A caveat: for those more accustomed to, and more interested in, the usually more philosophical, theological or sociological nature of The Diaries, you may want to skip this post. It’s about finance and economics and more technical than usual. Just a heads up. If you do decide to venture in, I will clarify a bit more than usual regarding the economy and investing world to give context — so another caveat, this one for those who are already well versed in all things finance and investing: you may find the first few paragraphs a bit elementary… feel free to skip ahead, but hang on and stay in. This one’s for you and there are worthy takeaways to be had.
The investing world is abuzz with Silicon Valley again and it has been for a number of years now. It feels like 1999 all over again. Both the American and European stock markets have been on a tear — in what is commonly called a “secular bull market” — for almost six straight years. People who are active or even passive investors in “the markets” have been making money hand over fist from doing absolutely nothing but just staying invested. It’s an odd paradoxical dichotomy — and it truly is — that as the American economy continues to drag and sputter, making financial abundance, or even stability, seem increasingly unreachable for the majority of Americans still, the top 1% have been doing incredibly well in “the markets”. This paradox is well known amongst the wealthiest in the country. It’s not a mystery or an unknown. It’s very well known, sad as it is, amongst the people who are making all the money. It’s a given. And there are very specific reasons for it.
One might remember investment guru Warren Buffet commenting a few year ago how ridiculous he thought it was that he pays less tax annually than his secretary does. This surprising statistic is simply due to the fact that the common bread earner in the United States pays a much higher tax on their “income” i.e. the money they earn from their job, than an investor does on the profits he or she makes in any kind of investment. That tax — known as the Capital Gains Tax — is capped at 15%. What this means is that whether you made $100 from your stock market investments last year or $1,000,000, you’re still only required to pay 15% tax on it. With the right kind of finagling — owning a few corporations that make big money — enough to fund even the most lavish lifestyles — but somehow mange to “not make a profit” but instead make a loss (and this is more common than the average person realizes…) and you can even reduce that measly 15% capital gains tax further down and come out paying Uncle Sam next to nothing, as in ZERO. You just have to know the game and how it’s played.
But this post isn’t about that. Perhaps one day we’ll go into further details about this sad but true paradox, because I must admit I do receive a fair share of requests from folks begging me to explain to them how on earth one is capable of making hundreds of thousands of dollars a year and paying next to no tax on it. It’s not as hard as most people think. In fact it’s quite easy. Again, you just have to understand how the system works. So yes… perhaps we will get into it one day… But today is not that day.
Another reason for this strange upside down economy is due to Federal Reserve policy. “The Fed” as it is commonly referred to is a large private cabal of banking cartels who control the monetary policy and the money supply of the United States. The funny thing is that the Federal reserve is NOT “federal”; they are not a branch of the U.S. government. They don’t work for the U.S. government. They answer to no one. But they make all the rules. (This is truly a whole book unto itself, let alone too much for even a series of posts — so one is encouraged to take some time to research this incredibly vexing scam…) In a nutshell this organization that controls all things monetary — think the economy — is the primary entity that loans the United States the money it needs to continue to operate. When you hear terms like the national debt or national deficit, this debt is owed to this company known as The Federal Reserve; they being a private bank who exist solely to make money charges the U.S. interest on the money it lends the country, just as any bank does; thus in a way one could say that the Fed has a vested interest in seeing the United States economy do well — at the moment the U.S. owes a staggering amount of money to this organization, something to the tune of 17 TRILLION dollars.
In exchange for all the money The Fed loans the United States to stay “in business” so to speak, the United States government allows the Fed to do just about anything it wants to — including for example keeping it’s books private and sealed. One might have a recollection of a few years ago when then-presidential candidate Ron Paul (remember him?) tried to pass a Bill in Congress to force The Fed to allow the U.S. government to see it’s books — as in take a look at its accounting records. This would seem to be rather a no-brainer, right? All public companies are obligated to make their accounting records open and available to the public — how much money they have, how much debt they have, how much money they are making in gross revenues and net profits, etc. etc. But The Fed is no regular “public company”. It’s ironic if not downright terrifying that 99% of Americans do not even realize that The Federal Reserve is not only NOT part of the federal government, but they are so private that no one in the United States government is even allowed to look at it’s books. The word shocking comes to mind. But terrifying fits the bill even more appropriately considering how much power this private group of banks has over the health and wealth of the whole country.
So how much power DOES this private group of banks have over the United States? Put it this way: The Fed has the ability to say yes or no to the United States government regarding how much money it loans them or doesn’t — as in any day they can collapse the American economy or continue to allow it to wrack up more debt. It’s all in THEIR hands and truly no one else’s. They also of course have the power to set monetary policy in general — this is why it is a fool-hearty idea to ever blame a good or bad economy on any American president, for they simply don’t have much power in regards to the economy, but that doesn’t stop most people from still doing this. The primary thing the Fed does in regards to “setting monetary policy” is they decide what the lending rate is at any given time in the American economy. At the moment it is set roughly around -0-. This is the rate of interest that banks can charge each other to borrow money from one another. This “prime lending rate” has a great influence on all the other interest rates in a healthy first-world society such as mortgage rates or car loan financing interest rates or the interest one receives from investing bonds or savings accounts or bank CDs.
You might have heard the term QE bandied about over the last few years. QE stands for Quantitative Easing, which was the Fed’s fancy term for lowering the prime lending rate down to a record low AND at the same time temporarily loaning the U.S. billions of dollars by buying various bonds from the United States and various other banks — they did this in order to “stimulate the economy”, as a means to get people spending again and to get banks loaning money to people again. So far it hasn’t worked out as well as many hoped it would. BUT to be fair it did at least according to general agreement amongst most experts save the country from sinking into another Great Depression from our recent Great Recession (the recent economic crisis we experienced in 2007 and 2008).
What this policy did do though was stimulate the hell out of the American stock markets. By lowering interest rates down to near -0-, people with money had no other choice but to invest their money in the stock markets — simply because they couldn’t make any money with their money from investing in anything else. Savings accounts, bonds and CDs offered zero to almost zero return, i.e. interest. If you add in even a small amount of inflation — the price of goods increasing compared to the value of the Dollar, and one would actually LOSE money if they had invested their money in a savings account, bond or bank CD due to how low the interest received was. So people with money jumped into the stock market.
This is what has created one of the strongest and longest running bull markets in American history. More and more money has poured into the markets and as long as this mysterious organization called The Fed continues to keep interest rates LOW, then people assume that the stock market will continue to go up. From the outside, from the view of the average American who doesn’t bother to pay attention to monthly and quarterly economic data, things still seem rather bleak to be sure. Unemployment has supposedly declined, though many doubt this claim. Jobs still seem few and far between and raise and promotions seem a fantasy of days long gone by for most.
Except in the world of finance that is. You see, every time we have economic data — the investing world holds its breath: if the data is GOOD, the markets tank, as an improving economy would compel the Fed to start raising rates again which could signal the end of the bull market. So instead people who are heavily invested hope that the data is BAD. In the world of investing this is known as the “bad news is good news” paradigm and without fail every time any economic data comes in that is “bad” for the average American, you can hear and see high fives flying around Wall Street like wild fire. It’s an upside down situation to be sure. Instead of the stock markets flying high due to a healthy economy, it continues to fly high due to hopes that the economy stays bad. This will keep rates low and insure that more and more money will continue to flow into the markets. Again this may sound shocking to the average person, but it’s not exactly “news” to those who invest their money for a living rather than work a regular salaried job. Frankly yes it’s easy to see why anyone first learning of this closely guarded bit of data would claim that it’s fucked up. It is.
In a nutshell there’s your lesson in finance and econ for the day. Now on to the main point of this post.
Today we are going to focus our attention on the Social Media sector of the investment world. [Again just for those who may not know this: the investment world is divided into sectors FYI. There are many of them and savvy investors are familiar with them all. For example there’s the Semi-Conductor sector (what we refer to as “the Semis”), the Consumer Discretionary sector (Tiffany, Coach, Whirlpool — basically anything that is not essential to the consumer but is purchased when the consumer has discretionary money laying around…), there’s the Oil sector — which is further split between the Refiners and the Oil Services companies, and on and on it goes. Believe it or not, once you enter this world — as with any — it becomes very easy to memorize all the various data points, statistics and acronyms.]
Two sectors that have been red-hot over the last few years have been the Technology sector (usually referred to as “Tech”) and the Social Media sector (often just referred to as simply “Social”). Companies like Facebook (FB), Google (GOOG), Twitter (TWTR) and Yelp (YELP) are all part of the Social Media sector and even the most distanced individuals have surely heard the stories over the years about the ridiculous amount of cash people have been making from investing in these “hot companies”. Silicon Valley is on fire at the moment, with venture capital spending reaching all time highs once more pouring money into the latest start-ups hoping that they can eventually turn them into the next Facebook or YouTube.
The word on the street for these companies is Unicorn. You may have even heard the word bouncing around lately as it is one of the many newest trending in the social media world. A Unicorn is any super hot start up company that is raising a ton of investment capital — usually to the tune of one billion or more — in the Valley with the intention of eventually going “public” — all long before the company starts actually making money. The companies just have to show growth in their user base and their “potential” to make money and people will throw millions upon millions of dollars at them. A few of the hottest Unicorns at the moment are Uber, AirBNB, and Pinterest. Yes from the inside it all appears just as blatantly stupid as it does from the outside. But this is just how the markets work. They are completely irrational, as they always have been.
At this very moment analysts and traders on CNBC’s midday show Halftime Report are all discussing the Social Media sector. Primarily because during this latest earnings season social media companies have been getting clobbered. After running up to more than $85 a share Facebook is now trading below $79. Twitter dropped from $55 a share to $38 in one day — you have to imagine having say a million dollars of your clients’ money invested TWTR and having that figure lose almost half of it in less than 24 hours to really understand the ramifications of such a dramatic drop. YELP not to be left behind performed the worst out of all of them so far, dropping from a high of $85 earlier this year to a measly $39 as of today’s trading session — losing 22% of it’s value in just one day and more than 50% from its highs of the year. When you contemplate the insane amount of money invested in these companies by hedge funds, money managers and investment banks — in the case of YELP, a smaller player, we’re talking billions of dollars invested, you begin to fathom just how much money that is to lose in such a short period of time. LinkedIn was the latest social player to kick the bucket: In one day their stock fell from $250 to $203, a 20% loss in less than an hour.
But why? WHY are social media companies taking such a beating? All the talking puppets on CNBC, Bloomberg and FOX Business News continue to talk about these companies with big smiles on their faces as if they are viable investment vehicles — no one ever saying what would be clearly obvious to even the least educated in business and finance: the American consumer is sick and tired of being advertised to, and social media companies make their money, or at least they’re supposed to, from collecting advertising revenue. You see, once upon a time Facebook made mention that it might start charging for it’s services — charging the everyday user to have a Facebook profile and communicate with their friends and family on a regular basis. The backlash could be heard in places as remote as the Himalayas! The week they made this announcement, as ironic as it may seem, the FB newsfeed was filled with posts advertising that the BAN FACEBOOK DAY was soon upon us as everyone and their brother announced that they would not stand to pay a single penny to use Facebook and they would immediately jump ship if such a fee was ever initiated. And that was the end of that idea. Facebook learned a valuable lesson from that stunt — people may love you if you’re free, but that doesn’t mean they have any intention of giving you any of their hard earned money. They don’t love you like THAT.
It turned out that Facebook was not as essential as it thought it might have been and thus they had to go back to the drawing board to figure out just how they were going to actually generate MONEY. See, Facebook WAS hugely successful in terms of it’s popularity amongst users. At one point it reached one BILLION users globally. That’s a phenomenal figure when you consider it for a moment: it translates to almost 20% of every single person on planet earth having a Facebook account of some kind. But the company didn’t make any money. The average person on the street, struggling to just pay their monthly bills always has a tough time understanding concepts like this: how can a company be as big as Facebook (or Amazon or Yelp or Twitter for that matter…) but not actually make any money?!? It seems illogical. And in reality it is. The truth is that these companies BORROW the money they have from what you commonly hear referred to as “angel investors” or venture capitalists. They then use that money to grow their business with the hope that one day they WILL make money… Some do. Many never make it. Amazon — one of the largest companies in the free world still operates at a loss every year. Yep. It’s true. They bring in billions of dollars a year in revenue. But every year they report not a profit but a LOSS, meaning that they spent more than they made. How is this even possible? Simple. They borrow more money and go further into debt based on the idea that one day they actually will make a profit. It’s a funny business. One that just about any average American would love to be able to take advantage of in their own personal finances to be sure. Problem is, banks and venture capitalists aren’t interested in you or me and our ability to pay our bills or even have enough money to eat for that matter. Instead they are interested in future profit potential. That’s life in a nutshell. As unfair as it is, that’s just how it is. You’d have a better chance at borrowing money from a bank — millions even — if you presented them with some dumb idea that showed that you could have half a million “users” by year end 2016 than you would just asking them for money to put food on the table or pay your mortgage. It’s capitalism.
So where were we? Ah yes, Facebook. So here’s Facebook, a simple idea, a dumb idea, at best a rip off of MySpace (remember them?) who was a rip off of Friendster (remember THEM?) showing tremendous growth in “users” but no way to make money from these users. So how to monetize all these users? That was the question…. This was back in the days when Facebook had swept Wall Street by storm by going public and seeing it’s stock price go from $16 to $45 in one day and then having it quickly fall back to $17 where it stayed for a few years, leaving many investors sorry they ever heard of the name. Imagine that kind of a loss in your retirement portfolio. Eventually Facebook got smart and created a very simple advertising vehicle for any and every one to use — a way for users to advertise to each other. “Here’s my Page. Like it!” It didn’t cost that much, you could set the amount you wanted to spend each day, and you could actually see your little ads pop up on the side bar of your Facebook screen now and then. It felt good. And it seemed to generate actual results. It was similar to buying an ad from Google to get more traffic to your website. And we all know how well Google had done… Facebook is presently worth about $178 BILLION dollars. Google is worth roughly TWICE that.
So began the great social media company frenzy. It was 1999 all over again. All a company had to do was show that it could grow its user base, forget about making money or generating a profit, and the investment dollars poured in. Twitter soon leaped onto the scene and ran up to $55 on it’s first day going public from a starting price of around $16. This valued Twitter at about 35 billion dollars overnight. For a company that wasn’t even making a billion dollars a year, nor anything close to it. But it was all about the user growth. Twitter still operates at a loss — meaning that it loses money every year rather than makes it. How would you like that kind of job? TO get paid for losing money? But the pundits had valid points: Twitter WAS popular. People did seem to have a valid interest in and excitement about it. The problem was and still is that that excitement is fleeting. Today’s Twitter is tomorrow’s Snapchat or Tumblr. Remember them? Yahoo purchased Tumblr — and what exactly was Tumblr in the first place? a blog for kids? — for some FIVE BILLION dollars. There’s money they’ll never get back. And Tomorrow’s Snapchat or Tumblr is next week’s Meercat or Periscope. The landscape is constantly changing in the hands of the ever-fickle American consumer. The truth is that they really just don’t CARE.
And that’s the big disconnect between Wall Street and Main Street. The average person on Main Street has a life. Family problems, car problems, job worries, relationship woes… They could care less about Facebook or Twitter or Snapchat or Tumblr in the grand scheme of things. When’s the last time you heard anyone even mention Tumblr? But the folks on Wall Street don’t recognize this simple fact of life. These are minor trivialities in the hearts and minds of the average consumer, these “fancy websites” they call social media. They don’t put food on the table. They don’t even offer anything relatively substantial or of value that cannot be had elsewhere. NEW is much more exciting to the consumer than been there done that. It doesn’t mean that mom still won’t keep trying to Message you on Facebook this year. She probably will. But are you really even paying attention anymore?
Environments like Facebook and Twitter have continued to remain semi-entertaining and even useful at times when one has nothing better to do or when there’s big news we want instant access to… But when we’re in the mood for big news, we are NOT interested in ads clogging up our newsfeed. Nor are we interested in ads when we have nothing better to do than scroll through old friends’ attempts at wit or their latest selfie or cat photograph. Let’s face it, social media is fraught with meaningless drivel. Hence the shift back towards more meaningful content platforms like blogs or even texting.
Every social media company is reporting user growth increasing but revenues and profits shrinking. And the simple reason for it is because nobody likes being advertised to. The television world and Wall Street already recognizes this fact as more and more people shift away from traditional TV towards digital alternatives like Netflix or Hulu or flat out stealing online. This is the time of the great peregrination of the consumer away from advertising — why? Because we can. And in an environment like this, you better not have advertising revenue as your main means of generating cashflow or you’re going to be screwed. YELP is the perfect example. Yelp is actually a great tool. Nearly everyone has it loaded on their phone and loves it. The problem is that no one is willing to pay for it. (The music industry is going through a similar shift…) Yelp wants to generate revenue from selling advertising. But the users who use Yelp the most absolutely REFUSE to use Yelp if they believe that any of the data they are reading such as reviews are being influenced in any way by advertising dollars — in other words, people want to believe what they read on Yelp. They want to read ALL the reviews, not just the ones that some company has paid to place there, and they certainly don’t want to find out that companies are able to pay to have negative reviews removed from Yelp. What’s the point of the app then? See the problem? Yelp is basically fucked. A valuable tool with no viable way to make money.
Twitter god love it is in a similar position. I personally use Twitter all day as a means to receive notifications about subjects I am interested in ON MY PHONE. In other words, I set up notifications to come directly to my phone from Twitter about various different subjects or different individuals or even tweets that may mention me — the president of Iran will shoot out an interesting tweet now and then, and where else can one access such data but Twitter? But that doesn’t mean I ever scroll through the Twitter newsfeed or what they call their “Timeline”. The truth is I never do. The notifications come to my phone. I scroll through them. Get the basic gist of what was said. And I move on. All on Twitter’s dime. Or better put on the billions of dollars invested in Twitter by their investors. All without ever paying for Twitter and all without ever seeing an ad. Hell, like most people I’m downright annoyed and pissed off when I see an ad on Twitter. How dare they?!? And yet THIS is precisely how they intend on making their money! From advertising. It’s farcical when you really start thinking about it.
We have to begin to realize and acknowledge that we’ve reached a crossroads in the global economy. We’ve raised a whole generation on free usage based on the idea that we’d make our money from advertising — while at the same time weening them off of advertising on every other platform. There are hundreds of apps now on the market that REMOVE ads from Twitter and Facebook. And one would be right to believe that very soon there will be apps to somehow remove the ads from Pandora and Spotify as well — which is how those companies make the majority of their money as well since they’ve programmed whole generations to believe that music should be free — just about the dumbest thing one could think to do if MUSIC was the one and only product that you wanted to sell in your business. Again, we’re at this major crossroads where at some point soon, something has to give. Investors are going to learn sooner than later — just as they did in the dot com crash of 2000 — that they can’t keep pouring money into businesses who don’t actually make money. And businesses are going to eventually learn that you can’t run a business offering the main product you sell for zero dollars. It’s an illogical business model. And all it’s done is destroy more than one industry, the music business just being one of them. TV is next. Social media never really was in reality. And people are just starting to see that now as these once high flying stocks crash and burn.
As a sidenote with a potential solution, look at the companies who actually DO have a chance at making money. Out of the three Unicorns mentioned above, Pinterest is another Yelp waiting to happen. They’ll garner billions of dollars in investment capital and blow through it all in the hopes of turning all those bored moms and housewives into advertising clicking robots, only to realize that those bored moms and housewives aren’t any more interested in clicking on ads as the rest of us, and they’ll go belly up a year or two after going public IF Wall Street is dumb enough to take them there. But Uber and AIRBnB are different. Both of them actually SELL something besides advertising. Sure there’s a social aspect to both companies. That’s just the new normal — there has to be a social aspect to EVERYthing now. Eventually we’ll have apps where people post their latest and greatest bowel movements for others to see and rate. (If those already don’t exist, which I can’t with certainty…).
But the key is that the social aspect to both Uber and Air BnB is NOT the product itself. It’s a byproduct of the actual product. And that really is the key to this new environment. Social is key. But it can’t be THE key. There has to be an underlying product to be sold. And “to be sold” means to CHARGE MONEY FOR IT. Just as PayPal charges a few pennies on the dollar for every transaction, they’re offering a very valuable product — the ability to exchange money with freinds, family and business associates without ever leaving your home or office, or even your couch for that matter. All from the comfort and ease of your smart phone. That’s smart. Uber and Air BnB are doing the same thing. Small fees. Nothing fancy. But they’re actually making money. And isn’t that the reason to start and run a business in the first place? What companies like Yelp and Twitter are going to do is a mystery. They’ve screwed themselves from the outset with a faulty business model. As have companies like Spotify. The next few months and years are going to be ugly as this grand experiment fails and falls to pieces in rubble all around the feet of Wall Street and Main Street investors. People are already asking “are we in a bubble” everyday now… and truth be told, in the bigger picture of the investing world, no, not quite yet. But in the social media sector we’re beyond bubble territory. We’re in the sloppy frothy messy slime and sludge of a bubble already burst. Most just don’t see it yet. If you’re into shorting, now would be the time…