light on the real efficiencies of the company, and Spotify hopes to hit the 25% gross margin point by the end of 2018.
I am highly skeptical that gross margins can rise that high unless they solve the music royalty problem.
Royalty costs are killer, forcing Spotify to shell out a massive $9.75 billion in music royalties since its inception in 2006.
Spotify is paying too much for its content, but that is the cruel nature of the music industry.
The ideal solution would eventually amount to producing high quality original entertainment content on its proprietary platform akin to Netflix's (NFLX) business model with video content.
Spotify's capital is being drained by royalty fees amounting to 79% of its revenue.
This needs to be stopped. It's a losing strategy.
Considering Google (GOOGL) and Facebook (FB) do not pay for their own content, it frees up capital to pile into the pure technical side of the operations, enhancing their ad platforms luring in new users.
This is why the Mad Hedge Technology Letter sent you an urgent Trade Alert to buy Google yesterday when it was trading at $1,000.
All told, Spotify has managed to lose $2.9 billion since it was created 12 years ago - enough capital to create a new FANG in its own right.
Dropbox was an outstanding success and attaching itself to the parabolic cloud industry is ingenious.
However, potential insane volatility should temper investors' expectations for the first day of trading.
The lack of a road show, no lockup period, and no underwriting or book building will sacrifice stability in the short term.
There is incontestably a place for Spotify, and the expected 30% to 36% growth in 2018 looks attractive.
But then again, I would rather jump into sturdier names such as Lam Research (LRCX), Nvidia (NVDA), and Amazon (AMZN) once markets quiet down.
The private deals that took place before the IPO changed hands were in the range of $99 to $150. Considering the reference point will be set at $132, nabbing Spotify under $100 would be a great deal.
The market will determine the opening price by analyzing the buy and sell orders for the day with the help of Citadel Securities.
It's a risky proposition that 91% of shares are tradable upon the open. Theoretically, all these shares could be sold immediately after the open.
Legging into limit orders below $140 is the only prudent strategy for this gutsy IPO, but better to sit and observe.
__________________________________________________________________________________________________
Quote of the Day
"One of the only ways to get out of a tight box is to invent your way out." - Amazon CEO Jeff Bezos
Mad Hedge Technology Letter
April 2, 2018
Fiat Lux
Featured Trade:
(WHY THERE WILL NEVER BE AN ANTITRUST CASE AGAINST AMAZON)
(AMZN), (WMT), (MSFT), (FB), (DBX), (NFLX)
POTUS's Amazon tweet of March 29 has given investors the best entry point into Amazon (AMZN) since the January 2016 sell-off. Since then, the stock has essentially gone up every day.
Entry points have been few and far between as every small pullback has been followed by aggressive buying by big institutional money.
The 200-point nosedive was a function of the White House's dissatisfaction of leaked stories that would find their way into the Washington Post owned by Amazon CEO Jeff Bezos, my former colleague and good friend.
Although there are concerns about Amazon's business model, notably its lack of actual profits, there is no impending regulatory action. And, if there is one company that's in hotter water now, it's Facebook (FB), which inadvertently sells every little detail about your personal life to third-party Eastern European hackers.
Amazon's e-commerce business does not violate the Federal Trade Commission Act of 1914 of "deceptive" or "unfair practices."
The American economy has rapidly evolved thanks to hyper-accelerating technology, and the jobs required to support the modern economy have changed beyond all recognition.
The Clayton Antitrust Act of 1914 addressing harmful mergers that destroy competition hasn't been breached either since Amazon has grown organically.
Analyzing the most comprehensive law, the Sherman Antitrust Act of 1890, which was originally passed to control unions, espouses economic freedom aimed at "preserving free and unfettered competition as the rule of trade."
And, in a way, Amazon could be susceptible, but it would be awfully difficult to persuade the U.S. Department of Justice (DOJ) Antitrust Division and would take a decade.
Amazon's business model will change many times over by the time any antitrust decision can be delivered, or even entertained.
Helping Amazon's case even more is the DOJ interpretation of the three antitrust rules. It is the company's duty to first and foremost protect the consumer and ensure business is operating efficiently, which keeps prices low and quality high. Antitrust laws are, in effect, consumer protection laws.
Amazon's e-commerce segment epitomizes the DOJ's perception of these 100-year-old laws.
The controversial part of Amazon's business model is funneling profits from its Amazon Web Services (AWS) division as a way to offer the lowest prices in America for its e-commerce products.
This strategy has the same effect as dumping since it is selling products for a loss, but it is not officially dumping.
POTUS has usually delivered more bark than bite. The steel and aluminum tariffs went from no exceptions to exceptions galore in less than a week. Policies and employees change in a blink of an eye in the White House.
The backlash is a case of the White House not being a huge admirer of Amazon, but individual government workers probably have Amazon boxes stacked to the heavens on their doorsteps.
It is true that Amazon has negatively affected retail business. It is doing even more damage to traditional shopping malls, which it turns out are owned by close friends of the president. The mom-and-pop stores have disappeared long ago. But Amazon could argue this trend is occurring with or without Amazon.
In addition, Walmart (WMT) was the original retail killer, and it currently is morphing into another Amazon by investing aggressively into its e-commerce division. Does the White House go after (WMT) next?
Unlikely.
Amazon didn't create e-commerce.
Amazon also didn't create the Internet.
Amazon also does pay state and local taxes, some $970 million worth last year.
Technology has been a growth play for years.
Investors and venture capitalists are willing to fork over their hard-earned cash for the chance to own the next Google (GOOGL) or Apple (AAPL).
Many investors do lose money searching for the next unicorn. A good portion of these unicorns lose boatloads of money, too.
Spotify, slated to go public soon, is a huge loss-maker and investors will pay up anyway.
Investors went gaga for Dropbox (DBX), already up 40% from its IPO, and it lost $112 million in 2017.
The risk-appetite is hearty for these burgeoning tech companies if they can scale appropriately.
Should investors be prosecuted for gambling on these cash-losing businesses?
Definitely not. Caveat emptor. Buyer beware.
It is true that Amazon pumps an extraordinary percentage of revenues back into product development and enhancement.
But that is exactly what makes Amazon great. It not only is focused on making money but also on making a terrific product.
The bulk of its enhancement is allocated in warehouse and data center expansion. Splurging on more original entertainment content is another segment warranting heavy investment, too, a la Netflix (NFLX). Did you spot Jeff Bezos at the last Oscar ceremony?
Contrary to popular belief, Amazon is in the black.
It has posted gains for 11 straight quarters and expects a 12th straight profitable quarter for Q1 2018.
The one highly negative aspect is profit margins. It is absolutely slaughtered under the current existing model.
However, investors continually ignore the damage-to-profit margins and have a laser-like focus on the AWS cloud revenue.
Amazon's AWS segment could be a company in itself. Cloud revenue last quarter was $5.11 billion, which handily beat estimates at $4.97 billion.
Amazon's cloud revenue is five times bigger than Dropbox's.
The biggest threat to Amazon is not the administration, but Microsoft (MSFT), which announced amazing cloud revenue numbers up 98% QOQ, and has grown into the second-largest cloud player.
(MSFT) is equipped with its array of mainstay software programs and other hybrid cloud solutions that lure in new enterprise business.
(MSFT) has the chance to break Amazon's stranglehold if it can outmuscle its cloud segment. However, any degradation to Amazon's business model will not kill off AWS, considering Amazon also is heavily investing in its cloud segment, too.
Lost in the tweet frenzy is this behemoth cloud war fighting for storage of data that is somewhat lost in all the political noise.
This is truly the year of the cloud, and dismantling Amazon is only possible by blowing up its AWS segment. The more likely scenario is that AWS and MSFT Azure continue their nonstop growth trajectory for the benefit of shareholders.
Antitrust won't affect Amazon, and after every dip investors should pile into the best two cloud plays - Amazon and Microsoft.
__________________________________________________________________________________________________
Quote of the Day
Having been in this market for yonks, ages, and even a coon?s age, I have seen trading strategies come and go.
First, there was the nifty fifty during the 1960?s. Junk bonds had their day in the sun. Then portfolio insurance was all the rage.
Oops!
While the dollar was weak, international diversification was the flavor of the day. After foreign stocks turned bitter, the IPO mania and the Dotcom bubble of the nineties followed.
Macro trading dominated the new Millennium until the high frequency traders took over.
What is the cutting edge management strategy today?
According to my friend, Anthony Scaramucci, of Skybridge Capital, activist shareholder trading now has the unfair advantage.
Anthony, known as the ?Mooch? to his friends, is so convinced of the merit of this bold, in-your-face approach that he has devoted nearly 40% of his assets to this aggressive posture.
That is no accident.
Have you ever heard the term ?unintended consequences?? Scaramucci argues that The Financial Stability Act of 2010, otherwise known as Dodd-Frank produced that effect with a turbocharger.
The Act brought in a raft of new shareholder rights intended to help Mom & Pop. But activist investors have, so far, been the prime beneficiaries of the reform, using the new regulations to shake down companies for quick profits.
Historic low interest rates are allowing them to leverage up at minimal cost, increasing their firepower.
These include known sharks (once spurned as ?green mailers?) like my former neighbor, Carl Icahn, and his younger, more agile competitor, Bill Ackman.
They can simply buy a small number of shares in a target company and demand a management change, share buy backs, the spinning off of assets, several seats on the board, and even making allegations of criminal activity, which are often unfounded.
A message from Icahn on the voicemail is not something management is eager to hear.
He even shook down Apple (AAPL) last year, with great success, harvesting a near double on the trade.
This is why names like Herbalife (HLF), Netflix (NFLX), and JC Penny?s (JCP) are constantly bombarding the airwaves.
The net result of this is that savvy activist shareholders have effectively replaced the traditional ?buy and hold? strategy as a way to add alpha, or outperformance.
This has enabled activist oriented hedge funds to beat the pants off of traditional macro hedge funds because many historical cross asset relationships they follow have broken down.
Tell me about it!
Suddenly, the world no longer makes sense to them and has apparently gone mad, at the investors? expense. Long/short equity managers, which comprise 43% of the funds out there, are also underperforming for the sixth consecutive year.
The activist managers themselves justify their often harsh actions by arguing that individual shareholders can ride to riches on their coattails. Shaking up management can result in better-run companies, even if it is at the point of a gun.
Activism accelerates evolution, breaks up clubby boards of insiders, and enhances the bottom line. Corporations can be forced to retool and restructure.
How does the individual investor get involved in the new wave of activist investors? The short answer is that they don?t. There are few, if any, such exchange traded funds (ETFs) in existence.
Doing the quantitative screens to generate short lists of potential activist targets, and then listening to the jungle telegraph regarding who is coming into play, are well beyond the resources of your average Joe.
You can try to give your money to the best activist managers. But they are either closed to new investors, or have very high minimum initial investments, often in the $1-$10 million range.
If you are lucky enough to get your dosh in, you will find the talent very expensive. Activist funds are one of the last redoubts of the old 2%/20% management fee and performance bonus structure. And ?hockey stick? bonus schedules are not unheard of.
When I ran my old hedge fund, we made 40% a year like clockwork. I took the first 10%, the limited partners the remaining 30% and they were thrilled to get it.
And you wonder why the small guys feel the market is rigged.
The activist trend won?t last forever. Interest rates will inevitably rise, making the strategy expensive to finance. If the stock market keeps rising, as I expect, then cheap targets will become as scarce as hen?s teeth.
Eventually, gobs of money will pour into the strategy, compressing returns as the Johnny-come-latelys pile in. In the end, trading around activist shareholders will get tossed into the dustbin of history, along with all the other investment fads.
Checking in With the ?Mooch?
It?s fall again, when my most loyal readers are to be found taking transcontinental railroad journeys, crossing the Atlantic in an a first class suite on the Queen Mary 2, or getting the early jump on the Caribbean beaches.
What better time to spend your trading profits than after all the kids have gone back to school, and the summer vacation destination crush has subsided.
It?s an empty nester?s paradise.
Trading in the stock market is reflecting as much, with increasingly narrowing its range since the August 24 flash crash, and trading volumes are subsiding.
Is it really September already?
It?s as if through some weird, Rod Serling type time flip, August became September, and September morphed into August. That?s why we got a rip roaring August followed by a sleepy, boring September.
Welcome to the misplaced summer market.
I say all this, because the longer the market moves sideways, the more investors get nervous and start bailing on their best performing stocks.
The perma bears are always out there in force (it sells more newsletters), and with the memories of the 2008 crash still fresh and painful, the fears of a sudden market meltdown are constant and ever present.
In fact, nothing could be further from the truth.
What we are seeing unfold here is not the PRICE correction that people are used to, but a TIME correction, where the averages move sideways for a while, in this case, some five months.
Eventually, the the moving averages catch up, and it is off to the races once again.
The reality is that there is a far greater risk of an impending market melt up than a melt down. But to understand why, we must delve further into history, and then the fundamentals.
For a start, most investors have not believed in this bull market for a nanosecond from the very beginning. They have been pouring their new cash into the bond market instead.
Now that bonds have given up a third of 2015?s gains in just a few weeks, the fear of God is in them, and dreams of reallocation are dancing in their minds.
Some 95% of active managers are underperforming their benchmark indexes this year, the lowest level since 1997, compared to only 76% in a normal year.
Therefore, this stock market has ?CHASE? written all over it.
Too many managers have only three months left to make their years, lest they spend 2016 driving a taxi for Uber and handing out free bottles of water. The rest of 2015 will be one giant ?beta? (outperformance) chase.
You can?t blame these guys for being scared. My late mentor, Morgan Stanley?s Barton Biggs, taught me that bull markets climb a never-ending wall of worry. And what a wall it has been.
Worry has certainly been in abundance this year, what with China collapsing, ISIL on the loose, Syria exploding, Iraq falling to pieces, the contentious presidential elections looming, oil in free fall, , the worst summer drought in decades, flaccid economic growth, and even a rampaging Donald Trump.
We also have to be concerned that my friend, Fed governor Janet Yellen, is going to unsheathe a giant sword and start hacking away at bond prices, as she has already done with quantitative easing (I?ve been watching Game of Thrones too much).
This will raise interest rates sooner, and by more.
Let me give you a little personal insight here into the thinking of Janet Yellen. It?s all about the jobs. Any hints about rate rises have been head fakes, especially when they come from a small, anti QE Fed minority.
When in doubt, Janet is all about easy money, until proven otherwise. Until then, think lower rates for longer, especially on the heels of a disappointing 173,000 August nonfarm payroll.
So I think we have a nice set up here going into Q4. It could be a Q4 2013 lite--a gain of 5%-10% in a cloud of dust.
The sector leaders will be the usual suspects, big technology names, health care, biotech (IBB), and energy (COP), (OXY). Banks (BAC), (JPM), (KBE) will get a steroid shot from rising interest rates, no matter how gradual.
To add some spice to your portfolio (perhaps at the cost of some sleepless nights), you can dally in some big momentum names, like Tesla (TSLA), Netflix (NFLX), Lennar Husing (LEN), and Facebook (FB).
