Did you see the strange story over the weekend that SpaceX (Elon Musk’s company) that aims to take the human race to Mars wants to drill for natural gas in Texas? It’s a strange one. The company finds itself in a dispute with a more conventional oil and gas company that claims ownership of the field. The Texas Railroad Commission (don’t ask me why) will resolve the dispute.
The story caught my eye because I’d also seen a tweet claiming that the market capitalisation of Tesla, another Elon Musk company, is greater than the S&P oil sector. That seemed well nigh impossible. True. Tesla has a market cap over $800 billion (around 75% of Australia’s entire GDP). But the oil and gas business is much bigger than the electric car business, right?
It turns out to be true, once you do a little digging. S&P and Dow Jones track an industry they call the Oil and Gas Exploration and Production Select Industry Index. It’s not ALL the companies in the US oil and gas sector. But it IS 44 of them, including household names like ExxonMobil and Valero Energy. These are not small companies.
Yet all 44 companies combined have a market value less than Tesla’s. And that figured directly into the subject I’ve taken on for the January issue of The Bonner-Denning Letter: Is this really the big Energy Transition everyone’s talking about?
It’s possible for non-profitable tech companies to go even higher
Are dozens — perhaps hundreds — of oil and gas companies (and tens of thousands of their employees) about to be made obsolete by a fundamental change in how the world produces, transmits and consumes energy?
If it were true, it would be the kind of trend that would lead to an epic trade. A trade that would last a whole decade (or more). A trade you could be on both sides of (long the new energy companies and short the old dirty ones). A trade that could make you more money than almost any other single investment over the next 10 years. But is it true?
Readers can find my answer next week, along with Bill Bonner’s latest Trade of the Decade. Bill’s Trades of the Decade do pretty much what it says on the tin. It’s one idea you can trade for 10 years. It’s designed to find something greatly overvalued or undervalued, and then watch mean reversion do its magic, raising the value of the underpriced asset/industry/stock or pruning the value of the overpriced asset/industry/stock.
His first Trade of the Decade was in 2000, long gold. That worked out well (in US dollars, it was an increase of around 300% over 10 years, from $285/oz in 2000 to $1,139/oz in 2010). He was ‘long’ Japanese stocks in the next decade but short Japanese bonds. That was a 50-50 proposition. Japanese stocks did alright. But the intervention of the Bank of Japan in the government bond market put a floor under bond prices.
What to do now after a 30-year bull market in bonds and negative real interest rates in much of the world? If financial asset prices take their cue from interest rates — rational investors comparing the expected return on stocks to the ‘risk-free’ return in government bonds — we have a problem.
Governments need to keep interest rates low to enable more borrowing, especially as the pandemic and lockdowns exact a huge economic toll on small businesses and renters. Rates may stay low for much longer than they naturally would.
Mr Market has thrown his lot in with the momentum traders and decided that equities — even those without a profit — are a better bet than fixed income in a world of artificially low interest rates. Better to go along with the trend, ride the momentum, and worry about earnings another day, Mr Market seems to be saying. Is he right?
It’s dangerous to think so. Goldman Sachs keeps track of 43 tech firms that have yet to make a profit. Led by electric car players Plug Power (fuel cells for electric cars) and Nio (a Chinese Tesla) the index is up 400%. Peloton, Pinterest, Roku, Snapchat Spotify, Lyft, Uber…it’s a who’s who of companies who’ve seen sales increase during lockdowns.
But not profits. Because apparently those don’t matter in the future. Or, more accurately, the present value of any future profits is very high in a low-growth, low-rate world. Investors seem quite happy to pay a steep premium for the chance to own a piece of a company that will be the foundation of a new world, with new energy and new technology and maybe even a new economy!
Or maybe this is the kind of thing that happens at the top of a cycle. Interest rate are low. Animal spirts are high. And so are valuations. At times like these, it takes a great story to capture the imagination (and the capital) of the public.
It’s no surprise, then, that the greatest storyteller CEO of all time is Elon Musk. He dreams big. And the public has fallen in love with his dreams. It’s a love story, with passion, belief and a lot of money at stake.
But if you keep your eyes on the prize and in the skies, make sure you keep your feet firmly rooted to the ground. Last March, margin debt in the US ‘bottomed’ at $479 billion. By December, it was up 62% to $778 billion. Remember, margin debt is money you borrow from your broker to buy stocks because you think they’re going up, using your equity or cash as collateral.
What would happen should stocks ever go down again (it’s possible)? A margin call is when you have to provide new cash to stay in a trade. You can take that cash out of the bank, if you have it. Or you can get it by selling something else. In a market-wide margin call, the most liquid assets get sold to raise cash quickly.
This is what happened in 2007. In fact, the last four times margin debt has grown this quickly have been followed by a market correction or a crash. In August 1973, stocks began a 50% correction. It was less severe in July 1983 (a 14% correction). But it also happened in March 2000 and June 2007.
If you have time and patience and plenty of liquid cash reserves, you can survive a ‘drawdown’ of 50%. Stocks, in the very long run, often bounce back. But as Lord Keynes said, in the long run, we’re all dead.
Your ability to withstand a big drawdown in the market depends on when you plan on retiring AND how much time it would take stocks to claw back their losses. Remember, a 50% loss requires a 100% gain for you to get back to where you were.
If stocks fall by half, they have to double to get back to the status quo before the crash. That DOES happen. The trouble is, history shows that when valuations are as high as they are now, expected returns in the future are low. Stocks are priced for all that future growth, right now.
With enough fuel — liquidity — it’s possible for non-profitable tech companies to go even higher. But losses can’t go to the moon, much less Mars. Watch for the insiders to sell. That will tell you that the jig is up. Or watch for space companies to start drilling for natural gas on their launchpads.
Editor, The Rum Rebellion