Here we go again. Boom and bust markets are a necessary evil of raw capitalism and therefore, I feel that nobody in particular is to blame for this go-round. Investors, throughout history, have proven their maddening penchant for bidding assets up to speculative bubbles that feed upon themselves. From there, it is only a matter of time before a financial crisis, as asset values collapse and finally correct toward reality. Our latest bubble flash point festers within Web 2.0 technology shares that remain inflated due to an accommodating Federal Reserve policy. I would advise people to maintain a conservative investment approach - in order to contain the looming damage and capitalize amidst the rubble.
The Federal Reserve Board
The Federal Reserve Board was created to fulfill a contradictory dual mandate of price control and full employment. To do so, the Fed can manipulate the money supply through its discount rate, banking reserve requirements, and open market transactions. In order to stimulate the economy, the Federal Reserve Board will lower its discount rate, reduce its reserve requirements, and purchase U.S. Treasuries through open market transactions. These steps literally create dollars, which the Federal Reserve hopes will circulate efficiently through consumer spending, capital projects, and financial markets.
In response to the 2007-2009 housing and credit debacle, Ben Bernanke and the Federal Reserve Board were forced to go on the offensive and take on an unprecedented campaign of easy money. The federal funds rate remains effectively at zero - and significantly beneath the global inflation rate. Investors are now forced to take on extraordinary risk - in hopes of generating real returns (nominal returns minus inflation rate). The Fed, of course, is merely a blunt tool that has no authority to directly allocate resources and surgically repair the U.S. economy. Instead of directing funds toward real estate and manufacturing, our empty suit bankers have money flowing into Silicon Valley and its current lineup of Web 2.0 stocks.
Web 2.0 Bubble
In America, a sucker is born every minute, and we are all susceptible to any get-rich-quick scheme. Today's Web 2.0 model is the perfect storm to capitalize upon all of the major foibles of human psychology. We are social animals, who have taken to the web, to not only gain acceptance, but to project our own narcissistic celebrity. In the era of Kim Kardashian and Paris Hilton, we have all embraced Web 2.0 technology as the head of our own public relations departments. On MySpace, Facebook, and Twitter, we are all famous for being famous.
As users, while we carefully cultivate our public image, we freely embrace customization behind-closed-door monitors and cell phones to purchase gadgets on Amazon (NASDAQ: AMZN), rock out to Pandora (NYSE: P) music, log on to Groupon (NASDAQ: GRPN) or Yelp (NASDAQ: YELP) to plan dates, and post up resumes on LinkedIn (NASDAQ: LNKD). As investors, these shares are priced to perfection, which means that the market is forcing us to believe that advertisers will continue throwing money at these websites in perpetuity.
Right now, Amazon trades at 140 times trailing earnings, while Groupon, Yelp, LinkedIn and Pandora are all allegedly multibillion-dollar enterprises. Yet again, sheep-like investors are falling all over themselves to place bets on firms that have not earned one red cent in profits. Money managers are relying upon Byzantine accounting practices to justify non-applicable price-to-earnings, such as Groupon's infamous adjusted consolidated segment operating income.
No. It is not different this time. Comparing Web 2.0 to the dot-com debacle is synonymous with taking solace in the fact that the 1989 Loma Prieta wreaked less havoc than the 1906 San Francisco earthquake. Both events caused significant damage, irrespective of scale.
We are targeting commodities, consumer staples, and emerging markets as the ideal risk-versus-reward playbook to cope with today's world economy. The G8 zone is likely to grapple with lost currency value, stagnant growth, and invisible, but very real inflation (flat wages and real estate prices / higher food and energy costs) in the near term. Meanwhile, the developing world, led by China, will continue to strong arm its way onto the global stage and voraciously consume natural resources. Your model equity portfolio should therefore be made up of select U.S. consumer staples, materials, and commodities firms that mint the majority of their profits overseas. Overseas profits will be all the more impressive - when they are repatriated into weak dollars.
Meanwhile, Web 2.0 stocks with no earnings are doomed to bankruptcy. As Pandora, Groupon, Yelp, and LinkedIn collapse toward zero, sheep investors will flock to Google (NASDAQ: GOOG), eBay (NASDAQ: EBAY), Apple (NASDAQ: AAPL), and Amazon , and bid these darlings into the stratosphere. Shortly thereafter, U.S. corporate earnings will stall, selling will accelerate in the niche Web 2.0 names, and large capitalization technology positions will finally crumble alongside the mayhem. At bottom, we will be informed, yet again, that Western Civilization is finished. Smart investors can then re-enter the tech arena, pick up Google and Apple on the cheap, and lay the groundwork for Web 3.0. These events are inevitable.
Take heed, as I am no prophet, by any means.
It is just that - we have already been here before.