Welcome to this week’s Research Notes. Before we get started, a quick poll…

Towards Normal

It feels like normalcy has returned to the equity market. Stocks are mostly valued based on cash flows (or, in many cases, the lack of). Bizarre rallies seem less frequent. The financial media is back to covering financial stuff.

To be sure, “normal” doesn’t mean easy. This remains one of the more challenging markets in recent memory. But at least now, the questions are more “what does demand look like in 2023?” as opposed to “if I short shares of this likely insolvent company, will Redditors band together and send the stock up 850% in a week?”

With the New Year at hand, it’s worth looking back on how we got here, taking a close look at a few of 2022’s biggest trends.

The Fed

The Fed has dominated market commentary this year. Even Elon Musk knows that.

Fears of rate hikes began almost immediately (and, truthfully, a bit earlier than I remembered). On January 5, the NASDAQ Composite dropped 3.4% amid hawkish minutes from the Federal Reserve’s Open Market Committee. The index never recovered:

In early March, the Fed hiked 25 basis points, its first hike since 2018. Fed chairman Jay Powell said at a press conference that the odds of a recession are “not particularly elevated.”

By May, investors are getting the message. On May 3, the 10-year hits a 3% yield for the first time since 2018. The S&P 500 touches a year-to-date low before recovering. The next day, Powell says the Fed is not considering 75 bps increases; the S&P 500 soars 3% on the news.

The optimism lasts overnight before a “Wall Street bloodbath”: the NASDAQ drops 5%, and the S&P 500 3.6%.

In June, a single week changes the narrative. Inflation accelerates to 8.6%, but investors and Fed governors still hope the increase is “transitory”. CNBC reports on June 10 that the surprising inflation figure should not change Fed policy.

Three days later, the yield curve inverts. On June 15, six weeks after Powell suggested otherwise, the Fed indeed goes with a 75 bps hike. It’s the first of four such increases.

It’s easy to forget how stunning the change has been. In January, analysts expected three increases, getting the Fed funds rate to 0.75% - 1.00%. The month before, consensus expectations signaled just two hikes in 2022.

Instead, we got seven, with the Fed funds rate now at a range of 4.25%-4.50%. As a result, the Fed has dominated equity market conversation since June.

That alone seems like a tell, that investors still aren’t getting down to the work of actually focusing on fundamentals. Indeed, some are still looking for someone to blame. Fed intervention matters, but it’s not the only reason for the market plunge in 2022.

The Bubble Bursts

To our eye, excessive valuations seem like the more salient factor. Here are some of the more interesting market capitalization figures

• Tesla: $1.06 trillion (now $432 billion)

• Carvana: $16.6 billion, down from $30B-plus in August 2021 (now $785 million)

• Affirm Holdings

  3
  : $22.7 billion, down from $46B in November 2021 (now $2.7 billion)

• Coinbase: $50.5 billion (now $8 billion)

• Snap: $67 billion, down from $130B in September 2021 (now $13.2 billion)

• Twilio: $41 billion, down from $72B in July 2021 (now $8.7 billion)

• Wayfair: $19 billion, down from $35B in March 2021 (now $3.7 billion)

• Lucid Group: $69 billion (now $12 billion)

What’s crazy is that the seven non-Tesla companies alone have shed ~$230 billion in market cap. Yet those losses are a drop in the proverbial bucket.

Big Tech stocks have lost trillions in market cap. Cryptocurrencies have declined by about $1.4 trillion. The 30-year Treasury is down 35%, its worst return in a century. There’s been nowhere to hide.

Returning to our list above, equally crazy is that a reasonably talented investor could still build a strong short case for any of those names at current levels. (On the way down, we did so for both Tesla and Carvana.)

It’s not just these speculative, questionable names. It was on literally the first trading day of 2022 that Apple became the first company in history to reach a market cap of $3 trillion. Is the current $2.1 trillion market cap necessarily more reasonable, for a company selling devices for $1,000-plus and facing increasing regulatory pressure?

We can look outside of equities as well. In the wake of the FTX scandal (and Terra and Celsius and Three Arrows), doesn’t a crypto market cap (if that figure even has any real meaning) of ~$860 billion have further to fall? The 30-year still suggests some conviction that the Fed will pivot, with its yield below the targeted Fed funds rate.

We’ve said multiple times this year that, despite the broader sell-off, equities don’t look cheap the way they do at a bottom. Reviewing the performance of asset classes more broadly this year, that exact same sense holds.

The End Of Meme Stocks And Dumb Rallies (?)

The game is up for meme stocks, it appears. YTD, GameStop is down 44%, KOSS 50%, and AMC 80%.

But look back to the beginning of 2021, and the view looks quite different. GME is up 341%; AMC 152%; KOSS 54%.

To some extent, these stocks are still defying gravity. Koss — the strangest of a strange group — trades at more than 40x FY22 earnings per share. Its patent lawsuits against the likes of Apple and HP over wireless headphones appear to have ended (though the company booked a solid net gain from litigation in fiscal Q1).

AMC still seems on a path to bankruptcy. Its effort to get around the limit on authorized shares by creating the APE preferred stock has failed; with APE below $1, the ability to raise capital has dwindled.

GameStop retains a market cap over $6 billion, and an enterprise value above $5 billion. Revenue is negative year-to-date; the operating loss has widened. The supposed transformation into — well, something other than a dying brick-and-mortar retailer — has shown essentially zero progress.

In that context, a GME short looks intriguing. It’s a case of the classic advice to short a stock after it breaks, rather than trying to precisely time when that break happens. (That advice has been proven correct time and time again in 2022; it’s a strategy we discussed extensively in our CVNA piece back in April.)

GME is a stock that in January rallied more than 30% in after-hours trading amid reports of a new project related to NFTs (non-fungible tokens). Even a more cautious 7%-plus gain in the regular session the next day added ~$750 million to GameStop’s market cap. Now, however, it’s much more difficult to see that kind of trading on such a thin catalyst.

Again, there’s a sense of normalcy after so many silly rallies in 2022, particularly in the first half of the year. AMTD Digital hit a market cap of $470 billion after going public at a valuation of ~$1.4 billion. Robinhood posted two huge sessions based on news (once the addition of stock lending to the platform, the other extended trading hours) that the company already had disclosed.

Even Amazon stock gained 9.9% after hours following the announcement of a stock split and share buyback in March. The rally moderated in the regular session the following day, but Amazon still added more than $70 billion in market capitalization, on a day the NASDAQ Composite shed almost 1%. By June, when Tesla tried the same move, its stock actually fell 7% the next session amid a market rout.

The one last bastion of social media-fueled pump and dumps seem to be low-float de-SPACs. Redbox was the most hysterical example, with online pumpers trying to orchestrate a short squeeze even after the company agreed to sell itself for less than $1 per share in stock. Gay dating platform Grindr saw such a rally last month; in February luxury travel platform Inspirato briefly cleared $100 after its merger closed with a redemption rate above 98%. Many others (anecdotally, it seems like most others) have posted triple-digit, if brief, rallies.

Those spikes, however, simply aren’t shortable. (There’s no borrow and no options.) GME and its ilk look somewhat tempting for aggressive traders/investors. So do any stocks that traders try to make into the ‘next’ GME or AMC. Bed Bath & Beyond is a perfect example: it briefly had its moment, going from $5 to $23 between late July and mid-August. It’s now below $3.

Streaming Media

At the beginning of the month, we highlighted the concerns facing the streaming media business. Looking back through 2022 news, it’s interesting to see the slow, dawning realization of the challenges ahead.

It started in January, when shares of Netflix declined 22% in a single session after the company missed subscriber targets for its fourth quarter. By March, Netflix chief financial officer Spencer Neumann replies “never say never”

Those shifts alone — from the two unquestioned leaders in the space — show some concern that the subscription-based model isn’t going to be enough. Sure enough, the next month, Netflix stock fell 35% after its first quarter earnings report showed a stunning subscriber loss. The stock tacked on another 12% decline over the next five sessions. The company itself floated the idea of an ad-supported product on the Q1 conference call.

The following day, Warner Bros. Discovery shut down CNN+ less than a month after its launch, yet another sign that the industry is starting to realize how difficult streaming subscription revenue will be to capture. But neither executives nor investors have completely come around. Three weeks later, Disney stock fell less than 1% despite soft fiscal Q2 numbers, as streaming subscribers topped expectations. The next month, the Disney board unanimously extended the contract of CEO Bob Chapek by three years.

Here in late 2022, it’s clear that even the modest reorientation of the industry’s strategy wasn’t enough. Netflix has now gone full-bore into advertising. Chapek has been replaced by his predecessor, Bob Iger; streaming profitability likely wasn’t the only reason, but Chapek’s decision to fire the company’s top TV executive no doubt contributed. WBD and PARA are near their lows. As we noted at the beginning of the month, AMC Networks instituted layoffs precisely because streaming profits weren’t replacing those in the legacy business.

But we may come back to the sector one more time in the New Year — because it’s possible the industry and the market haven’t fully grasped what the new media environment actually looks like. And so what might be true for streaming might also be true for so many other sectors that were ‘hot’ in 202. Even with big declines, expectations haven’t yet become reasonable enough to match with the likely reality.

As of this writing, Vince Martin is short Tesla.

Stocks mentioned: AFRM 0.00, AMTD 0.00, AMZN 0.00, APE 0.00, BBBY 0.00, COIN 0.00, CVNA 0.00, DIS 0.00, GME 0.00, HOOD 0.00, KOSS 0.00, NFLX 0.00, TSLA 0.00, WBD 0.00

Disclaimer: The information in this newsletter is not and should not be construed as investment advice. Overlooked Alpha is for information, entertainment purposes only. Contributors are not registered financial advisors and do not purport to tell or recommend which securities customers should buy or sell for themselves. We strive to provide accurate analysis but mistakes and errors do occur. No warranty is made to the accuracy, completeness or correctness of the information provided. The information in the publication may become outdated and there is no obligation to update any such information. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Contributors may hold or acquire securities covered in this publication, and may purchase or sell such securities at any time, including security positions that are inconsistent or contrary to positions mentioned in this publication, all without prior notice to any of the subscribers to this publication. Investors should make their own decisions regarding the prospects of any company discussed herein based on such investors’ own review of publicly available information and should not rely on the information contained herein.