Month: August 2020

Authored by Charles Hugh Smith via OfTwoMinds blog,

The problem is the economy that’s left has no means of creating tens of millions of jobs to replace those lost as the 1959 economic model collapses.

Fundamentally, the economy of 2019 was not very different from the economy of 1959: people went shopping at retail stores, were educated at sprawling college campuses, went to work downtown, drove to the doctor’s office or hospital, caught a flight at the airport, and so on.

The daily routine of the vast majority of the workforce was no different from 1959. In 2019, the commutes were longer, white-collar workers stared at screens rather than typewriters, factory workers tended robots and so on, but the fundamentals of everyday life and the nature of work were pretty much the same.

Beneath the surface, the fundamental change in the economy was financialization, the commodification of everything into a financial asset or income stream that could then be leveraged, bundled and sold globally at an immense profit by Wall Street financiers.

This layer of speculative asset-income mining had no relation to the actual work being done; it existed in its own derealized realm.

For decades, these two realms—the structure of everyday life (to borrow Braudel’s apt term) and the abstract, derealized but oh so profitable realm of financialization–co-existed in an uneasy state of loosely bound systems.

If you squinted hard enough and repeated the mantras often enough, you could persuade yourself there was still some connection between the everyday-life economy and the realm of financialization.

The two realms have now disconnected, and the real-world economy has been ripped from its moorings, as patterns of work and every-day life that stretch back 70 years to the emergence of the postwar era unravel and dissolve.

The trends that are currently fatally disrupting retail, education, office work and healthcare have been in place for years. When I wrote my 2013 book about the digitized future of higher education in a low-cost union of high-touch and low-touch learning, The Nearly Free University, all these trends were already clearly visible to those willing to look beyond the models embedded in the economy for decades or even centuries.

Visionaries like Peter Drucker foresaw the complete disruption of the education and healthcare sectors as far back as 1994. Post-Capitalist Society.

The problem with this disruption is it eliminates tens of millions of jobs–not just the low-paying jobs in retail and dining-out, but high-paying jobs in university administration, healthcare, and other core service sectors.

The last real-world connection between everyday life and financialization was the over-supply of everything that could be financialized: the way to reap the big profits was expand whatever could be leveraged and sold. So retail and commercial space ballooned, colleges proliferated, cafes sprang up on every corner, etc.

Meanwhile, financialization’s unquenchable thirst for higher profits stripped everything of the redundancy and buffers required to stabilize the system in times of crisis. So hospitals no longer kept inventory because by the logic of financialization, all that mattered was maximizing the return on capital–nothing else could possibly matter in the derealized realm of speculative profiteering.

Now healthcare finds itself trapped between the pincers of financialization’s stripmining and the collapse of retail in-person demand–the financial foundation of the entire system. Under the relentless pressure of financialization’s stripmining and profteering, healthcare only survives if it can bill somebody somewhere a staggering amount for everything from office visits to procedures to hospital stays to medications.

Once that avalanche of billing dries up, the entire sector implodes: a sector that accounts for almost 20% of the U.S. economy.

Higher education is also imploding, and for the same reason: its output no longer justified its enormous cost structure. The same can be said of overbuilt retail and commercial space: the financial justification for sky-high rents have imploded and will never come back. The over-supply is so monumental and the collapse of demand so permanent, the gigantic pyramid of debt and speculative excess piled on all these excesses is collapsing.

A bailout by the Federal Reserve won’t change the fundamentals of the collapse of financialization; all the Fed can do is reserve scarce lifeboat seats for its billionaire banker-financier pals. (Warren, you know Bill, have you met Jamie, Jeff, Tim and the rest of the Zillionaire Rat-Pack?)

Despite the record highs in the stock market–the ultimate expression of financialization disconnected from the real-world economy–financialization is also imploding. Financialization still claimed a connection to the real world of income streams and the value of the collateral underlying all the speculative profiteering: the high rents paid by the restaurants on the ground floor and the businesses for office space above justified the high value of the collateral, the commercial building.

Foundational swaths of the real-world economy have been swept away, and so the collateral is largely worthless. Lots of people want their employer to start paying for business-class airline seats again so they can jet around the country on somebody else’s dime, staying in pricey hotels and attending conferences, but these activities no longer have any financial justification.

The economy of 1959 is finally expiring. The enormous time and money sinks of transporting humans hither and yon no longer have any financial justification.

The problem is the economy that’s left has no means of creating tens of millions of jobs to replace those lost as the 1959 economic model collapses. We all know that automation is replacing human labor, but the real change is the collapse of the financial justification for the enormously costly systems we now depend on to generate jobs: healthcare, retail, tourism, dining out, education, working downtown, and all the professions dependent on managing all this complexity.

While the elimination of low-skill jobs–a longstanding trend–is attracting attention, the implosion of the 1959 economic model and financialization will soon sweep away millions of high-paying professional jobs that no longer have any financial justification.

As the 1959 economy implodes, so does the tax system based on payroll taxes and property taxes. This article sketches out the perverse incentives for employers to invest in automation rather than hire workers: Covid-19 Is Dividing the American Worker (WSJ.com)

There are alternatives, but they require accepting the implosion of both the 1959 economic model and its evil offspring, financialization.

I sketched out an alternative way of organizing work, everyday life and finance in my book A Radically Beneficial World. There are alternative ways of organizing civilization other than the insanely wasteful and exploitative system we now inhabit.

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My recent books:

Will You Be Richer or Poorer?: Profit, Power, and AI in a Traumatized World ($13)
(Kindle $6.95, print $11.95) Read the first section for free (PDF).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($6.95 (Kindle), $12 (print), $13.08 ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 (Kindle), $8.95 (print); read the first chapters for free (PDF)

Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).

*  *  *

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.

Somehow, we missed this little easter egg buried in Palantir’s S-1, which was released Tuesday afternoon.

In what was titled a “Letter from Palantir’s Chief Executive Officer”, Palantir’s CEO Alex Karp lambasted Silicon Valley’s monolithic progressive culture ensconced within companies like Google-owner Alphabet, where employees have rebelled against the company’s work for the DoJ. In the letter, Karp defended Palantir’s government work, and challenged the Silicon Valley “elite” to try thinking for themselves for once, instead of kowtowing to every progressive whim.

“Our company was founded in Silicon Valley. But we seem to share fewer and fewer of the technology sector’s values and commitments,” Karp wrote.

Palantir’s decision on who to hire are among the most deliberative decisions made at the company, and Karp insisted that its hiring is geared around one principle: “the creation of effective software,” a prerogative upon which “our welfare and security depend”. Karp shared Palantir’s strategy of “flexible” leadership, and insisted it has helped the company tamp down on preening managers and egotistical “producers” who actually contribute little to the final product.

Karp directly takes American tech behemoths to task for their sanctimonious moralizing after they deliberately misled the American people about the true nature of their business models.

Our company was founded in Silicon Valley. But we seem to share fewer and fewer of the technology sector’s values and commitments.

From the start, we have repeatedly turned down opportunities to sell, collect, or mine data. Other technology companies, including some of the largest in the world, have built their entire businesses on doing just that.

Software projects with our nation’s defense and intelligence agencies, whose missions are to keep us safe, have become controversial, while companies built on advertising dollars are commonplace.

Finally, the letter directly addressed the company’s reputation as being on the innovative cutting edge of surveillance and spyware.

In a triumph of form and function, the most impactful part of the letter arrives at the conclusion, where Karp sets forth a new principle that clarifies the relationship between “the public” and its new technology overlords in Silicon Valley.

The world’s largest consumer internet companies have never had greater access to the most intimate aspects of our lives. And the advance of their technologies has outpaced the development of the forms of political control that are capable of governing their use.

The bargain between the public and the technology sector has for the most part been consensual, in that the value of the products and services available seemed to outweigh the invasions of privacy that enabled their rise.

Americans will remain tolerant of the idiosyncrasies and excesses of the Valley only to the extent that technology companies are building something substantial that serves the public interest. The corporate form itself — that is, the privilege to engage in private enterprise — is a product of the state and would not exist without it.

Our software is used to target terrorists and to keep soldiers safe. If we are going to ask someone to put themselves in harm’s way, we believe that we have a duty to give them what they need to do their job.

We have chosen sides, and we know that our partners value our commitment. We stand by them when it is convenient, and when it is not.

Karp doesn’t make himself widely available to the press or the public, which is one reason this letter is so important. Read the entire letter below:

* * *

Our welfare and security depend on effective software.

In times of stability, the right software helps our most critical institutions serve their markets and the public. In times of crisis, effective software can be essential to an organization’s survival.

Our software platforms are used by the United States and its allies around the world. Many of the world’s most vital institutions, from defense and intelligence agencies to companies in the healthcare, energy, and manufacturing sectors, rely on the software platforms that we have built.

The challenges that we face, and the crises that we have and will continue to confront, expose the systemic weaknesses of the institutions on which we depend. Our industrial infrastructure and manufacturing supply chains were conceived of and constructed in a different century. Government agencies have faltered in fulfilling their mandates and serving the public. Some institutions will struggle to survive.

Others will collapse.

Our customers come to us because their technological infrastructure has failed them. The enterprise software industry’s focus on custom software tools and applications is misplaced. Those approaches often only work briefly, if at all. The problems and needs of an organization often change before the software can even be deployed.

Our partners require something more. They need generalizable platforms for modeling the world and making decisions. And that is what we have built.

II.

Our company is a creative enterprise, filled with strong personalities who are immensely talented and care deeply about their work.

The culture of our company is more than a mere byproduct of the people we choose to hire. Our culture and means of organizing ourselves are preconditions for the creation of effective software.

We identify what needs to be done and organize ourselves around the outcomes that we hope to achieve. This requires that we stay flexible about who should be leading what and when.

At many organizations, employees spend their days, even their careers, posturing for others, concerned with claiming credit for success and avoiding blame for failure.

Entire companies can subsist for years on a business model that may have made sense at some point in the past. In the short term, there are often profits to be extracted from the enterprise, and from customers.

We have rejected this way of working. The alignment of interests between our employees and our company, and between our company and our customers, is one of the principal reasons we have come as far as we have.

III.

Our work and the use of our software present difficult questions.

The construction of software platforms that enable more effective surveillance by the state of its adversaries or that assist soldiers in executing attacks raises countless issues, involving the points of tension and tradeoffs between our collective security and individual privacy, the power of machines, and the types of lives we both want to and should lead. The ethical challenges that arise are constant and unrelenting.

We embrace the complexity that comes from working in areas where the stakes are often very high and the choices may be imperfect.

The more fundamental issue is where authority to resolve such questions — to decide how technology may be used and by whom — should reside.

Our society has effectively outsourced the building of software that makes our world possible to a small group of engineers in an isolated corner of the country. The question is whether we also want to outsource the adjudication of some of the most consequential moral and philosophical questions of our time.

The engineering elite of Silicon Valley may know more than most about building software. But they do not know more about how society should be organized or what justice requires.

IV.

Our company was founded in Silicon Valley. But we seem to share fewer and fewer of the technology sector’s values and commitments.

From the start, we have repeatedly turned down opportunities to sell, collect, or mine data. Other technology companies, including some of the largest in the world, have built their entire businesses on doing just that.

Software projects with our nation’s defense and intelligence agencies, whose missions are to keep us safe, have become controversial, while companies built on advertising dollars are commonplace. For many consumer internet companies, our thoughts and inclinations, behaviors and browsing habits, are the product for sale. The slogans and marketing of many of the Valley’s largest technology firms attempt to obscure this simple fact.

The world’s largest consumer internet companies have never had greater access to the most intimate aspects of our lives. And the advance of their technologies has outpaced the development of the forms of political control that are capable of governing their use.

The bargain between the public and the technology sector has for the most part been consensual, in that the value of the products and services available seemed to outweigh the invasions of privacy that enabled their rise.

Americans will remain tolerant of the idiosyncrasies and excesses of the Valley only to the extent that technology companies are building something substantial that serves the public interest. The corporate form itself — that is, the privilege to engage in private enterprise — is a product of the state and would not exist without it.

Our software is used to target terrorists and to keep soldiers safe. If we are going to ask someone to put themselves in harm’s way, we believe that we have a duty to give them what they need to do their job.

We have chosen sides, and we know that our partners value our commitment. We stand by them when it is convenient, and when it is not.

V.

The ability of our most vital institutions to protect and provide for the public requires the right technology.

And we believe that as a result, over the long term, the strength and survival of democratic forms of government do as well.

Alexander C. Karp

Chief Executive Officer & Co-Founder

Palantir Technologies Inc.

* * *

Source: Palantir S-1

Never to be outdone by its sell side competitors, the deep thinkers over at Wedbush (who just anointed Tesla with a $3,500 price target hours ago) have now slapped a ‘street high’ $700 bull case price target on Apple shares this morning.

The target comes after the NASDAQ has rallied to new all time highs nearly every day this month. Apple has similarly been on a tear, rising from about $370 to the $500 level over the course of barely a month. Apple is also up more than 120% off of its March lows.

Apple, like Tesla, has seen its shares helped along upward by retail investors buying them on news of a forthcoming split which, of course, adds no actual value to either company’s equity. 

But this run-up hasn’t stopped Wedbush from putting out the “most bullish view” on the stock out of any shop. Analyst Daniel Ives wrote that “a further re-rating of Apple’s stock is on the horizon as Cupertino heads into this transformational iPhone product cycle.”

He called Apple’s opportunity with the 5G iPhone a “once in a decade” opportunity – noting that the launch of the new phone comes at a time when “a significant percentage of worldwide iPhones are in the window of an upgrade opportunity”. Ives thinks that about 350M of the 950M iPhones globally are due for an upgrade. 

He has also said the company has seen “eye popping” growth in both wearables and its services business. 

Ives gave Apple’s services business a $950B valuation “given the increasingly importance of this key revenue stream that is getting new appreciation by investors.” He predicts AirPod unit sales of 90M this year versus 65M in 2019.

Apple’s stock split is set for August 31.

With the way shares have been moving, it’ll be time for another split as soon as this one has consummated…

Authored by James Rickards via DailyReckoning.com,

Central Banks Are Driving Gold

Gold as an asset class is confusing to most investors. Even sophisticated investors are accustomed to hearing gold ridiculed as a “shiny rock” and hearing serious gold analysts mocked as “gold bugs,” “gold nuts” or worse.

As a gold analyst, I grew used to this a long time ago. But, it’s still disconcerting when one realizes the extent to which gold is simply not taken seriously or is treated as a mere commodity no different than soybeans or wheat.

The reasons for this disparaging approach to gold are not difficult to discern. Economic elites and academic economists control the central banks. The central banks control what we now consider “money” (dollars, euros, yen and other major currencies).

Those who control the money supply can indirectly control economies and the destiny of nations simply by deciding when and how much to ease or tighten credit conditions, and when to favor (or disfavor) certain types of lending.

When you ease credit conditions in a difficult environment, you help favored institutions (mainly banks) to survive. If you tighten credit conditions in a difficult environment, you can more or less guarantee that certain companies, banks or even nations will fail.

This power is based on money and the money is controlled by central banks, primarily the Federal Reserve System. However, the money-based power depends on a monopoly on money creation.

As long as investors and institutions are forced into a dollar-based system, then control of the dollar equates to control of those institutions. The minute another form of money competes with the dollar (or euro, etc.) as a store of value and medium of exchange, then the control of the power elites is broken.

This is why the elites disparage and marginalize gold. It’s easy to show why gold is a better form of money, why it’s more reliable than central bank money for preserving wealth, and why it’s a threat to the money-monopoly that the elites depend upon to maintain power.

Not only is gold a superior form of money, it’s also not under the control of any central bank or group of individuals. Yes, miners control new output, but annual output is only about 1.8% of all the above-ground gold in the world.

The value of gold is determined not by new output, but by the above-ground supply, which is 190,000 metric tonnes. Most of that above-ground supply is either owned by central banks and finance ministries (about 34,000 metric tonnes) or is held privately either as jewelry (“wearable wealth”) or bullion (coins and bars).

The floating supply available for day-to-day trading and investment is only a small fraction of the total supply. Gold is valuable and is a powerful form of money, but it’s not under the control of any single institution or group of institutions.

Clearly gold is a threat to the central bank money monopoly. Gold cannot be made to disappear (it’s too valuable), and it would be almost impossible to confiscate (despite persistent rumors to that effect).

If gold is a threat to central bank money and cannot be made to disappear, then it must be discredited. So it becomes important for central bankers and academic economists to construct a narrative that’s easily absorbed by everyday investors that says gold is not money.

The narrative goes like this:

There’s not enough gold in the world to support trade and commerce. (That’s false: there’s always enough gold, it’s just a question of price. The same amount of gold supports a larger amount of transactions when the price is raised).

Gold supply cannot expand fast enough to keep up with economic growth. (That’s false: It confuses the official supply with the total supply. Central banks can always expand the official supply by printing money and buying gold from private hands. That expands the money supply and supports economic expansion).

Gold causes financial panics and crashes. (That’s false: There were panics and crashes during the gold standard and panics and crashes since the gold standard ended. Panics and crashes are not caused or cured by gold. They are caused by a loss of confidence in banks, paper money or the economy. There is no correlation between gold and financial panic).

Gold caused and prolonged the Great Depression. (That’s false: Even Milton Friedman and Ben Bernanke have written that the Great Depression was caused by the Fed. During the Great Depression, base money supply could be 250% of the market value of official gold. Actual money supply never exceeded 100% of the gold value. In other words, the Fed could have more than doubled the money supply even with a gold standard. It failed to do so. That’s a Fed failure not a gold failure).

You get the point. There’s a clever narrative about why gold is not money. But, the narrative is false. It’s simply the case that everyday citizens believe what the economists say (usually a bad idea) or don’t know enough economic history to refute the economists (and how could you know the history if they stopped teaching it fifty years ago).

The bottom line is that economists know that gold could be a perfectly usable form of money. The reason they don’t want it is because it dilutes their monopoly power over printed money and therefore reduces their political power over people and nations.

To marginalize gold, they created a phony narrative about why gold doesn’t work as money. Most people were too easily impressed by the narrative or simply didn’t know enough to challenge it. Therefore the narrative wins even if it is false.

In fact, central banks went from being net sellers to net buyers of gold in 2010, and that net buying position has persisted ever since. The largest buyers are Russia and China, but significant purchases have also been made by Iran, Turkey, Kazakhstan, Mexico and Vietnam.

Here’s the bottom line:

Central banks have a monopoly on central bank money. Gold is the competitor to central bank money and most central banks would prefer to ignore gold. Yet, central banks in the aggregate are net buyers of gold.

In effect, central banks are signaling through their actions that they are losing confidence in their own money and their money monopoly. They’re getting ready for the day when confidence in central bank money will collapse across the board. In that world, gold will be the only form of money anyone wants.

As confidence in the dollar is eroded due to Fed money printing and congressional super-deficits, investors will gradually look for alternative stores of wealth, including gold.

These trends begin slowly and then gather momentum. As the dollar price of gold really begins to soar, investors will take notice. Even more people will invest in gold, driving the price still higher.

Investors like to say that the price of gold is going up. But what is really happening is that the value of the dollar is going down (it takes more dollars to buy the same amount of gold).

This is the real inflation and the real dollar collapse most investors miss at the early stages.

Eventually, confidence in the dollar will be lost completely, central bankers will need to restore confidence, and they’ll turn to some type of gold standard to do so.

We’re a long way from that point right now.

But if central banks are voting with their printing presses in favor of gold, if the super-rich and their advisers are all jumping on the gold bandwagon, what are you waiting for?

Here’s a once in a lifetime opportunity to front run central banks and acquire your own gold at attractive prices before the curtain drops on paper money.

As the coronavirus outbreak continued to slow in the Sun Belt, and across the US (even the northeast is seeing new lows in hospitalizations related to the virus), our attention drifted back to India and the Middle East on Wednesday, and Europe as well.

Iran’s death increased by 119 on Wednesday to 21,020,  surpassing 21,000, according to health ministry spokeswoman Sima Sadat Lari, who told state TV the total number of identified cases had risen to 365,606, after 2,243 new cases were counted in the past day, up from 2,213 a day earlier.

Lari added that 2,243 new cases were identified in the past day in Iran, rising from 2,213 a day earlier.

“Unfortunately we have been facing a surge in coronavirus infections in recent weeks. I urge everyone to avoid unnecessary trips,” Lari said.

We imagine Iran’s neighbors would prefer Iranians to stay home, too.

It’s not Oxford/AstraZeneca, but the University of Cambridge, which is running its own vaccine project, has some news on Wednesday: it’s due to start vaccine trials in the coming months after securing government funding for the project. Speaking of the British Government, PM Boris Johnson reiterated his stance on children returning to school on Wednesday by saying that staying home would do them “more harm” than returning to school and risking  a spike in coronavirus infections.

UK Education Secretary Gavin Williamson defended the Johnson government’s overnight U-turn on mandatory face masks in secondary schools, after declaring last night that headmasters would have the leeway to decide whether to require pupils to wear them.

“What we’ve always said…this would be something that we’d keep under constant review,” Gavin Williamson told Sky News. “Then when we issued the further guidance for the full return of schools in early July, again we emphasis the importance of keeping this area under review.”

As if Myanmar’s long-suffering Rohingya Muslim minority hasn’t suffered enough, Myanmar health authorities reported the country’s largest recorded spike in new COVID-19 cases on Wednesday. Most of the cases were recorded in Rakhine State, where much of the persecuted Rohingya population lives in densely populated camps.

In India, Delhi continues to struggle from a new rise in coronavirus cases despite surveillance data showing that 30% of the city’s residents may have already been infected with the virus.

However, this latest outbreak comes weeks after what appeared to be a successful effort to slow the spread.

Delhi reported 1,544 new cases on Tuesday, taking the city’s tally to 164,071. The city currently has 11,998 active cases.

Over the past day, 1,155 people have recovered, bringing the total to 147,743 patients who have recovered in the city so far. Delhi reported 17 new deaths bringing its death toll to 4,330.

After issuing new travel advisories targeting fellow EU members, Germany on Wednesday said it would scrap mandatory free coronavirus tests for returning travelers, a measure introduced earlier this month. Citing capacity constraints at its laboratories, Germany said the policy had been enacted hastily as a spike in new cases stoked fears of a comeback that has yet to emerge, though daily case totals remain elevated. Rules about mandatory quarantines for travelers, however, will remain in place.

Elsewhere on the Continent, bars and restaurants in and around Marseille will be forced to close at 11 pm local time starting Wednesday night and the obligatory wearing of masks will be extended to the entire city in France’s latest attempt to quell a recent upswing in new cases that has focused on the country’s two biggest cities, Paris and Marseille.

More than 23.9 million people around the world have been diagnosed with the coronavirus, and 15.5 million have recovered. More than 819,000 have died, according to data from Johns Hopkins University.

After its initial spike back in May, Durable Goods Orders rebound has slowed and that deceleration of the ‘V’ was expected to continue in today’s preliminary July data, but instead saw a resurgence… rising 11.2% MoM (against expectations of a 4.7% rise).

Source: Bloomberg

Year-over-year, durable goods orders remain down 5.0%, but the “V” is filling in fast…

Source: Bloomberg

The headline beat was driven by a surge in defense orders and continued rebound in auto demand…

Additionally, core capital goods orders, a category that excludes aircraft and military hardware and is seen as a barometer of business investment, rose 1.9%, slightly more than forecast.

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

“Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, where the mania runs wild and prices go parabolic.”

– Paul Tudor Jones

From 1976 when Apple (AAPL) began in Steve Jobs’s garage to 2019, its worth rose to $1 trillion. Subsequently, from March 20, 2020, the trough of the COVID market crash, to today, the value increased by another $1 trillion. Over 44 years to hit the first trillion, and less than half a year for the second. Apple is up 240% from the March lows.

We consider ourselves value investors. That means we prefer to invest in companies that are “underpriced.” Over time, this strategy typically translates into better than market returns and a margin of safety. In our view, it offers a better risk/return profile. The graph below shows the value of this strategy over the last 80 years.

We own Apple, yet fully admit it is anything but a value investment. This article provides the opportunity to discuss Apple’s valuation and current market conditions that lead value investors, like ourselves, to own a very expensive company like Apple.

Apple Mania Running Wild

Is Apple worth $1 trillion, let alone the recently added second trillion? To answer this question, we share some well-followed valuation ratios and financial trends. The orange dotted line in each graph is its respective ten-year average.

As shown, valuation ratios are more than double their ten-year averages. Without any doubt, Apple is expensive using these historically reliable techniques.

The disconnect between fundamentals and market cap, shown below, explains why valuation ratios are soaring.

Over the last ten years, sales and income growth have slowed considerably. Sales over the previous five years have grown by 3.22% per year, while income by 1.82%. Despite the troubling trends, the stock has nearly quintupled since 2015.

What’s Apple Worth?

We employ two internally built cash flow models to help us assess Apple’s value.

Model #1 – Our first model uses the present value of 30 years of projected earnings for comparison to the current market cap. We assume a forward 5% income growth rate, which is faster than the 3% rate of the last five years.

Model #1, using a generous income assumption, values Apple’s current stock price at a 58% premium to its future cash flows. This model tends to agree with the ratios shown above.

Model #2 – Our second model uses forecasted cash flows instead of net earnings and similar assumptions as our first model. Model #2 is more friendly but still puts the current stock price at a nearly 15% premium to its valuation.

Why A Value Investor Owns Apple

So, why do we own such an expensive company?

Weak growth trends, expensive valuations, and our models are all meaningless if one thinks Apple can grow earnings at much faster rates. For instance, in our first model, Apple is fairly valued if it can grow net income at 9%.

That is not the reason we own Apple.

Here is a hint:  “The equity market has traded soft under the surface of the headline indices, which are now being driven by just one stock—Apple.” Morgan Stanley

The passive nature of the market compels us to own it. To better understand the effect that passive investing is having on all types of investors, we suggest reading our article, Passive Fingerprints Are All Over This Crazy Market.

The market is putting a proverbial gun to our head and other investors.  It whispers in our ears; if you want to keep up with your benchmark, you must own the “Big 5.” (Apple, Microsoft, Amazon, Google, and Facebook)  Failing to hold some or all of them guarantees you will underperform. Those five companies account for 26% of the S&P 500.

As we wrote in Bulls Chant Into A Megaphone:

“What investors are missing is that the top-5 stocks are distorting the movements in the overall index.

For each $1 put into each of those top-5 stocks, the impact on the index is the same as putting $1 into each of the bottom 394 stocks. Such is clearly not a true representation of either the market or the economy.”

The graph below tells another version of the same story, the “Awesome 8.” This slightly expanded list of companies has also grossly outpaced the “market.”

We own Apple and some of the others listed above.  We have done very well in them allowing us to keep pace with the market. However, we fully understand the gains are not commensurate with underlying fundamentals.

Managing Risk

We do not take Apple’s high price and precarious valuations for granted. There is little doubt that over time they regress to the norm, barring substantial growth. At some point, Apple investors will get burnt.

To properly manage risk and sleep well at night, we establish tight stop limits. Further, we frequently take profits and reduce exposure when Apple becomes technically overextended.

For example, we are currently holding only half our original position as the price is extended by three standard deviations. Typically such an aberration results in a pullback or at least a consolidation.

Summary

There is little doubt that we are in the mania stage of the bull market. In this phase, value is grossly underperforming growth. To keep up, we are accepting of the risks embedded in expensive stocks such as Apple. We do this, however, with full knowledge of the risks and employ tactical risk management strategies.

We look forward to a day when we can own a portfolio of value stocks. When we can buy and sell securities based on economic and fundamental reasoning. When the irrationality of mania does not impinge upon our strategies.

We believe there will be a day when we can scoop up Apple shares for fractions of the current cost and possibly when it is once again a value. Admittedly though, the price of Apple as a value play is well below where it is today.

We leave you with an age-old question – is this time different?