Beware the Naked Companies

By Rodney Johnson

The markets peaked in early October, and since then something remarkable has happened. Investors have lost their drive to buy-the-dips!

Instead, we’ve transitioned to sell-the-pops, and that’s not a good sign.

For decades, investors typically drive stocks higher after a week of losses, treating such pullbacks as a chance to buy good companies at a discount.

In the years when that wasn’t the case the markets fell into bear territory, which makes sense. If investors aren’t willing to buy as stocks sink, then by definition equities will fall further.

This is interesting because the economy is humming along just fine. Unemployment remains historically low, interest rates are low and it looks like the Fed will hold off after December, and GDP, while not great, appears to be on track for 2% to 3% growth. We’re sort of back to the muddle-through economy that we’ve had since the Financial Crisis.

But that misses one big point…

Since the downturn in 2008 and 2009, the equity markets are up 250% to 300%, while the economy has expanded by just 50% in total.

The difference in growth rates meant that, at some point, something had to give.

Either GDP was going to rocket higher, justifying such lofty valuations, or stock prices were going to fall. Well, GDP isn’t at risk of shooting to the moon, so it looks like we’re in the midst of pullback.

Whether we’re on the cusp of simple correction or headed for a full-on bear market remains to be seen, but one thing seems obvious. The psychology has changed. We’re no longer pouncing on falling stocks like vultures. We watch stocks fall and then, nothing. We let them fall again. It’s as if we’ve had our fill and simply lost our appetite for risk.

As we look forward to 2019, I have a word of advice…

Avoid naked companies

I’m not talking about firms with no clothes, or those in questionable industries. I’m referring to those lofty, pie-in-the-sky estimate companies that are devoid of earnings but command nose-bleed valuations.

As we look to 2019, several of these firms are making plans to go public, which could turn out disastrous for everyone involved.

Tops on the list are Uber and Lyft, the ride-hailing companies that operate illegally in most areas. These firms look like transportation companies, they operate like transportation companies, and they connect travelers with drivers willing to transport them for a fee like transportation companies. But to avoid all that sticky red tape, regulation, and taxes, these firms claim to be mere software firms.

Right.

They’ve ramped up ridership by offering services at less than what it costs to get people from here to there, which is fabulous for booking rides, but it’s a sucky way to reward investors. While still private, these companies have commanded huge valuations, with Uber valued at $120 billion in its last financing round.

But things might be changing…

Recently I read an article about Uber’s push to go public next year. On the opposite page was a story about scooter companies hemorrhaging cash because people vandalize and steal their equipment, and the average use of a rented scooter doesn’t pay for the unit before it wears out anyway.

These two things – Uber and scooters – are connected. Uber knows it doesn’t make money off of its cab, er, software offering, but it points to other services that could actually generate cash, such as freight logistics, food delivery, and, you guessed it, scooter rentals.

We might also see WeWork, the co-working space that appeals to Millennials, go public next year. The company doesn’t issue financial statements, but its valued in the billions and uses debt to sign long-term leases on office space around the country and then fills the space with very short-term agreements to small companies or even single entrepreneurs.

If the economy cools even a little, such an approach might leave WeWork with a lot of empty offices and yet huge lease obligations. But that’s OK, it has beer on tap, so what could go wrong?

Maybe I’m wrong

It could be that the markets turn around and shoot higher when we resolve our trade differences with China, or when President Trump and the Democrats reach across the aisle to move infrastructure financing through Congress.

Maybe we regain our animal spirits and surge ahead.

But maybe not.

And if we start 2019 on a whimper instead of a bang, don’t rush to buy shares in naked companies when they hit the markets. You could find yourself losing your shirt.

Rodney

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