The (un)surprising cause of the next financial crisis.
You know that it is coming, you just don’t know how … The next financial crisis.
Most predictions agree on the timing (2019 / 2020) and that it will be one of the deepest crises in the world history (the economy has been growing consistently for 10 years now), but no one can predict how it will happen. Knowing that, of course, would be priceless. Traders and hedge fund managers who took the ‘right side of the trade’ and bet against the 2007 subprime crisis made hundreds of billions over night. Jon Paulson and many others got famous and (even much) richer.
Crises are certain; they are inevitable like death and taxes because the world economy is based on the concept of greed. Human greed is good — it is what drives the economy up … and then gets it going again after it falls over the cliff. It is a necessary substance; a serum and a poison in one.
It was in the U.S. that greed got reinvented as a good thing. That is, it was the new world that injected poor immigrants with the idea of American dream and made money into a universal merit of success. And ever since it has been the U.S. that gave the world market bubbles. Last time it was the subprime mortgages and derivatives that no one understood; this time it is the tech sector.
There are two sides to the tech sector. Facebook and Google are what Standard Oil Co. Inc. was at the beginning of the 20th century—a well tolerated monopoly. Together with Apple, they form the ‘old’ side of the tech sector — the one that actually makes money … and tons of it. But beyond that,there is the utopian tech sector. You know: Silicon Valley, its millennial founder-entrepreneurs, with zen-like smiles, enlightened modesty and open shirts. So very unlike the old world dominated by Wall Street, they and their tiny little start-ups inspired the beginning of the present economic recovery by promising to create an infinitely more efficient and cleaner way of doing things, exchanging factories and steel for smartphones and abstract products.
Three companies — Amazon, UBER and Tesla (ATU) — are a perfect embodiment of this trend. To some extent, ATU are truly revolutionary — making our lifes cheaper (Amazon), more practical (UBER) and exciting (Tesla) — but for the most part, people love them because they are a sensation.
Good enough is just not good enough when it comes to financial markets. People don’t want to be told that they should stick their savings into a 1.5%-yielding super-slow-growing annuity. No, we all want our chance at becoming millionaires, and if that requires us to chase a sensation, then so be it. This is not to say that UBER hasn’t changed the urban transportation for good, that Tesla doesn’t make innovative cars, or that Amazon doesn’t offer convenience and price that others can’t match. No. The problem is that somewhere down the line, ATU have become a religion of future and people forgot to value them on the cold basis of profits & losses. Somewhere down the line, ATU freed themselves from the dryness of discounted cash flow analyses, and they took the whole market with them on a trip to forever.
Amazon — a nightmare of the old-industry CEOs — continues on its path toward the world domination because it can afford to reinvest everything it makes and more*. It is a company doomed to die. For now, the world is still large enough. Amazon can keep on growing, expanding into other sectors and devouring its competitors. That, of course, makes it into an irresistible investment proposition — a company on a path to become the ultimate monopoly; the one place where we buy everything. Inevitably, though, it will reach a point when it will grow too big. It will either have to be cut in pieces by the government labelled as a ‘monopoly’, or it will be re-priced by the market, increasing its cost of capital because the promise of further growth and domination will make no sense anymore (people will begin to ask for a profit eventually).
*Amazon is a life work of an ex-hedge fund manager (who else better to trick investors’ minds) — a company which functions like a perpetuum mobile. Jeff Bezos has once drawn his Amazon flywheel concept on a napkin. Lower prices lead to more customers, which attract more outside sellers to Amazon, who should be OK with smaller profit in order to be able to sell on Amazon. Reinvestment of all profits improves company and reduces cost leading to lower prices again in a vicious endless circle. One arrow is missing — that arrow going out: ‘profits to shareholders’.
UBER — a clever, but first and foremost a cheaper way to do urban transportation. A company that has burned through billions of private money to become the one and only player in the business that it created — intelligent transportation. But, for all its dominance, UBER is facing a ‘Groupon moment’. Its technology is becoming commoditized and re-used by cheaper alternative providers.
Tesla — This one is easy. A tech company on a mission to beat auto industry on its home turf. Tesla burns cash at a breathless pace in a race against time to get its Model 3 production fully running before other giants enter the space with better alternatives. Blessed by what has been until now an inexhaustible level of positive investor sentiment, the company’s plans are truly colossal, but the last estimates show that it will burn through its cash reserves by the end of this financial year. If Musk is forced to go to financial markets asking for money again this year, it could be a make-or-break moment for Tesla.
People always fight the last war. Scarred by 2007, investors are looking for the next big short; the next Collateralized Debt Obligation, or other structured product that could bring the markets down. There might not be one this time round. All financial crises are caused by some sort of a market bubble; a situation when prices overshoot value, which eventually leads to an ‘aha’ moment and a downward spiral. ATU and other utopian tech companies have infected markets with a profound belief that they are about to revolutionise world. This made them into cash-burning giants with a zero cost of capital. And that’s fine for now. But, their eventual (and unavoidable) collapse may prove to be systemic, dragging down the market, not because of their size (which is insignificant), but because investors will reprice the market, taking the promise of infinitely more efficient tomorrow out of the equation.
See you on the other side,