I don’t know who has been more brazen over the past week — Russian strongman Vladimir Putin or Amazon.com czar Jeff Bezos.
Both have defied the conventional wisdom and common sense in the past few weeks to carve out paths that appear more focused on satisfying their own megalomaniac personalities than improving the lives of their stakeholders. And both have set themselves on a collision course with disaster.
At Amazon.com, Bezos has opted to ignore investors’ demand for proof that his plan works by investing ever more shareholder funds in cockamamie schemes such as building distribution centers to surround every major and many minor U.S. cities. Someone needs to tell the Amazon skipper that the more he builds out a physical presence, the more his company looks like an ordinary brick-and-mortar retailer, except with a mind-blowing price/earnings multiple of 505x.
Compare that to a pretty decent department store chain named Nordstrom (JWN),which sports a 18.3x multiple, or Macy’s (M) at 14.6x. And the executives of those two companies don’t get distracted by designing third-rate mobile phones (WSJ review) or harboring drone delivery pipe dreams.
On some level, I love the idea of drone delivery, by the way, but it’s hard not to draw the comparison to Icarus, who perished for his hubris in flying too close to the sun. Not to mention the sad fate of the animated, drone-flying “The Jetsons,” which only lasted two years in prime time television, 1962-63, as the space-age flip side of “The Flintstones.”
A great analyst once told me that “profits are the market’s way of saying that you are a valuable part of the ecosystem.” The longer that Bezos puts off profits in pursuit of his dreams of providing same-day delivery for lazy suburbanites, the more the markets will punish him for destroying value rather than creating it.
Over in Eastern Europe, meanwhile, Putin’s subversive effort to put Ukraine back directly under Russia’s thumb is threatening to ignite a conflagration. Moscow’s central bank was forced to raise interest rates to defend the ruble and prevent capital from leaving the country. Although a surface calm has emerged in recent days, a variety of risk measures have moved sharply higher, including the value of credit default swaps intended to insure against Russian bank and corporate defaults.
The euro zone finally appears to be united on the notion of imposing serious sanctions on Russia that would dramatically undermine its banking system and cut off the oxygen to Russian companies.
European news media are reporting that sanctions will be aimed at cutting off Russia’s banks from global capital markets, as well as preventing technology transfers that would help Russian companies drill in vast “unconventional” oil and gas fields in which the carbon is trapped in shale formations rather than sand or tundra.
Reports suggest that Russia needs an investment of nearly $1 trillion over the next two decades to prevent the output of its oil and gas fields — the source of its wealth — from declining dramatically. Analysts are smart to wonder what companies or investors are going to bet on those projects with such an unstable government in place.
Yet Putin and his team of former KGB and GRU officials directing the separatist operation are loath to back down from annexing Ukraine, as it appears to be a popular idea among the Russian people and provides seemingly important military and agricultural benefits.
You would think that global equity and credit investors would be worried about the potential for such a conflict to rewrite the European borders in a major way for the first time since the Iron Curtain came down. But so far big-cap stocks in the United States and even the euro zone have been oddly insouciant, touching new highs as recently as the middle of last week.
Some creases in the story are emerging in peripheral locations.
While the smackdown of Amazon.com was the most prominent story line at the end of the week, I would urge you to also pay attention to another major development: The thrashing of the small caps, which is getting close to an epic scale.
There will most likely be a strong, if temporary, bounce-back in the small stocks in coming days, but last week a 13-year uptrend in the ratio between the Russell 2000 ($RUT) and the big-cap S&P 500 ($SPX) was broken, as you can see in the chart below.
Drawing trend lines on ratio charts is a perilous proposition, but they do capture a change in mood pretty well. Many readers may not realize the fact that there are long stretches of favoritism among investors between big caps and small caps. The smalls can get very cheap vs. the bigs in a hurry, i.e. through a three-year span of heavy selling — and then spend ten years rising and getting expensive again. It’s the old “escalator up, elevator down” cycle of valuation.
The last time this happened in a major way is shown in the second chart, which plots the shellacking the smalls took relative to the bigs from mid-1996 through 1999. The year 1999 is best known by investors today for the massive dot-com rally in big techs, but if you weren’t there you may not know that small-cap stocks were systematically ignored and fared poorly that year. (They ultimately got their revenge in 2000-2002, as smalls fared well relative to bigs in the tech wreck.)
The bottom line is that investor sentiment is quite quiescent at this time, which is certainly nice and I am not complaining. But the widening wipeout of the small caps, the easy knockdown of a popular stock like Amazon.com, and the looming economic attack on Russia are major developments that could upset values in days and weeks to come.
I’m not expecting a super-serious, dramatic, abrupt dislocation but rather a period of ebbing confidence that will sap investors’ vitality over the rest of the summer until prices on Wall Street are oversold instead of overbought, and there are hints of a resolution in Eastern Europe.
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