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Much has happened over the last three months that has had me regularly shaking my head. I’ve talked about how ignorance has been bliss with tech companies, but it’s also happened elsewhere. For instance, in the last week a number of retail REITs have given quarterly reports. Guess who seems to be producing the best stock performance? Simon Property Group, the one who is refusing to even say what rent collections have been like, except to say they’re better than prognostications. Then why not say what the number is?

For what it’s worth, I’ve only really taken a decent look at three retail REITs. My sense was people don’t understand the amount of liquidity they have. They can actually survive for quite a while in adverse scenarios, and all they have to do is follow the REIT rules for distributions by the end of the year. That doesn’t mean they’re great investments, but I don’t see how people can expect them to go bankrupt in short order. There’s certainly commercial real estate out there that’s troubled, but expressing that position through broadly shorting retail REITs doesn’t seem easy.

At least at first blush, recent moves in the stock market seem mystifying. Participation gets more and more narrow. At this point only the five biggest stocks are really carrying the market. For that matter, Goldman says the Nasdaq’s market capitalization is now bigger than the market cap of all of the rest-of-world’s stock markets outside the U.S. We’ve seen these kinds of love affairs before, though. The first one I think of is the surge in financials around 2007. The problems looked increasingly scary while the stocks kept on climbing. Eventually we pulled out of the area– too early. I definitely remember being castigated towards the end of 2007 for refusing to participate in the soaring financial sector. Obviously that tune changed strongly in 2008, but of course there was no way to prove that in 2007.

So what’s going on in tech, now? In a lot of ways, I think it’s the same basic idea as financials in 2007. It’s the hot sector, so people own it. And much like financials in 2007, there are problems, and I think they’re getting increasingly loud. The timely problem I’d focus on right now is how their businesses are likely to be troubled by the economic contraction. To me, it seems extremely likely there are serious problems, and only willful ignorance is keeping them up. But when something has been working so long, people assume it will continue forever and practically have to be forced to change.

I feel like I’ve spent enough time going over Facebook and Google and their likely topline advertising revenue problems. Advertising is way down, GOOG at least is cutting marketing expenses, and while people seemed to buy into their idea that the speed of revenue declines has moderated, earnings estimates are down 30-40%, which is probably still too optimistic, to my mind.

Apple has been hit by the slowdown as well. iPhone sales aren’t the be-all and end-all for the company, but KeyBanc came out with numbers last week saying their research indicates that iPhone sales are down in April (-77% y/y, -56% m/m). Surely that’s not good. Earnings estimates are down about 20%. Perhaps their EPS is relatively insulated because they continue the aggressive financial engineering they’ve been doing for several years. They’re still selling cheap debt and buying back shares. Love it or hate it, Apple’s financial engineering has continued to work (though it may get tougher as business slows.)

Amazon reported a weak quarter and weak guidance. Their near-term earnings estimates are down 75% and annual estimates are down more like 30%. Plus they’re the subject of Congressional scrutiny and labor discontent. Analysts are still pretty optimistic on their bouncing back next year though. I’d sure hope so, as even on those optimistic numbers they have a 64 P/E.

Microsoft seems like the strongest of the bunch. They remind me very much of Cisco back in 2000, in a seemingly unassailable position. With that view, annual estimates haven’t gone down at all, and near-term numbers have only been shaved a touch. I readily acknowledge they’re the best of the bunch, but I think they have the Cisco problem. Cisco didn’t stop being a great company in 2000, but their customers disappeared. It was pretty dramatic for Cisco as all those dot com companies disappeared, and I don’t think it will be that exciting for Microsoft. Nonetheless, their XBox division is already reporting a slowdown, and I expect that to spread. I’m not sure when people will care about valuation, but I suppose it should be mentioned the P/E is 30, while their large and mature business is optimistically growing 15% (I think more realistic growth numbers should be in single digits.) A good company, but not exactly a bargain price.

That seems like a motley crew of hot stocks to me, but nobody seems to care. What can change that optimistic investor psychology? I think two basic things are concerning – disappointing Q2 reporting and disappointing future guidance. Q2 is highly likely to be bad everywhere, including tech. Can investors ignore that? Anything is possible, but I wouldn’t want to bet on that with my money. Look at somebody like Twitter who for years has been relatively upfront with what’s going on, and their stock isn’t exactly in the stratosphere – it’s actually below what it sold for in 2013. When investors are forced to see the Q2 results, I wouldn’t think that’s a happy day. Can the tech companies punt on guidance again when they report for Q2? I wouldn’t put anything past them, but it’s hard to imagine how they can continue to make claims of eternal growth in an environment of economic contraction. Does this chart look like continuing forward EPS growth to you?

Source:  https://www.zerohedge.com/markets/stocks-have-never-been-more-expensive-disconnect-between-markets-and-reality-hits-idiotic

Ultimately, we’ve seen this situation before, and it previously hasn’t resolved well for the giant old champions. Will Q2 be the final straw? Will something else happen? I’m not positive, but I know every time the market has this setup, with some invincible stocks that must be owned, eventually they underperform, as everybody already owns them. It’s a bit frustrating to watch them keep outperforming, but it tends to be true in these cases that the bigger they come, the harder they fall. I’d think if you took a nap for a year, big tech should be a significant underperformer between now and then. Does it start now? July? August? The timing part is harder to say for sure – much like it was easy to see danger in financials in 2007, but harder to say when they would break.

Stocks are getting the benefit of the doubt mostly everywhere. Of course, that happened at past peaks as well. People get lazy with their thinking, and something needs to wake them up, which generally involves losing considerable money. The risk this time seems a bit worse, though. Every generation seems to think the younger generations aren’t as able as they were, but part of me wonders about the criticism that the education system only now actively discourages critical thinking skills. That was kind of true in my day– it was usually easier to get a better grade on a paper if you agreed with the teacher’s opinion. But increasingly it seems more people tend to believe there’s a right way and a wrong way to think – things are very black and white, very binary, and not nuanced. That sort of thinking can get you in trouble in the market over time. The market is mostly about probabilities; the correct answer often is “it depends;” and the result is you have to pay attention to the evolving information every day.

I feel like a lot of things just don’t pass the ‘does this make sense’ test because there aren’t many people doing that approach to thinking about hopes and probabilities. A consumer staples stock we own recently was up 22% in one day on a positive broker note, and was up about 75% for the week on a good quarter. That’s good for us, but doesn’t that seem a bit much?

Instead of critical thinking, what seems to be important these days are things more like 52-week highs, trendlines, systematic strategy positioning, and option dealer positioning. Go with the flow. It’s good to recognize that’s the reality right now, and because of that we need to pay attention to those things, but at some point people are going to figure out that we’re dealing in  ‘trading sardines‘ here. (Hint: Don’t’ open the can.) I’m worried that time is getting close. We left rationality a long time ago, led by recurring Fed interventions and supports. That’s fine, it is what it is, but we’ve seen some warning earthquakes, and for my part I’m heeding that warning. Caution may not look good tomorrow, but I think as time goes on my odds get better and better.

To me, this is like early 2008. Bombs have already started dropping. It seems pretty clear to me that more bombs are set to drop, and my focus is primarily on trying to avoid them rather than betting on Peloton being the next Tesla. I’d avoid that stuff like the plague. Clearly those momentum, trendline investments have paid off in recent years with the ever-present belief in the Fed put, but that’s way more risk than I’m willing to take with all the forward-looking economic contraction issues. I wonder out loud if when the history books talk about these times in the market, whether we’ll hear crazy stories of stock manipulation through the often difficult to comprehend options and derivatives markets. There’s been an awful lot of strange-looking stuff going on for a while. Every strategy can work for a time. Right now critical thinking skills don’t seem to matter much and aren’t making much money. Nonetheless, this doesn’t seem like a good time to throw critical thinking in the ditch and focus on trading sardines.