Double Trouble – We’re In A Massive Bubble

Of course, it is hard to know if one is truly in a bubble until after it pops.  And even if you could be sure that you are in a bubble, it is impossible to know when it will pop.  I am considering the signs of a bubble in wondering if we are in one now…..

The crash is now ten years old – does anyone remember anything about it other than how it was really smart to buy at the bottom?

Tax reform makes us all think that money will rain from the sky – and with a $1.5T tax cut, maybe it is raining money?

Bitcoin just hit $14,000 – I mean $16,000 – I mean $19,000 – and most people investing in it don’t really know what it is.  As an aside – and so I can be a humbug – I mentioned in my last Real Estate Philosopher article that if you wanted a good gamble, Bitcoin was a good place due to the Wave of Money still cresting out of countries with difficult political situations.  I admit I love when I’m right…..I hereby am not making any prediction about Bitcoin except that it is going to continue to be fun to read about it every day in The Wall Street Journal.

Stock markets keep hitting records and almost ‘never’ have corrections.  Does anyone even remember when the last bear market was?

Elon Musk keeps getting billions of dollars for money-losing businesses and every time things get worse he just says we’ll invest in something else and the stock goes up.  Somehow Tesla is worth more than Ford or GM.  Really?

For Amazon, the latest article says it will be worth a trillion dollars next year – and, as I have mentioned in prior articles, after one subtracts stock based compensation Amazon has never made a penny.  I think that without the cloud side business, it has lost an awful lot of money, and continues to do so.  It is disrupting the real estate world because it doesn’t have to make money.

Unicorns – supposed to be mythical beasts – are now roaming all over the place, including populating the real estate world.  Most of them lose money and have never made money.

Uber is supposedly worth $60B and (I think I was told) loses money on every trip – and it seems like a lot of parties are now going into the same business.  Indeed, little dinky companies like GM and Ford are going to compete with Uber.

Money gets raised for all sorts of things.  People are eager to invest in startups.

Economists are bullish – I think unanimously bullish – no better indicator of a bubble than that.

Interest rates are still ridiculously low.  No one – and I mean no one – dares to even predict interest rates will ever rise again.  They are permanently low- right?

Everyone knows that the key to success in life is just put your money into index funds and ‘no matter what’ never sell.  Indeed ‘buy on dips’ has been the rallying cry, and only suckers sell any more.

Tax cuts for businesses will propel the stock market dramatically higher.

Employment is at all-time lows but somehow inflation is tame.

Overall there is greed and not fear in the markets.  I mean I admit it myself – I feel, well, “greedy.”  I “feel” like buying Bitcoin and have to restrain myself not to actually do that.  When someone pitches me a tech startup, I “feel” like investing – and, full disclosure, I just wrote a pretty big check only a few days ago into a tech startup.

Also, when I read about a hot stock I “feel” like buying it.  And when a client approaches me about investing in a real estate deal I “feel” like saying yes.

Warren Buffett’s admonition is timely:  “Be greedy when others are fearful and be fearful when others are greedy.”  I bet Warren Buffet is fearful right now.

I ask you as you read this – are your investments in the black?  Are you eagerly looking for the next deal?  Are you stretching your underwriting standards just a bit?  Instead of distressed deals (your original business model), have you now ‘evolved’ to plain old ‘good’ deals?  Or have you further ‘evolved’ from ‘good’ deals to ground up development in order to hit your investment hurdle goals?

Do you remember what happened in 2001?  Many of us got caught up in the idea of investing in companies that didn’t make money.  It happened in early 2001 – Barron’s ran that famous report that showed all of the internet stocks and their cash burn and how many months they had left.  That made clear that the various emperors weren’t wearing any clothes and only about 90 days later it was all over.  Billions of dollars up in smoke and mirrors.

What I always find fascinating is how fast fear turns to greed and greed turns to fear.  If there is a selling panic going on and someone yells ‘this is the bottom’ – then everyone piles in.  And if things go up too high and someone makes clear this is the top, there is a selling panic and everyone piles in there too.  Have you seen the movie Trading Places?

This applies at market tops just as well when someone yells ‘look out below!’

Any day, any week, any month, any year, greed will turn to fear.

Okay, so if I am right, what will happen in the real estate world when greed does actually turn to fear?

The obvious answer is that those who got too far out over their skis will be hurt and those more prudent will not be hurt as bad.

So, I say to everyone “stick to your long-term game plan.”  And don’t do the following:

  • Don’t let the animal spirits in the market change your underwriting.  To those clients who tell me mournfully:  “Bruce – I haven’t done a deal in over a year,” don’t let that push you to do something foolish.  Not doing deals is a moderate level bummer – doing a bad deal is a terrible, awful, horrible bummer that you regret for the (sometimes many) years you are stuck dealing with it – not to mention what it does to your long-term track record.

  • Don’t try to time the market.  You just can’t do it.  The goal should be long-term value creation, knowing that in the short run market swings will help or hurt you.

  • Don’t put yourself in a high-overhead situation where you are pressured to do deals that are not good ones.

  • Don’t rush off to different geographies if the market you really know gets too expensive.  This is consistent with Warren Buffet’s admonition “If you can’t run your own business successfully it doesn’t make sense to then enter a new business you know nothing about.”

  • Don’t ‘hunker down’ – I would never advocate that, as it implies you are trying to time the market based on the theory that it is too high now and it will go lower and, of course, you will know just the right moment to jump in.  Of course, keep on looking for good deals, which are harder to find and/or require different intellectual capital to unearth.

  • Don’t sit by and let the brokers be the ones creating the value.  Instead of hoping brokers – or others – will call you with deals, I advocate that you be the one who “creates” the deals by figuring out a market anomaly – a non-obvious assemblage – a change of use – or another way to “create” the value in the deal.

  • Don’t fool yourself into thinking that it is better to chase higher yields with higher risk.  If you do this, you haven’t really changed the risk profile of your business – it is really the same thing in the end in terms of expected upside.  The goal, of course, is to take advantage of situations in which the risk/reward does not balance but instead tips in your favor.

  • Follow the view that “competition is evil,” and avoid competition as much as possible.  As Michael Porter (and many other great thinkers emphasize) it is much more important to be “different” than to be “better.”

Before this article gets too long, I will end it with a lesson I recall reading after the 2001 market crash.  It was in Barron’s, I think, when someone wrote a piece saying:

“We should have listened to Warren Buffett”

This time around, I don’t counsel hunkering down, but I do counsel not getting sucked in.  Bubbles always pop at some point.

Since I always say one shouldn’t make predictions and then do it anyway, I will make a prediction about what will happen to real estate when the bubble does eventually pop:

Development projects that are in mid-stream will get nailed; however, my sense is that, generally, commercial real estate with cash flowing assets will not get hit that badly and will be one of the ‘best’ places to be when the tide goes out.

The Latest Bubble

Here are further thoughts about Amazon and its effect on the retail world, which I have named “The Amazon Retail Distortion”.  See the article I wrote in my last Real Estate Philosopher.

I note that roughly fifteen years ago – in mid 2001 – Barrons wrote a perceptive piece that, in one article burst the internet bubble.  It pointed out that no matter how many “eyeballs” internet companies were getting, almost all of them only had a few months left of cash to burn and if they didn’t raise more money by then they were broke.  And so it was.  Between three and six months later virtually all of these companies disappeared in a puff of smoke.

Of course, I am not Barrons, and I don’t see Amazon going bankrupt any time soon, but I continue to wonder when the Amazon bubble will burst.  When it does there will certainly be a mass celebration in the retail world.

Consider my last article where I made the point that Amazon has been given a now twenty-year gift from Wall Street and investors that it doesn’t have to make money.  And this still continues, incredibly.

Their last quarter – which came out after my last article – put them at breakeven or worse when taking out stock based compensation and losing significant money if their cloud business – which has nothing to do with their retail business model – is excluded.  Indeed the article I read said they made 40 cents a share (for a stock trading at $1,017 a share), they expect somewhere between a small loss or a small profit next quarter, their income fell 50% from last year, and their operating costs were increasing.  The same article – incidentally – mentioned that Jeff Bezos was temporarily the world’s richest man…

Face it – Amazon makes no money in retail!

Yet retailers that used to make money – or are making money – are getting clobbered by it.

My – continued and reinforced — view is that Whole Foods will reveal the lack of clothing of Emperor Amazon.  Consider a recent Wall Street Journal article entitled “Amazon Rewrites Rule Book for Grocers.”  The second paragraph starts with “while Amazon doesn’t need to make money from its grocery division yet, food sales are crucial for traditional players like Kroger, WalMart and Target….”  Seriously?  Amazon doesn’t have to make money on food but WalMart does?  Seriously?

And then a few days later what appears to be a “shocking” headline that Amazon is lowering some prices at Whole Foods crushes grocery stocks.  Again, I ask, seriously?

Whole Foods is known informally as “whole paycheck” and is struggling, so they lowered some prices.  Gee – wow.   I looked at the article and the price changes on some vegetables wasn’t enough to change my shopping patterns.  Amazon’s (brilliant?) strategy in groceries is to take on experienced behemoth players in a razor-thin-margin business and lower prices against WalMart?  Seriously?

If you are going to bet on WalMart – which makes something like $15B in cash a year — versus Amazon – which makes nothing – and you bet on Amazon, your bet has to be based on one thing; namely, that it will continue to have a free pass on making no money in its core business.

My last article generated a lot of responses – some favorable and some implying I had no clue.  The ones telling me I had no clue mentioned that a huge percentage of Americans use Amazon and they are brilliantly run, etc.  My response is that even if that is true, Amazon is still losing money or at least not making money.  Plus, I don’t know why the fact that you use Amazon to buy a book has much to do with groceries.

Maybe the theory is that someday, once they have put all the retailers out of business they will have a monopoly and raise prices then?

It is a lot like my partner coming in and telling me about a new client that wants our pricing so low that we are losing money.  He then says to me “Bruce, don’t worry, we’ll make it up on volume!”

I reiterate my prediction that Amazon’s ability to destroy the retail world is based on mis-placed hype and an irrational stock market valuation.  I do have to admit though that irrational stock market valuations can persist for a long period of time.

My advice to retailers is the same as in my last article:

  • Don’t freak out – this is a temporary phenomenon – albeit a long one – it will end at some point, and I think pretty soon.  Sooner or later someone more respected than me – like Barrons maybe – will poke at the same hole in Amazon I am poking.

  • Set up your business so that you can survive until the Amazon Retail Distortion ends.

  • Perhaps follow the other suggestions in my previous Real Estate Philosopher articles; namely: (i) don’t try to be “better” than others and instead try to be “different” from others, (ii) sell only exclusive branded goods in your store, (iii) consider yourself as much in the distribution business as the retail business, and (iv) don’t go nuts setting up expensive structures to enhance the consumer’s “experience” in the store, which I bet will get old awfully fast and be intensively expensive and difficult to maintain.

How To Beat Amazon

I have been reading all the articles about Amazon buying Whole Foods and how that ends the grocery business for everyone else, including Walmart.  And beyond that, it also means the end of retail since Amazon could buy other retail companies too.  From the articles it sounds like “game over” for not only groceries but all of retail.  This seems like kind of defeatist thinking.

So I was thinking about how one could compete with Amazon.   Here is how to do it….

First – let’s examine why Amazon is so hard to compete with in the first place.

It is brilliantly run for sure – but so are many other companies.

It has a dominant place in many markets, with a super-strong distribution network, etc, but it has one amazing thing going for it and that is that, for reasons no one can satisfactorily explain to me, Wall Street determined long ago that Amazon doesn’t have to make money!

I am certainly very impressed with Jeff Bezos, but I think this was just an (incredibly) lucky break.  I don’t think this break was due to Bezos’s amazing skill or Amazon’s incredible business model.  He just got (incredibly) lucky.

Look at the other major tech stocks that are consistently held up next to Amazon; namely, Google, Microsoft, Intel, Facebook, and Apple.  They are all the same except for one HUGE difference – the others are all printing insane amounts of money.  But Amazon barely breaks even after you take out stock-based compensation and the billion or so it is getting from its cloud business (which does actually make money).

For example:

  • Apple will likely make about $50B this year and is worth $750B

  • Amazon is on pace to make about $2B this year and is worth $450B

Seem a little funny to you?

So how do you compete with a company that doesn’t have to make money when your company has to make money?  It is like competing with the government isn’t it?

There is a simple plan that I espouse, which is to just wait a bit longer…..

My thinking is that buying Whole Foods is going to be a disaster for Amazon.  This is because, for the first time, it is going to be obvious that the Emperor’s core business model is not wearing any clothes.

Instead of just fulfilling orders and taking a cut – and loving every minute of not having to make money to have a high stock price – Amazon is now embroiling itself in one of the most brutally competitive businesses in the world and taking on the strongest competitor in the world; namely, Walmart and a fair number of other established players as well.  These players are not a bunch of patsies – they know the groceries business super well, which has razor-thin margins and has to be run pretty close to perfectly to make a profit.

In addition, Amazon is taking on a struggling business in Whole Foods.

This acquisition is not a layup for Amazon but a very poor risk/reward in my assessment.

My proposition is that Amazon will do well with Whole Foods only as long as Wall Street continues to give it a free pass not to make money.

And what happens if Whole Foods proves to be a major burden on a company that has never actually run a retail company – not to mention a groceries company.  At minimum a major distraction for management.  At maximum, maybe a further drag on the relatively small earnings……

In my assessment, what happens next is Wall Street – which is all of us who buy and sell stocks one way or another – and which can be so fickle as we all know – will start to wonder “why is it that a company that cannot make any money is worth close to half a trillion dollars?”

After twenty years of not making money – in its core business – for Amazon, investors might conclude that maybe they should put their money into business models that actually make money – and not put their dollars into a company which is dramatically over-valued by customary valuation metrics.

What happens then?

Suddenly, Amazon and Bezos – and Whole Foods – are judged just like everyone else.  The stock goes down to a normal number.  I have no idea what that number is, but certainly a lot less than it is today.  Maybe a company that is growing at 20% a year and earning two billion dollars might be worth, say, $40 billion?  Yikes – that is about 10% of what it is trading at now.  But I am just musing here.  My point is it would be an awful lot less.

At this point Amazon would have to actually make money in its core business, which means that – just like everyone else – Amazon will have to charge more money and do the same things retailers are doing.  At this point the Amazon-based distortion of the retail world, which I will call the “Amazon Retail Distortion”, will finally be over.

So I suggest that your game plan, if you are a retailer competing with Amazon, should be the following:

  • Don’t freak out – this is a temporary phenomenon – albeit a long one – it will end at some point – and Whole Foods might be the beginning of that end

  • Set up your business so that you can survive until the Amazon Retail Distortion ends – and yes get your costs as low as possible and your business run as efficiently as possible.

And consider following the other suggestions in my previous Real Estate Philosopher articles; namely: (i) don’t try to be “better” than others and instead try to be “different” from others, (ii) sell only exclusive branded goods in your store, (iii) consider yourself as much in the distribution business as the retail business, and (iv) don’t go nuts setting up expensive structures to enhance the consumer’s “experience” in the store, which I bet will get old awfully fast and be intensively expensive and difficult to maintain.

Am I right here?  I guess we shall see.  However, I do wish the retailers the best of success.  I run a real estate law firm and certainly know how emotionally draining it is to have business go up and down dramatically.

Also – this is my hobby as well as my job.  If you are running a retail company and struggling and want to brainstorm with me, just call me!