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Greetings and welcome back to We Study Markets!

Happy Fed day – It’s expected that Jerome Powell will announce another 75 basis point increase to interest rates this afternoon.

Despite a mixed earnings season so far, there has been some good news: Microsoft (MSFT) jumped 5% in after-hours trading after giving an optimistic sales forecast.

Today, we’ll discuss what the Dollar Milkshake Theory means to you, El Salvador’s bond problems, the bull case for Netflix, and how to value Amazon. All this, and more, in just 5 minutes to read.

Read on! 📖

IN THE NEWS

👊 El Salvador hits back against default fears with new buyback program (FT)

Explained:

• El Salvador has been a hot topic for investors, particularly those interested in Bitcoin, as the country was the first to make the digital asset legal tender (alongside the U.S. dollar). Since this adoption, and several highly publicized initiatives to attract entrepreneurs, engineers, and investors within the Bitcoin space to El Salvador, such as the announcement of a ‘Bitcoin city‘ at the base of a volcano, the cryptocurrency’s price has been in a steep decline.
• Due to the country’s already shaky financial footing, considerable investments in owning Bitcoin and related projects have only contributed to uncertainty from international investors about wanting to own the country’s debt. As a result, El Salvador’s sovereign bonds have traded at a meaningful discount in recent months.

What to know:

• Despite hopes from the country’s President that El Salvador may be able to increasingly bypass traditional financial markets to raise capital using its Bitcoin holdings as collateral, this latest news highlights that for the time being, El Salvador must double down on conventional sovereign bond markets by taking measures to quell investors’ nerves. And debt downgrades from rating agencies like Moody’s precipitated the bonds’ fall further into distressed territory.
• The buyback program is an important step, though, in the right direction towards remedying these concerns, at least from bondholder’s perspective, as bond prices jumped on the news. El Salvador’s Finance Minister has explained that they will use special drawing rights at the IMF, alongside a $200 million loan from the Central American Bank for Economic Integration, to buyback its current outstanding debt.

 

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🤔 Netflix’s CEO tries to convince investors of its bright future (Nasdaq)

Explained:

• After a wonderful pandemic for Netflix, largely defined by huge subscriber growth, as everyone looked for ways to fill hours of boredom while at home during lockdowns, the stock is now down 63% year-to-date.
• One reason for this is that with the global economy broadly re-opened, investors fear that subscriber growth has peaked for the foreseeable future, meaning that the company would have to increasingly spend larger and larger sums on content to convince new users to join who now have less time to stream shows.

What to know:

• Another option Netflix has been exploring, though, is more effectively monetizing households who have been playing it fast and loose with liberal password sharing. But maybe growth hasn’t peaked after all, as the company’s co-CEO, Reed Hastings, has suggested, “looking forward, streaming is working everywhere…It’s the end of linear TV over the next five, ten years.”
• Despite large penetration of streaming content in the U.S., a significant portion of television time is still dedicated to cable and broadband. So will the cord-cutting trend lead to the extinction of cable in the next decade? We aren’t holding our breath. Hastings is either a visionary with profound insights into how rapidly trends like streaming adoption are accelerating, or he’s desperately trying to rally the bulls to save Netflix’s dwindling stock.
• Let us know what you think about Netflix’s future – simply hit reply to this email.

 

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✂️ IMF Cuts World Economic Forecasts (CNN)

Explained:

• In a report released Tuesday, the IMF is forecasting major slowdowns in the three biggest economies: the United States, China, and Europe. A fragile global economy has been hammered by the ongoing war in Ukraine, inflation prints higher than expected, and tighter monetary policy around the world.
• The IMF expects the the world economy to grow just 3.2% this year, down from 6.1% in 2021. Next year they are forecasting just 2.9% growth and consider a 2.5% growth level to be a global recession.

What to know:

• The forecast presumes everything stays as is. Dangers, such as Russia continuing to increase limits or even stop the flow of gas to Europe, would send inflation even higher and further dampen economic growth.
• Do you ever wonder if these forecasts act as a self-fulfilling prophecy? Whereby consumers hear of bad news and rising prices and further cut back on spending, adding to less economic growth?

 

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DIVE DEEPER: Understanding the Dollar Milkshake Theory

The world is currently awash in dollar-denominated corporate and sovereign debt, and the repercussions of this massive leverage may eventually be a burden too heavy to bear. It may kick off a sovereign debt crisis as the loans can’t be repaid.

In the meantime, however, it creates a massive demand for dollars for both trade and debt repayment. As mentioned, this will lead to the US dollar strengthening and siphoning off the liquidity of currency markets worldwide, according to Johnson.

In a sovereign debt crisis, Johnson expects the dollar’s value to rise dramatically against all other assets and suck up the liquidity of foreign currencies. As the dollar rises, global capital will flow into the United States, so American markets would have plenty of liquidity, but markets globally could see a severe credit contraction.

Ultimately, this forces vulnerable countries to either print more of their own currency to obtain dollars (which can lead to hyperinflation), or adopt the US dollar as their base currency. As this happens, the dollar and dollar-denominated assets rise even higher.

In other words, the USD will hoover up many foreign currencies and may cause a global currency crisis causing chaos in the global economic order.

This is the risk that very few people see coming as most investors seem to lean towards the Ray Dalio camp of the dollar falling in value relative to other major currencies.

Do you have a plan for a rapidly rising dollar? What kind of probability would you assign to the Dollar Milkshake Theory unfolding as Brent Johnson sees it?

Learn more about the Dollar Milkshake Theory here.

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QUOTE OF THE DAY

“If there was ever a company where it was dumb to worry about a single quarterly result, it’s Amazon. This is a company that has remade two industries in the last 20 years, all while showing a lordly disdain for short-term profit. If you like the big story at Amazon, a terrible quarter is nothing but a buying opportunity.”

–Robert Armstrong

 

Meaning

Robert Armstrong is a notable value investor who runs one of our favorite investing newsletters (besides this one of course), Unhedged.

In discussing Amazon’s equity valuation, Armstrong uses the above quote to highlight that, time after time, those who have bet against Amazon have been wrong.

The company is a remarkable case study in innovation, growth, and perseverance. But does that mean the stock is a good buy?

Well, because of Amazon’s proven track record, and fast-growing businesses like Amazon Web Solutions (AWS), investors are happy to pay a premium to own such a quality business, which means it trades at around 50x next year’s expected earnings. This is not a level that we would typically call “cheap.” Then again, the stock is down from an almost $2 trillion valuation last year, to now a $1.2 trillion market capitalization and carries no net debt.

One approach to valuing the company is to break down Amazon into its distinct operating businesses, value those independently based on their cash flows and growth with respect to the multiples that peer businesses trade at, and sum the parts back together.

Based on an approximate net income for AWS of $16.5 billion in the last 12 months, and conservatively sticking on it the same multiple (45x) as Salesforce which isn’t growing as fast, then this unit is worth approximately $740 billion.

Next comes valuing Amazon’s retail business, which Armstrong concedes is quite tricky, given that the online retail spending boom which transpired during the pandemic makes year-over-year comparisons tough while providing uncertainty as to how much growth is still possible over the coming years.

Armstrong goes on to say that Amazon’s retail business is likely worth at least as much Walmart at $390 billion, which means the stock is increasingly trending towards fair value territory, and may even be cheap depending on how optimistic you are about its core operations continuing to grow.

Amazon’s story will continue to unfold over years, and more likely decades, rather than quarters. We continue to be very impressed by the company, but it’s more tricky to decide whether it’s a good buy right now.

For these sorts of questions, we like to use our intrinsic value tools over at TIP Finance to project out and discount free cash flows. Give it a try (for free), and let us know what you think – Is Amazon’s stock cheap?

 

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SEE YOU NEXT TIME!

That’s it for today on We Study Markets!

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