Over the past several years, I have encountered a wide variety of forms of excessive risk. These risks have manifested in a variety of ways, from the gross overvaluation of companies to businesses being able to borrow money at virtually no interest rate whatsoever, to the propagation of concepts such as cryptocurrency and other digital “assets.” I have watched these ideas taken to levels of excess that I have to admit, have been well beyond what I anticipated. I suppose it is difficult to fully capture to what extent a person is willing to go in the name of greed. I also believe it is this greediness across the spectrum of investments, from equities and debt to speculative constructs that do not exist in the physical realm, that has led us to the point we are at now in the bear market, where enough pressure from enough sources is resulting in a shakeout of excessive risk-taking across the board. I am calling this the “Great Reset,” because what is happening right now is a reset of an understanding of risk, reward, and underlying expectations for the entire market.
When I look at how the equity market has behaved the last several years, one of the first companies that comes to mind is Netflix. Fueling its content growth and subscriber growth with debt, it leveraged cheap capital as a means of hyperscaling their business into such a dominant force, that no company would dare attempt to compete in their space. The problem with that logic was as clear to me six years ago, when I first started my official career in this industry, as it is to me today – Apple exists, Amazon exists, CBS Viacom and Disney and Hulu exist, and the list goes on. Even back in 2016, Apple could choose at any point to double the Netflix content spend while using only one-fifth of the company’s profits, and they could lay siege like that for years and years and years. No debt, just organic growth and reinvestment. Without other deals and platforms, the only way Netflix could possibly keep up with that is to either raise prices, give up its platitude of “no ads,” or raise more debt.
It turns out that they needed to do a combination of all three – but it is not because Apple alone competes with them. All those other players decided that what Netflix was doing was lucrative, yet not terribly special, and could over time either be replicated through technology of their own, or through leveraging various platforms to house their content without the licensing component. At the end of the day, Netflix has had a small moat, with nothing terribly compelling about its service, that has been entirely unable to grow into an entity that can stand on its own two feet, so now it is getting crushed. The world has run out of people for them to scale into, the pricing lever is not a “go up forever” mechanism, the cost of content increases as more competitors enter the space with large wallets, and 200 days later the stock now trades for 25% of what it did back on November 16th.
Netflix is not the only cautionary tale about debt-fueled business structures, so-called “hyper growth,” and the lack of acknowledgement of economic gravity. Tesla is quickly realizing that it is difficult to build a car consistently well; their stock has been sliced by nearly half while they go through a combination of layoffs and stock split tactics in an effort to buoy their company’s valuation. Rivian, another electric vehicle manufacturer (sort of), was valued at one point higher than the Big 3 automakers COMBINED, and they had not even produced their first vehicle yet. That stock is down 84% from its peak, now having produced a whopping 3,568 vehicles as of April this year. Snowflake, a cloud computing data storage company, is down 71% and the company does not make any money. Palantir, a data analytics company, has been in operation for nearly 20 years, has lost over 80% of its value, and the company has NEVER BEEN PROFITABLE. Carvana, another entirely unprofitable company, has lost over 90% of its value. And then you have special purpose acquisition companies, or SPACs, which have gathered businesses which would have otherwise be traded on pink sheets at best, dossie them up as quasi-legitimate businesses, and attempt to package them as “the next big thing” through an IPO, in spite of most of these companies having treacherous balance sheets. There has been so much excess, so much speculation, so much greed and losses involved investing in companies with these incredibly shaky business models and (lack of) fundamentals.
But what has allowed these conditions to exist?
Persistent loose monetary policy has enabled and fueled it. For nearly fifteen years, we have had a debt market that has offered virtually no yield. With the Fed Funds rate at near-zero for so long, the cost of debt to risk-takers has been negligible, hence the gluttony on the risk-taking side. Why worry about risk when banks and private equity will deliver truckloads of money, hand over fist, at the smell of anything that resembles an investment? And the banks themselves have plenty to gain in the advisory fees not only to make these loans, but to enable this type of dealmaking, to encourage this sort of behavior and to profit from having encouraged such. Charlie Munger has referred to this behavior as “wretched excess,” and after serious consideration I cannot come up with a better phrase to describe it.
And while it has been nice for those with resources to receive incredibly favorable terms, it has cost the general public in so many ways, from an inability to use savings accounts to earn interest, all the way to bailing out the airlines. Boeing, prior to the pandemic, already had $100 billion in debt and liabilities. Boeing had the audacity to approach the U.S. Government in March of 2020 to ask for a $60 billion bailout. The whole idea that the American public should be footing the bill for Boeing’s excess, Boeing’s poor management, is asinine. The Federal Reserve couldn’t help but intervene; they decided to financially back the corporate bond market through purchases, which allowed Boeing to take out $25 billion more in private loans. Boeing now sits with $208 billion in debt and liabilities, a completely unprofitable business, and if the company folded now none of its shareholders would see a dime as the book value per share currently is -$26 a share and would only fall further in a fire sale. In my opinion, this company should have been forced into Chapter 11 bankruptcy. Its creditors should have either been forced to negotiate or the company be liquidated. The creditors should have been punished, not rewarded, for creating and accepting such loose debt terms. Instead, government intervention rewarded the creditors and Boeing for their greed, and the American people once again footed the bill as it was touted once more as a “too big to fail” scenario.
Cryptocurrency has been no exception to any of these themes. When the vast majority of the people using these platforms come from low GDP per capita, unstable parts of the world, there is likely a Ponzi scheme occurring. These people, fueled by personalities such as Elon Musk convincing them that this “is the future” and that they too can “go to the moon” in wealth buying and holding these special digital coin as long as they have “diamond hands” and keep “HODLING.” Falling 67% since its November high, companies left and right are being forced to liquidate assets as they borrowed against this “asset.” Entire cryptocurrencies have begun to fail as confidence wanes. Crypto is a con. The Ponzi scheme is reaching a breaking point, and it is this author’s hope that sooner rather than later, the asset class collapses and we can move on from the Tulipmania that has existed for over half a decade with respect to crypto and other digital assets. Gary Gensler, head of the SEC, and other lawmakers have also worked to establish policies that perpetuate this con, something that both the Chinese and Indian governments had the courage and good sense to outlaw. Our elected officials and regulators did not have that resolve, and we suffer as a country for it.
This is what free money does. It enables greed and fails to punish poor decision making and bad behaviors. It rewards misrepresentation, it rewards people making money conning their friends and family, and ultimately it leads to where considerable pain is inflicted across the entirety of the market, irrespective of what you are invested in. Contrary to the narrative distributed by much of the media, this is not something that happened purely because of stimulus, or Ukraine, or any other one-off cause. These conditions are the culmination of years of excessive risk-taking in every direction, fueled by extraordinarily cheap leverage.
In the years leading up to where we are at now, it has been survival of the unfittest.
The good news for long term investors, who have been focused on fundamentals and respected risk-reward and risk management, is that while quality companies and assets can fall alongside their lesser quality peers, the higher quality companies not only tend to recover with greater strength of value, but have likely used the downturn as a means of either acquiring market share from competitors or outright acquiring competitors to make their company stronger. This has been our approach for the last several years – to respect what we don’t know such as timing inflation or interest rates, to understand when one is likely paying too much for any asset, and to be patient even in the face of hysteria. And while there is pain now in the short-term, as this prolonged shakeout occurs, I believe we end up with much stronger businesses and stronger long-term investment prospects for it. It just requires patience to allow what is currently happening to see itself to completion.
How we make money matters. How wealth is built matters, and we are seeing that play out in real time.
The Great Reset has begun.