Markets on Markets
Charts, Netflix, Housing, & 90s Rappers
Happy Sunday, DYD team!
Great to be back with the Markets on Markets. Just wanted to give a special thanks to all those who reached out with comments and criticisms on the format and style of writing within the last edition. Your insights are pure gold, and at the end of the day, we want this newsletter to be the best it can be for all of us.
So keep ‘em coming! Let me know what you like, hate, or think is completely wrong. But enough dilly-dallying (dilly-dallying? is it 1964 again?), let’s dive in.
The Dow may have had it’s biggest drop since 2020 last week, but hey, at least we got to celebrate 4/20 and Marathon Monday (if you’re with me up in the North East, that is). It wasn’t all bad, but JPow’s hawkish rate commentary on Thursday made sure the week ended bad. Along with that, we saw Netflix completely take a dump while a slew of other companies, including the likes of Tesla and Verizon, kept the earnings party going.
There’s a lot going on out there, but look no further to stay on top of what’s most important.
There’s really only one ticker out there that’s worthy of our attention this week.
Following in its user’s footsteps, Netflix spent way too much time endlessly scrolling down last week. Shares ended the week with an -36.6% return, and we have to take about it.
Not just because of how garbage shares looked following last week’s earnings, but because the market’s reaction, in this case, is maybe the ultimate embodiment of the post-COVID stock market.
But first, the numbers. You would never know it, but last quarter’s performance was really not that bad. EPS came in higher than Snoop Dogg, delivering $3.53/sh while investors only wanted $2.89. On the other hand, revenue came in a bit light, soaking up only $7.87bn vs $7.93bn expected.
At the same time, free cash flow spiked to $802mn despite heavy CapEx spending, representing a ~16% jump from last year. But, as you know, literally no one cared. There’s an elephant in the room and he goes by the name of subscribers.
Or more specifically, a lack thereof. “Global net paid subscriber additions”, which in English translates to “subscriber growth”, went negative for the first time in over a decade, leading to the loss of over one-third of the firm’s value. Following a pullout from the Russian market, Netflix waved goodbye to over 700,000 members while the rest of the world only delivered 500,000 subscriber additions. Ultimately, we can use basic math to see that amounts to the -200,000 figure everyone’s throwing around.
But if you can believe it, that wasn’t even the worst part. Guidance often carries greater prominence in immediate price action following earnings calls, so when Netflix hinted at their expected loss of 2mn subscribers next quarter, the market vomited. If that prophecy came to fruition, that’s a ridiculous 10x in the amount of subscriber losses compared to this quarter. While much of that is likely priced in already, if shares fall at the same magnitude, we can expect a single-day loss of over 350%. Look out below.
But still, Netflix retains 222mn subscribers around the world and detailed on the call plans to introduce an ad-supported version of the streaming service as well as a soon-to-come foray into the gaming space. The negatives certainly outweighed the positives last quarter, but the market’s digestion of the news seems…irrational.
Sure, if you hold the view that Netflix’s future free cash flow growth is entirely dependent on quarterly net subscriber additions to their streaming service, then yes maybe a more than one-third cut to their valuation makes sense. My view would simply be this is the epitome of the post-COVID market’s tendency to react violently to any unexpected detail thrown its way, whether it be good or bad. Markets move a lot faster these days, and although I wasn’t in the game until 2018, the boomers tell me this is unprecedented.
Blame algos and HFT all you want, but there are two other factors related to the sheer magnitude of market moves brought in by COVID. First, the Fed’s money machine was ramped up to 11, adding previously unfathomable amounts of liquidity and allowing markets to flow freer and faster than ever before. Second, retail traders have entered the chat. Compared to institutions, retail traders (keep in mind I am one) are not exactly the smartest bunch. It’s hard to make an argument against the fact that added liquidity and retail eyeballs would cause an increase in volatility and magnitude, and that’s gotta be playing a large role here. I mean, 35% loss?? Over losing 0.09% of their customer base?!? Gimme a break.
Moreover, the company has plans for the first time to expand material revenue beyond simply a once-a-month subscription fee. The password-sharing charge seems like a no-brainer, as no good company has ever let their brand and intellectual property run as loose as Netflix does right now. And guys, Squid Game season 2 is coming soon, and although I’m 100% sure it’ll be hot trash, you know everyone’s gonna have to tune in.
As you’ll see below, I’m hella bullish on this name (in the long-term), so be sure to let me know why I’m wrong.
The Housing Conundrum
Rates and prices and sales - oh my!
Apologies for that cringe I just gave you, but unfortunately, there’s no better way to size up the current state of the housing market. And last week, the picture only got more complicated.
Here’s a stat to ensure the craziness has fully sunk in: according to Fortune, March homebuyers on average paid 20% more than those just two months earlier - and a massive 38% more than their one-year-ago counterparts. Wow.
The largest contributor to that egregious growth has of course been our friend JPow and his rate hike mischieve. Not only have Powell and the FOMC already doubled the Fed’s base rate, but they’ve also indicated plans to double rates again in May. Now, it is true that those “doublings” include last month’s jump from 0.25% to 0.5% and, presumably in May, a 0.5% to 1% jump, which might not seem like much. But keep in mind it is the degree of the change that matters more than the absolute value.
And that’s how you get charts like this. The 5.11% average 30-year fixed mortgage rate is not completely absurd in the grand history of U.S. housing, but it is the highest we’ve seen in about a decade. Further, just observe the slope since 2H’21 - looks more like $GME last January than boring ol’ mortgage rates.
In the normal world, rate increases generally lead to slowing house price appreciation (not declines, just slowed growth). But Americans are so damn house-deprived, thanks largely to FUD from developers around building too many homes following a little thing called the GFC, that homebuyers are largely taking all that extra $$$ created during the pandemic and YOLOing it on the first decent house they find.
As a result, the supply/demand dynamic has thus far been much stronger than any hesitations created by rising borrowing costs. Rates are high, but demand has been so much higher. And just a few weeks ago, we learned via the Case-Shiller index that home prices entered 2022 on an absolute trip, rocketing 19.2% in January after previously setting mutlitple growth-related records earlier in the year.
When that roller coaster ride looked to be nearing its peak, many economists began to predict a tapering of housing demand in the latter half of 2021. Turns out, that slowdown didn’t actually kick in until February, with existing home sales falling for the first time in months. And last week, we learned the trend continued in March, registering a decline of 2.7%.
But even still, home prices rose. Those existing homes saw their average sale value accelerate to $375,000, a monstrous 15% annual gain. I don’t know about you, but my Macro classes never mentioned anything about slowing demand and rising prices.
The weirdest part of all, however, might just be how equity markets have reacted. Housing related stocks like Zillow and Opendoor have gotten nothing but slaughtered while demand for their services only skyrockets, exemplifying just how lethat the rotation out of growth stocks has become. Meanwhile, homebuilers like Lennar and D.R. Horton trade at dirt cheap earnings multiples of around 6x.
Moral of the story: the U.S. housing market is gross. If you’re in the market for a home now or anytime in the next forever, all I can say is good luck.
Chart of the Week
Who would’ve thought - in a period immediately following a once-in-a-generation pandemic combined with the highest inflation since the Iran Hostage Crisis, a war in Europe, mangled supply chains, and a nationwide decline in beer drinking - that investors would be feeling a little depressed right now?
You’d have to be a genius to make that call. Nevertheless, that’s the situation we find ourselves in when it comes to public equity markets. Each week, the American Association of Individual Investors (AAII) takes a survey measuring the collective mental health of retail investors. And as of recently, it’s safe to say that they’re feeling almost as insecure as Parag Agrawal about his performance as Twitter CEO.
I mean, just take a peek at this chart:
You might notice we’re not doing so hot on the whole bullishness thing. Even 4/20, a national holiday arguably bigger than Thanksgiving, couldn’t cheer us up.
And in fact, that 15.8% “Bullish” reading is the lowest since 1992, which is also the same year that CD sales surpassed cassette tapes for the first time (not that I know what either of those things are). Meanwhile, bearishness has stormed past its historical average in the past three weeks, suggesting that the whole 8.5% CPI report really took a toll on investor vibes.
And why wouldn’t it? No one likes seeing higher prices at the grocery store, assuming there are groceries to buy. But, it helps to keep in mind that humans are stupid and fall victim to things like “illusory superiority”, a psychological effect that causes us to think we’re better or more well off than other people. So, it’s not uncommon for consumers to think “I’m doing fine myself, but damn the economy is a mess.”
And this effect likely plays out in the minds of investors as well. If that’s not good enough, maybe knowing that, according to the AAII, in both the 6 and 12-month periods following an unusually low “Bullish” reading, the S&P tends to outperform both its average and median annual returns. Still not good enough? Well, the same effect happens following unusually high “Bearish” readings, and right now, it’s a classic double whammy
Hot Take of the Week
After Wednesday’s disgusting 35.1% drop following Q1 earnings, the conversation among investors is (temporarily) focused on how horrifyingly low Netflix’s subscriber growth has become. That’ll likely stick around for a bit, especially given guidance for -2m net adds in Q2. However, I see this as partially a macro-induced hiccup and partially the result of increasing industry (over)saturation rather than a structural, long-term issue with the fundamentals of the firm.
Tuesday’s earnings were kind of like when Tom Brady loses a game - sucks for now, but you know he’ll be back on top soon. On Thursday, extra salt was dumped into the firm’s open wound in the form of HBO announcing the addition of 3mn subscribers last quarter.
But here’s the difference. First, HBO only has 77mn global subscribers, about one-third that of Netflix. Obviously, growth is easier when you’re at the bottom. But, recall that HBO and AT&T had a lot going on this quarter. The finalized merger between Discovery and WarnerMedia likely attracted outsized user growth from the abnormally large amount of coverage the firms received. But most importantly, even with that growth, WarnerMedia’s operating income dropped 32% over the period (shoutout CNN+).
And to me, that’s the key difference. Netflix, despite losing 200,000 subscribers, more than tripled its operating income over the same period. Sales grew around 9% year-over-year and management was emphatic that sales and margins would continue to improve throughout 2022 despite anticipated subscriber growth. It’s far too simplistic to analyze Netflix with a primary focus on subscriber growth - monetization of those users, customer satisfaction, and (call me crazy, but) actual financials matter too.
And I mean, Netflix has…
A clear leadership position in the industry
Sky-high NPS scores (higher than Amazon) and retention rates
A wide moat through the ability to bring local content to a global stage
Name recognition and first-mover advantage
Some of the industry’s best data and analytics
Intentions to increase monetization through password-sharing charges
Plans to enter other lucrative business lines like digital ads and gaming
And a whole lot packed into the content pipeline
Lastly, I don’t have to tell you all that if any company has proven itself capable of a full-scale pivot into a different business model, it’s Netflix. Does anyone remember those mailed DVDs? Yeah, me neither.
So what do you think? Is this a falling knife, or the biggest BTFD opportunity of the year? I got in on Wednesday at $221, so please feel free to roast me as much as your heart desires.
(Strat here) - I actually disagree with Mr. Aurelius here and will detail some of the reasons why our dear writer deserves the roasts in the company deep-dive that is coming out tomorrow morning!
(Markets again) Strat eats crayons.
The Week Ahead
Like we said at the beginning, there’s a slot going on out there. Who knows what the overlords have in store this week, but all we can say is this is what we’ll be watching:
Earnings: Twitter, Facebook, Apple, Amazon, Microsoft, Google, Coke, T-Mobile, Intel, Robinhood, McDonald’s, Caterpillar, Mastercard, Visa, Ford, PayPal, Qualcomm, and Chipotle all report this week (to name a few).
Macro: Core PCE, Advanced GDP Readings, Durable Goods Order, and Personal Income data get released.
17-years ago yesterday, the first YouTube video ever was uploaded to the platform
Investors made more with Ethereum than Bitcoin last year (and that’s still pre-merge)
Honestly, I’m over this already, but the entire world is still freaking out. Elon Musk has roughly $46bn in funding secured (for real this time)
JPow pulled a Larry David and just came out and said exactly what we’re all thinking
The IMF certifies itself as a bonafide hater of the global economy, lowering growth estimates to 3.6%
Nick Maggiulli complicates the inflation picture even more by keeping things simple
Elon Musk really doesn’t like short-sellers, even if they’re trying to - I don’t know - end child starvation or cure cancer
Much like a delinquent 9th grader, American Airlines just can’t wait for summer
In its path to conquer the world, Amazon has decided to help some homies out
Brian Armstrong and the besties of the All-In pod toe the line of full cancellation
Nick Maggiulli is getting a lot of attention this week, as I just bought his new book “Just Keep Buying”