Posted May 13, 2021
By Sean Ring
More Inflation, Cathie Wood’s Ark Gets Hit, Elon’s BTC WTF?
I’ve died and gone to Memeland. It’s been a stellar few days on social media. The memes are worth the price I had to pay for it, which is arguing with Biden supporters over just how much regret they’re feeling right now.
So let’s start today’s Rude with some Grade A dopamine hits.
Lumber still climbs, Breaking Bad-style…
“Democracy is the theory that the common people know what they want, and deserve to get it good and hard.” - H.L. Mencken.
Have we hit 4% inflation? Already?!?!?!
Consumer prices jumped 4.2% year-on-year for the first time since 2008.
Less than a month ago, Jared Dillian of The Daily Dirtnap, called 4% inflation but said it would take a year. Genius moves quickly, it seems.
Now he says to watch out for 10% next year. I think he’s right. And I think it’ll get here quicker, again.
Jay Powell cannot control inflation any more than King Canute could control the waves. At least King Canute admitted and demonstrated his lack of control.
Jay Powell is starting to sound like a clueless academic who dropped helicopter money but thinks he can somehow claw it back.
That’s not how it works, Jay.
Jay will see, sooner or later. Probably sooner.
As for what to do in this Confederacy of Economic Dunces, here are two great charts, courtesy of the WSJ:
Now you can see why my colleague Jim Rickards and I like gold so much. It just hasn’t moved as much as other commodities, such as copper, corn, and lumber. We think it’s primed to move, considering the lightning-quick inflation spike. When gold gets going during inflationary periods, it outperforms stocks and bonds by multiples.
Our next chart looks at producer prices for manufacturing versus consumer prices. As producer prices lead consumer prices, we can see a sharp price increase for manufactured goods for end users coming soon.
So our inflation thesis looks sound.
Another notch in our favor is the trouble tech stocks and funds are having.
Cathie’s Ark Hits Macro Headwinds
We’ve not talked about Cathie Wood in the Rude yet, and it’s high time we did.
Wood is one of the most successful fund managers over the last few years, riding the tech wave like a Hawaiian surfer through the Bonsai Pipeline. It has been an impressive run, and she deserves every bit of credit she’s been given for her excellent performance.
She’s made bold calls on Bitcoin ($50,000) and Tesla ($4,000 on a split-adjusted basis) and was vindicated on both.
Wood runs Ark Investments, a firm she founded in 2014 after her old bosses at Alliance Bernstein thought her buying edgy technology companies was too risky for them.
But Wood’s funds at Alliance Bernstein underperformed during the financial crisis, and she’s now facing the same set of macroeconomic circumstances as she was then.
In general, tech stocks get hit hard during inflationary times, as higher interest rates, labor costs, and materials costs crush growth. Growth is a critical component of pricing tech stocks, so when it gets hit, the stock price falls disproportionately.
I’ll oversimplify this a bit, but it’s still useful to see how the math works.
Let’s take a boring old brick-and-mortar company that expects a cash flow of $1,000,000 per year for the next 5 years. Let’s also say rates are at 2%. It expects to experience zero growth over the next five years. What is that company worth?
It’s worth roughly $4,713,459.51.
Let’s take the same boring company, but now let’s imagine rates doubled to 4%. All else being equal, what’s the company worth now?
Now it’s only worth $4,451.822.33. That’s a 5.55% drop in value. Keep that percentage in mind.
Now let’s look at a high-flying tech company. The cash flows are growing 10% per year. The discount rate is still 2%.
This company is worth $5,733,606.58. That’s what growth does for you!
No, imagine we have an inflation shock, where rates double to 4% again. Addtionally, growth goes to zero for the next five years. What’s the company worth then?
The company dropped to $4,451,822.33. That’s a 22.36% drop in value, over 4x the 5.5% drop the no-growth stock experienced.
So there are a few things we can deduce from our oversimplified case.
- “Boring” companies must pay dividends to make up for their lack of growth, but do not fall as sharply during downturns.
- High-flying tech companies are not islands unto themselves. They must worry about macroeconomic headwinds even more than older, more established companies.
- A drop in expected growth hammers growth stocks.
- Increases in interest rates hurt all stocks, but some more than others.
- Small rate rises from a low base hurt more than rate rises from a higher base. That is going from 2% to 4% doubles your interest rate. But going from 10% to 12% only increases rates 20%. We’re in a very low rate environment, which is why rate rises hurt more.
Again, this is just to demonstrate what’s happening to the tech sector. And that means Wood will just have to take it unless she changes tack.
Of course, Wood shows no sign of that. She’s sticking to her guns and calling this pullback temporary.
Her investors don’t seem nearly as optimistic as she is:
Elon Musk just sent out a tweet that blew up the internet.
I bet Elon isn’t giving back that $101 million profit on Bitcoin, though. TSLA still has $1.3 billion in digital assets on its balance sheet, so there’s that.
The Winklevii, of Facebook, The Social Network, and Bitcoin fame immediately shot back:
After getting crushed, Bitcoin has recovered somewhat, just under $50,000.
I don’t have all the information on the energy Bitcoin takes to mine, but I think it’s rich that suddenly Elon’s worried about it. I mean, isn’t he in the renewables business anyway?
Why the sudden pullback after agreeing with @jack of Twitter that Bitcoin will be a crucial driver of renewables for years to come?
And finally, I think Chamath looks great with long hair, as does the Twitterverse:
But that’s not going to be you, because you know better and will act!
Friday is coming quickly - only one more Rude for the week.
I’ll see you tomorrow for a week ending caffeine special.
Until then, all the very best,