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Why the Rally Won't End Well

Written by Briton Ryle
Posted April 5, 2017

Is this rally even fun anymore? Every single day it's the same story: Apple, Netflix, Google, Amazon, Tesla, Nvidia, AMD, U.S. Steel, and Facebook. Apparently these are the only stocks that matter any more...

Forget oil. Oil stocks rallied 15% last week, and it wasn't worth a mention. Because, you know, oil stocks are doomed. Inventories are extremely high, U.S. shale companies are ramping production like there's no tomorrow, and Saudi Arabia can't control prices anymore. (Of course, the call options I recommended to my Real Income Trader subscribers last Wednesday have more than doubled.) 

Ford just told us that March sales were down 7.5%. Never mind that subprime auto loans are at ridiculous levels. This is clearly a non-story: the stock dropped 1.7% on the news. I mean, how bad can car sales be? After all, Tesla is killing it. Why else would the stock rally so much in the last couple of days that the company is now worth more than Ford?

I mean, Tesla sold 76,234 cars last year and lost money, while stupid Ford sold 6.6 million cars, made $9.4 billion, and pays a 5% dividend. It's reassuring that investors have figured out that Tesla is the superior company. 

Obviously, Netflix and its projected $11 billion in revenue for this year is a bargain at $62 billion. It'll grow into that valuation sometime in the next decade. Better buy it now — you don't want to miss out. 

I guess I'm starting to sound grumpy right about now. And I guess I actually am kind of grumpy. Because I really do want Tesla and Netflix to get the hell off my lawn.

Amazon vs. Netflix 

Here's the thing about Netflix that bugs me the most. It's not the valuation, exactly. Even though its U.S. subscriber base is close to being maxed out, there's a whole world out there of potential Netflix members. And Netflix's relationship with Disney should not be underestimated...

My biggest problem with Netflix is Amazon. If Amazon is a significant competitor to your business, well, good luck with that. 

Amazon is killing U.S. retail. Moody's has a list of 19 distressed retail companies that may well be close to bankruptcy — companies like J.Crew, Claire's, Gymboree, Nine West, rue21, and Sears. One member of the list, Payless Shoes, declared bankruptcy yesterday. HHGregg is a top candidate to be next. 

Nike just got hammered on earnings. Under Armour did, too. Macy's and Target are closing stores as fast as they can. Ralph Lauren is closing its flagship store on Fifth Avenue. 

Amazon basically beat them all. Amazon rules the backbone of the Internet with its Amazon Web Services (AWS) hosting operations. And it's coming for Netflix...

Remember when Twitter made a big splash by getting the rights to stream Thursday Night NFL games last year? Yeah, guess who nailed that down this year? Amazon. It will be part of Amazon Prime.

At this point, there is no better deal in the world than Amazon Prime. It alone is cheaper than a year of Netflix. And you get free shipping. You get movies and other TV (including Bosch, the detective series I love). And Amazon is starting to roll out grocery delivery as part of Prime. You can access bestseller books through the Kindle. 

It's just amazing. One company is taking out huge swaths of the U.S. economy. I just don't see how investors can stay so bullish on Netflix when Amazon is a competitor.

CAT Videos

On Tuesday, the Dow Industrials posted a modest gain of about 40 points. Roughly half of that gain came due to a nice 2% rally for one stock. Nope, it wasn't Goldman Sachs, but good guess. With the way Goldman has the lockdown on the revolving door to Washington, it would make sense that it would stay in perpetual rally mode. 

It wasn't McDonald's, either. That's a good guess, too, because investors have been happy to keep the stock at record levels even though its revenue has been falling for four years and is expected to fall to $21 billion this year and $19 billion next year. I mean, what's not to love? $25 billion in debt and 20% of the next generation of customers, the millennials, have never eaten a Big Mac. No word on how they feel about Quarter Pounders...

No, the big winner for the Dow yesterday was Caterpillar. And again, this makes perfect sense. At $95 a share, CAT is less than 20% from its all-time highs from back in 2011. That was the peak of the post-crisis Chinese pump job. CAT took in $65 billion in revenue and had net profit a little over $5 billion. 

This year, CAT will take in around $38 billion in cash and will lose money on a per-share basis. Interest payments on its $36 billion in debt, along with the $2.94 a share dividend, are depleting its cash reserves. 

But of course, investing is about the future, and analysts see 3.5% revenue growth for CAT in fiscal 2017. Fantastic! But what those revenue growth estimates are based on, I don't know.

The global economy is barely growing at all. China is shrinking its capacity for both steel and aluminum. That means less mining activity. There is a glut of iron ore out there, and coal. But sure, Caterpillar looks like a great investment right now. 

Can This End Well?

My answer to this question is a simple "no." No, it can't end well. Valuations are too high, and it seems clear — to me, anyway — that the Trump administration is not going to be able to deliver on its fiscal promises of tax reform and infrastructure spending. 

I am convinced a sharp correction is coming. The question is when.

Here's the saying I'm keeping in mind right now: the market can stay irrational longer than you can stay solvent. Who knows how long investors can suspend their disbelief and buy stocks? 

So here's the deal: if you wanna make some loot on the downside of this market, you have to use put options. It's just too risky to try and short stocks right now. Put options let you define your risk. You can put up a little cash, have a leveraged bet, and if you hit it, you win big. And I'll tell you right now, your odds of hitting it on the downside sometime in the next couple of months are a lot higher than hitting it on the upside.

Until next time,

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Briton Ryle

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An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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