Amazon Next Big Short

Amazon: The Next Big Short?

Yet another week when a “Trump news event” moves markets. In the backdrop of a burgeoning trade war with Europe, Jean-Claude Juncker, European Commission President made a trip to the White House. Concessions were made (as if the leaders had a choice) and risk assets rejoiced. We can’t imagine that risk assets have been “restrained” by trade war fears (come on, the Nasdaq is up almost +20% over the past four months), but stocks jumped again on easing trade tensions. Almost any news boosts stocks in a bubble. The other big news item this week was Facebook’s negative guidance. Yep, “Dump Facebook” is hitting user growth. In any case, Facebook must be getting close to market saturation. When grandmothers start getting on Facebook, the hip youngsters will leave Facebook (which will become uncool) for another social media. Thursday after-market, Facebook reported disastrous second-quarter results that sent the stock tumbling to its largest one-day loss in market value by any company in U.S. stock-market history. A loss of -20% for the session. Oh, and Facebook insiders sold more stock than usual in the second quarter, with top executives dumping 13.6 million shares. As we wrote in last week’s Commentary, companies are buying back shares on the market while the company insiders are personally dumping their shares. And you don’t think these markets are rigged? Just to confirm Facebook was not a one-off. Twitter also announced a slow-down in growth, with Twitter shares plunging -20% on Friday.

On the macro front, we saw a light week. Existing home sales eased in June, -0.6% and worse than estimates for a +0.2% progression. New home sales retreated significantly, -5.3%, again worse than estimates for a -3.1% decline. Wholesale inventories and durable goods both disappointed consensus estimates. The former was flat for June (vs. +0.3% expected) and the latter only rose +1% in June (vs. +3.0% expected). The Q2 GDP revisions for the U.S. were revised up to +4.1% (versus +2.2% at the initial estimate). This was the best quarter for U.S. growth since 2014. Naturally, Trump jumped on this number, proclaiming “We’re going to go a lot higher than 4.1% GDP growth”. Something unsettles us in Trump’s reckless over-confidence, but we’ll see. In any case, nothing tells us this week that the U.S. economic expansion set to weaken.

Big Short, The Sequel

In 2007, several astute investors/analysts sniffed out the impending crisis in Subprime debt. Those who bet on the collapse of Subprime made fortunes, as portray in the film The Big Short. Guessing what asset class is the next to blow up is not easy. Or rather it is easy to identify dangerous assets, but the timing is nearly impossible. An example of this is the VIX. For the two years prior to February 2018, the VIX volatility index set records, holding at historical lows for such an extended period. We all knew that volatility had to return to the markets, but almost all traders who attempted to go “long vol” got wiped out. The lucky few who were positioned long vol via the ETFs at the end of January 2018 scored +90% gains on their positions.

If there is one asset class that is candidate for the next blow-up, it is big tech. Of course, technology shares already experienced a bubble in 1998-2000, but most folks on the trading desks today are too young to remember the Tech Bubble. Perhaps past will be prologue. We can’t be systemically negative on technology companies, because many of these companies are transforming society with their innovations (most would argue for the better). However some company share prices clearly don’t reflect the value-added by these companies for society. Facebook and Twitter are perfect examples, and their share price collapses this week should not be a surprise (and for free market people, such as ourselves, the price drops were welcome).

Another company that we would classify with Facebook and Twitter is Amazon (AMZN). Amazon’s valuation is ridiculous, with a forward P/E 74x earnings (trailing P/E is 184x earnings, reflecting how euphoric earnings estimates are for Amazon). This week, Amazon missed on Q2 sales ($52.9B vs estimate of $53.4B), but EPS doubled analysts’ estimates ($5.07 vs estimate of $2.50). Of course Amazon’s shares soared, but astute investors must be wondering how a company can report such strong EPS growth as company revenue lags. Oh, accounting trickery never ceases.

We have two problems with Amazon: (1) the stock price and (2) the vulnerability of its business.

Price. As mentioned, a trailing P/E of 184x just gives us flashbacks to the Tech Bubble. Amazon is over-owned – almost no investing household in the U.S. does not have some exposure to Amazon, if not indirectly via its 10.3% weight in the Nasdaq for passive investors.

The chart of Amazon below is just absurd. Like a slow-motion car wreck. If you don’t see the postlude of this chart, you should not be investing.

Amazon chart

Vulnerability.

Short-term, Amazon faces headline risk. Donald Trump hardly hiding his desire to “punish” Jeff Bezos, whose success rivals (and exceeds) that of Trump. Each time Trump tweets on Amazon, traders use the tweet for profit-taking. Trump’s latest gripe against Amazon is that the company uses the U.S. Postal Service as its “delivery boy” and does not pay a fair price to the postal service. Probably not true, but this is headline risk. Expect Trump to invent more reasons in the future to attack Amazon and Bezos.

Longer-term, the real worry we have with Amazon is new legislation to level the playing field between online retailers and brick-and-mortar retailers (or mom and pop business, as politicians seeking new regulations will refer to traditional retail). Amazon is just a warehouse. They are a middle man in the retail world. Unlike Apple Stores or many clothing retailers, who produce the products that they sell in their retail outlets, Amazon produces nothing. Amazon’s business plan is simply to undercut traditional retailers and drive them out of business. Not much unlike the Wal-Mart business model. While society has pushed back against Wal-Mart, notably for its cutthroat dealings with suppliers and unfair labor relations, Amazon still has a positive image – generally- among the public. Many people go to Best Buy, Amazon’s showroom, to see and touch the product, before going home to order from Amazon, with free shipping. Huge savings for the consumer. And who does not like saving money.

The problem is, once the competition is out of the way, who does not think that Amazon will raise its prices and profit margins. Sounds like a monopoly in the making, no? And what do good governments and politicians do to monopolies? R-E-G-U-L-A-T-E. And that is the big risk for being a long-term investor in Amazon.

We foresee an “internet equality” tax proposal in the near future. For the moment, inter-state sales by Amazon avoid most state sales taxes. Expect politicians in Washington to create a tax that levels the playing field, and final price to the customer, between Amazon and mom & pop retailers. With Trump at the helm, a tax on on-line retailers would definitely be something that he’d push for.

Conclusion

We are not recommending outright short on Amazon here. No one can guess when the Amazon bubble will burst. But we do recommend getting out of long positions and Amazon and even index funds with high weightings to Amazon. When the Amazon price bubble bursts, it will be as quick as Face Book and Twitter this week. Traders can use bearish put spreads with Amazon at these price levels.


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