Summary
- The notion that profitless stocks should be avoided, no longer makes sense. The market has discounted them mightily, and 4% inflation - its effect on 50% to 60% revenue is minimal.
- We are likely at the bottom of this ersatz recession with minimal layoffs.
- We just have to tough it through this month, and October should get the bull started.
- My concern turns to mid-2023, where I think Dan Niles prediction of an S&P that breaks 3600 (he says 3000) might come to pass.
You’ve heard dozens of times now, “sell all profitless hyper-growth names”. It’s time to re-assess.
Why has it worn out its usefulness? Does this notion bother you? That is your first clue. There is a reason for taking a contrary approach and applying a skeptical analysis to “accepted wisdom”. A key point to making this switch is when every market participant repeats the same mantra. Odds are, it is rapidly becoming obsolete. In this case, whether you feel that inflation is still going higher, and disbelieve the new emerging facts or not, at some point the value of rapidly growing companies which by necessity must be highly successful will reassert itself as a wise investment. Of course, companies that are buying market share with equity raises are as doomed as ever. I am not talking about those or other types of zombie companies. Let’s also say that the notion of “profitless” is really over-broad. There are plenty of companies that are taking free cash flow and reinvesting it back in their business. In the tech world, gaining share now is more important than showing a profit. That aside only the most obstinate will insist that inflation is not subsiding, the fact is, supply chain kinks are coming out of the economy. There are few areas such as rents are still stubbornly high, yet overall it is pretty clear that the rapid rise in interest rates and the artful (or perhaps purposefully blunt) jawing of the Fed put fear into corporate America. Hiring has slowed, and the “Tech Titans” and their contenders are reversing their ravenous consumption of technology personnel. This has led to a great reshuffling of that talent as it spread to small and midsize enterprises, where it can play a more productive role in bringing them into the digital age.
Alas, good news is now the bad news
On Friday, we had a very good employment number at about 350,000 new jobs, and the unemployment rate rose by 3.7%. Last month was 3.5%, so wasn’t that bad news? No, because the unemployment number counts the number of people looking for work, so in this case, more people are coming into the workforce, with the 60 to +64-year-old cohort coming back into the workforce. Contrary to public opinion, the older aged workforce can be extremely productive. Also rising were the first-time jobseekers - this was very good news indeed. Average hourly wages came down a bit and as workforce participation accelerates, wages will continue to moderate.
What does this mean for high-growth unprofitable stocks?
The notion that wages, one of the largest motors of inflation coming under control, and the other data points indicate that we will level off on inflation. 4% happens to be the consensus of where inflation should move to, shortly. Let’s dwell on that for the moment. Let’s take MongoDB ( MDB ) for an example; Revenue soared 53% year over year in the second quarter, driven by the sizable 73% growth for Atlas, MongoDB's fully managed cloud-based database platform. Atlas now accounts for 64% of total revenue, with the rest coming from enterprise-focused products and services. Atlas subscription model as it grows will contribute mightily to profit visibility. So let’s play the “Long Duration and Inflation” game. Inflation will be at 4% by year-end, let’s say it takes another eighteen months to get back to two percent. In 18 months, MDB growing at 53% will easily cover the 6% to 8% ding to profits. Will we see profits in 18 months? I hope not, but I definitely am confident there will be free cash flow. You see, MDB is at the center of digitization. The move of legacy applications stuck on the Mainframe. This is easily a trillion-dollar (yes, with a "T") market opportunity. It would be the height of foolishness for the executive management of MDB to throttle back on that growth. Will MDB capture it all, obviously not, there are other platforms out there. Will MDB be the next Microsoft ( MSFT ), that’s not conceivable right now. That’s not to say that it is inconceivable, meaning there is another MSFT, or GOOGL out there. Why would a Snowflake ( SNOW ) or an MDB ease up on that mission to satisfy the purveyors of value stocks or some talking head that is looking backward instead of forward?
The recession will end before we even really notice it if it ever really was a recession.
What do I mean by that? Everyone knows it is 2 quarters of negative growth. Though, there has never been a recession that didn’t have massive layoffs. It is likely, as I have been saying, that the big enterprises were hoarding tech talent. That is where the biggest growth in salaries is to be found. So now the big boys have stopped hoarding talent, a lot of that talent doesn’t want to sit in the office anyway. Which is where a lot of the big companies want their people to be. Smaller mid-sized companies will be only too happy to get their hands on that remote talent. That will fire up the lagging productivity numbers we’ve been having, and voila! More productivity means even less inflation. Last November was the peak in the market, and we experienced a long slide down as the stock market got busy discounting inflation and what we now know was a recession of some sort. The graph below is a great illustration of what is likely to happen next.
If you start the above with the market peak aligned with November there’s nearly a perfect alignment with the rest of the cycle, are we at the absolute bottom? Good question, Dan Niles, a hedge fund god whom I admire greatly, expects a crash down to 3000 on the S&P. I don’t see that now. It could happen next year, when all of these rising rates might really take the economy by the throat. However, right now and until the end of the year, I believe we are nearing very strong support from market participants. Where will they gravitate to in a slower-paced economy? Not the cyclical value names, though, this could very well be an “everything” rally. I believe they will start picking up the SNOW and MDBs of the world. I also think that all these foundries being built will need the machinery to turn out those chips that run everything. Select chip stocks which are the equivalent to the transports of the last century will also be in demand. Let’s not forget the energy stocks, which will still benefit from $90 to $100 WTI. I sense good times ahead once again. That does not mean that you eschew hedging, husbanding your cash, and making select shorts (either via puts, or simply shorting). I did a lot of that this week.
My Trades
Long EA Put 131 strike Sept 02 @ $1.4 closed $2.35
Long Put BBY 75 strike Oct 21 @ $6 Closed at $8.45
Long Put CHWY 30 strike Oct 21 @ $1.95 closed at $2.30
Long Put BBY 72.5 strike Oct 21 @ $4.90 closed $5.50
Long Put NCNO 35 Strike Oct 21@ 3.60 closed $5.10
Long Put SQQQ 42 Strike Sept 23 @ 4.2 per contract closed $2.73 (loss)
I felt confident that we were in a bearish phase, so looking for short opportunities was relatively easy. In many of these names, the stock actually popped on bullish news. Serop ElMayan, our options guru at Dual Mind Research inspired this tactic, and I am making full use of his insight. I also had several hedges going on with SQQQ, SPSX, and SARK which I held intermittently this week, but closed out before the weekend with minimal gains.
I am sure it won't surprise anyone that I have been picking up shares of MongoDB. I have not gotten to SNOW as yet, however, if the market opens down tomorrow, I will be sure to get back in and this time I think I will hold onto it. Expanding on my interest in biotech, I started a position in Veeva Systems ( VEEV ), also added to Seagen ( SGEN ), and blue bird ( BLUE ). I sold down a lot of my energy names in my trading account, not because I am less confident in the sector. I did so because I would rather hold the cash. There is nothing wrong with taking some profits as well. The Oil companies have held up very well compared to the actual product, though if some of these quality names do fall hard I will gladly add some back, I haven’t touched my long-term investment in Devon Energy ( DVN ), Apache ( APA ), Coterra ( CTRA ). I will continue to hold them. I have been adding back my Amazon ( AMZN ), and Alphabet ( GOOGL ), as they have been falling. Contrary to some negative comments about not timing stocks, I guess I have been lucky selling AMZN and GOOGL at higher prices and slowly adding back to them now. In fact, I believe that timing the market is something that has been quite successful for me and my friends in the DMR community. So yes, if you put in the research work to measure the market’s temperature it is possible to skate where the puck is going, not where it was.
For further details see:
Selling High-Growth Profitless Stocks Now Is Dumb, Here's Why