This article was first published in the National Post on February 18, 2023. It is being republished with permission.
by Tom Bradley
One of my rules of thumb is that if something doesn’t seem to make sense, it probably doesn’t. Right now, there are more things than usual going clink, clink ... clunk.
Let’s start with a macro example that’s almost over. Last year, central bankers did a 180-degree turn. They went from having their foot on the accelerator to stimulate the economy to hammering the brakes to get inflation under control. Much of the commentary about this reversal has focused on the continued strength of the consumer and how resilient the economy is.
The commentaries underplay the time lag. Monetary policy takes time to filter through the economy. Until now, most households and corporations were able to make relatively easy adjustments to their budgets, as well as benefit from previous financings done at low rates. Tougher decisions will need to be made as mortgages come up for renewal and the low-hanging fruit is used up.
The next six months will determine how successful the central banks have been in their mission. The prior data points were just noise. But beyond that, here are four more potential clunkers looming for investors.
The red flag of China
Despite recent geopolitical events such as Brexit and the war in Ukraine, investors don’t seem to be treating China as a big risk factor. I’m specifically referring to companies that are dependent on China for manufacturing and/or sales growth. Stocks like Apple, luxury brand companies and German automakers are holding up well considering how important China is to them.
If we’re not heading into a cold war, it’s certainly getting chilly. There’s a lot of denial going on in the corporate world. It doesn’t appear firms are moving fast enough to lessen their reliance on China.
A lack of green
Under the same theme of not far or fast enough, it’s surprising to me that major oil companies such as ExxonMobil, Chevron and BP aren’t using their enormous cash flows to meaningfully expand into other energy sources.
Not too long ago, they were falling all over themselves to outgreen each other, but now that they have more cash flow than anyone to move the climate dial, they’re downplaying their commitments to alternatives while raising dividends and buying back shares.
Energy diversification isn’t like Meta's investment in the metaverse, which doesn’t yet have a path to profitability. Renewable energy is now competitive with fossil fuels and there’s money to be made.
If you Google “Uber earnings,” you get a wall of articles with “strong quarter” in the title. Indeed, in the fourth quarter of 2022, Uber's revenues were US$8.6 billion, ridership was at an all-time high and “adjusted EBITDA,” the company’s fantastical measure of profitability, was positive.
To be more specific, Uber earned US$665 million before interest, taxes, depreciation, amortization, stock-based compensation (which totalled US$1.8 billion in 2022), the cost of protective equipment for drivers and a slew of other items.
What’s going on here? Uber has been around for more than a decade. It’s a global leader in two business areas. When will analysts and the media stop giving it a pass on its financial reporting? How about good old net income — that is, profit after all costs, including paying and protecting employees.
The private-public gap
Stocks in the public market are instantly repriced when there’s news or the outlook changes. That’s not the case for private assets. Price adjustments take time and are at the discretion of the investment manager.
This pricing lag is part of the charm of holding private equity, debt and real estate in your portfolio. They behave differently than public markets and are wonderful diversifiers. It would seem, however, that private valuations have strayed far from what similar assets are trading for in the public arena.
There’s an argument that the privates have it right. Public markets are irrational at times, with price volatility that doesn’t reflect what’s happening at the underlying companies. I get that, but I feel like I’m reliving the classic behavioural study that asked participants how good a driver they were and 80 per cent said they were above average. In this case, too many firms are saying their portfolios of companies and loans are doing well despite an economy in transition and higher financing costs.
I can’t help but wonder who is putting money into funds holding private assets that have done so well when they can buy similar companies on the stock market that are marked down.
Whether you agree or not with my interpretation of these conundrums, hopefully, I’ve alerted you to some potential clunks.
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