For the regular followers of this blog, I want to apologize for the hiatus. I started writing this blog  on Aug 18th, however family and work priorities meant, I just could not muster the time to finish writing the article. 

The following chart is quite stunning!

The chart represents the price of QQQ, an ETF that tracks a modified-market-cap-weighted index of 100-NASDAQ-listed stocks.  For a brief period during the tech-bubble of late 1990s/early 2000s, QQQ rose in value above $100, then crossing it on the downside on Mar 28, 2000 to then take a greater than 14 years to again cross the $100 threshold.  Speak of tech-winter!

Since then, not withstanding the bearish move in late 2018 and the covid-pandemic, QQQ has increased almost three-folds in value! Most of these gains are on the backs of the so-called FAANG (Facebook, Apple, Amazon, Netflix, Google) or FATMAN (Facebook, Apple, Tesla, Microsoft, Amazon, Netflix) stocks.

The table below provides a summary of some fundamental metrics for these names

Amazon is producing rather impressive numbers as a growth stock, with revenue growth of about 28 % YoY with a gross profit margin of healthy 40 %. It is also trading at  premium valuations, a reflection of strong continued growth story with EV/EBIT of about 100 and trailing P/E ratio >100.  The growth numbers for Netflix are quite similar to those of Amazon though it seems to be trading at discount in valuation relative to Amazon!

(I cannot believe I am using the word discount for a stock trading at close to 60 P/E, such are the times)

Tesla on the other hand is trading at gravity defying valuations with EV/EBIT ~300 and a P/E multiple approaching 4 digits! The growth numbers by no means seem to justify these super-premium valuations! Whats going on? For one, Tesla is a story stock lead by a charismatic CEO in Elon Musk. The cult of Tesla is such that for its followers the company and its mission is beyond the realm of what can be rationally analyzed using standard accounting principles.

The remainder of the tech behemoths, AAPL, FB , Alphabet (Google) and Microsoft are all trading at slightly above market multiples of PE ratio at about 29, with revenue growth in healthy double digits (except APPLE) and gross profit margin at a very healthy level of >30 %. While the valuation numbers for these tech behemoths seem high relative to market average (~15), in the current environment pandemic induced lock-downs and the fed (and fiscal) induced liquidity surplus and no visible signs of (CPI) inflation, I can buy the argument that may be atleast for these 4 stocks current market prices do indeed reflect the strength of the business.

A counter argument though is that these top 5 stocks (Amazon included) now account for a bigger share of total US markets, greater than at the top of the internet bubble in 2000. As a result, now, the so-called Buffet Indicator— which takes the broad US-equity market index; Wilshire 5000 total market index and divided it by the annual US GDP– is now at the highest level since before the internet bubble of 2000, see below:

James Montier of GMO, recently put out a fascinating article, titled, Reasons (Not) to be Cheerful, where in he succinctly outlines the idea that now is the time to require high-margin-of-safety in investments and how with current valuations, Mr Market clearly does not seem to share that view. He goes on to draw comparison between two-types of investors in the markets, –the I know investor– and the I don’t know investor, an idea borrowed from the works of Howard Marks. The later camp of investors are the types who acknowledge the fact that future is unknown and embraced by this uncertainty, they demand a margin-of-safety.

I find myself drawn to the later camp of investors as well. Look at where we stand today in the markets and drawing analogy with what this means in relation to history, I am convinced more than ever that markets seem to have priced in all the good news and the odds are stacked against upside based on fundamentals.

As reported in a recent blog on Mid-Year Portfolio Review, I have a decent exposure to two of the top-5 tech stocks, FB and AAPL.  As stated above, while there are reasons to  still be optimistic about continued growth for these two FAANG stocks, I also want to be prepared for the downturn. As such, Mr AVI portfolio is sufficiently diversified, however market risks still persist (as was evidenced by a drop of >30 % in Mr AVI equity portfolio, during the COVID-induced market collapse in late March) and I am starting to seriously educate myself on an alternative to portfolio diversification, namely portfolio hedging!

A hedge in its simplest form is an investment that is intended to move in the opposite direction of assets in one’s portfolio. A hedge provides an inverse exposure. If at-risk investment should decline in value, a hedge, if designed appropriately, will increase in value in commensurate fashion so as to offset the losses in one’s portfolio. In that sense hedge can also be thought of as insurance.

For most of us ordinary mortals, house is the biggest component of our net worth and without exception all of us carry insurance to protect this asset! Drawing on this analogy, it sure makes sense to insure one’s portfolio, especially if it starts to represent a non-trivial fraction of ones net-worth.

The following chart (from proshares.com) offers a nice tabulation of various hedging strategies with inverse exposure.

In the upcoming posts, I will take a deep dive into each of these strategies, with the prime purpose of finding a suitable hedging vehicle for Mr AVI equity portfolio that does not break the bank!

Video/Book/Article/Audio for the Week

• Podcast: Tobias Carlisle who’s runs the Aquirer’s Multiple Blog and ETF (ticker: ZIG), put out a list of top 50 investing podcasts in 2020. I have been perusing through this list and came across the Cautionary Tales podcast run by Tim Hardford. If there is binge-watching for Podcast, I would give Cautionary Tales a big up vote! Worth checking it out…
• Video: An old video interview with Bill Ackman, where in he explains why he thinks Buffett is by far the world best investor of all times.
• Blog: Shout out to Modern FImily blog, which is focused on personal finance and FI. Their series on guest interviews of families who have reached FI is quite a fascinating read.