Momentum traders have been aggressively buying tech stocks and as they do this creates a "short squeeze" where bears or short sellers panic adding fuel to the fire. In a short squeeze, short sellers panic and buy to cover to cut their losses. We are taught that the value of any company is the present value of all future cash flows. But this rule of measurement is often thrown out the window when it comes to FANG stocks. Netflix's recent earnings release showed the company as reporting negative free cash flow of over $2 billion. Not only that, but the company projected negative free cash flow of $3 billion to $4 billion for 2018. This means Netflix has a cash burn equal to the entire market capitalization of some mid-cap companies yet Wall Street reacted with a stunning 13% surge in the stock.
|FANG Stocks Have Been The Momentum Behind This Market!|
Part of this boils down to greed and that investors tend to get caught up in the emotional hype that the value of a growing company will continue higher and higher so they should get on that train and ride it all the way to the station. At the same time once aboard they delude themselves of the reality of new competition, market setbacks, and the possibility as the company matures its stock will be brought back into line with the market in general. We should never forget that even the tallest trees never grow to the sky and that at a certain point growth slows.
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The fact is nobody can really predict what the future holds, however, it is difficult to deny a strong case for caution can be made in that the recent psychology of this market aligns well with that of a blow-off top. A key requirement of such a market is that almost all the participants are in complete denial of the risk they face and have borrowed strongly against their future to join in to get a share of the bounty that lays before them. This means not only do they accept the current sky-high valuations as rational but see a great deal of room for earnings to expand as the pace of global growth accelerates.
Circling around to the title of this piece, FANG Stocks Have Potential To Really Bite Investors, it is logical that these so-called bright spots that have pulled the market higher also have the most room to fall as valuations retreat. Today there are signs that central banks are becoming more concerned about asset bubbles growing as a direct result of their promoting the belief they will always be there backing economies with newly printed money. All this has driven a massive surge in debt across the globe as consumers, businesses, and governments have thrown caution to the wind setting up a scenario that ends in tears.