Is the E-Commerce Bubble In A Mania Stage?

The Bank of American Merrill Lynch surveys should be taken seriously. I’m not saying, I agree with them always, but they usually have interesting perspectives. It’s weird how this survey usually has contrarian bets because most surveys reflect what the market is expecting. It’s possible that fund managers might acknowledge that something they are long can fall in a mean reversion. As an aside, it’s important to not get caught up in the philosophy that everything must mean revert. There should be a catalyst for the reversion. For example, you shouldn’t think stocks must fall because they are valued higher than the mean. There needs to be a catalyst for that correction.

The chart below shows the biggest tail risks in July and August. A tail risk is a low probability event which could cause a market crash. On a normal distribution curve, the ends are flat. When a situation has fat tails, the chances of unlikely events increase. This definition is debated among investors because one can argue that the supposed fat tail event that was the financial crisis wasn’t a black swan. It’s not surprising that housing prices cratered because prices increased faster than they historically did and faster than population growth in the hot areas which were Florida, Arizona, and California. If you did your research, like some subprime shorts did, the event was predictable. I interpret the usage of tail risk below as what can cause a correction. The only true tail risk I see in the list below is the nuclear threat of North Korea. That is a very low probability event which can be a disaster for the markets and civilization.

Not surprisingly, the North Korean threat increased since it wasn’t on the radar in July. I think in the survey next month this threat will disappear. The addition of North Korea and the debt ceiling issue pushed the other categories lower; I don’t think the chances of an ECB/Fed policy mistake fell. The debt ceiling issue will gain more focus in September as it probably won’t be solved by the next survey meaning its percentage should grow. The answer highlighted in red is the only answer which wasn’t new that increased in popularity. I don’t have expertise in the inner mechanisms of the market to determine the risk of a flash crash, but for long term investors it probably doesn’t matter. If an asset falls 10% and immediately rallies 10%, does that matter? The only thing it does is suppress valuations as some investors fear it will happen again. That could present buying opportunities.

The chart below is another Bank of America Merrill Lynch chart, but it isn’t a survey. As you can see, the chart looks at previous bubbles and compares them to the current rally in e-commerce. E-commerce is up about 500% which is near the median rate of return for the bubbles listed. I think this is a reasonable comparison because investors are speculating that e-commerce will suddenly become highly profitable even though it has historically had low margins. The internet makes being in retail tough because it’s so easy to comparison shop. The two online retailers that I follow are Wal-Mart and Amazon. Wal-Mart paid $3.3 billion for Jet.com which is an online retailer which, before it was acquired, had plans to lose money until 2020 to catch up to Amazon by investing in the business. What secret sauce is Wal-Mart getting from Jet.com if the company is losing money? Wal-Mart could’ve paid Google to improve its search engine rankings instead of buying Jet.com.

The reason Wal-Mart made the acquisition is because Amazon’s stock is ramping higher. The market is excited about e-commerce. Amazon wouldn’t be profitable if it wasn’t for the cloud business. The bull thesis on Amazon’s e-commerce business is that the company will take so much share in the online retailing space that it will be able to eventually control the market and raise prices. I argue that if Amazon raised prices, shoppers would move to competitors. This is an age-old conundrum that won’t be solved soon as online retail is only 8% of total retail. It’s obvious that online’s retail share will grow in the next few years. The question is whether Amazon’s stock will rally forever without much profits other than from AWS. The talks of Amazon being a $1 trillion dollar company are purely based on momentum. If Apple was worth $1 trillion, the current valuation would be reasonable. Amazon’s valuation is unreasonable at the current level, so why would it double? The simple truth is that no one who thinks Amazon will double is looking at profits.

Wal-Mart reported earnings on Thursday. I like to look at the results as a tool for gauging the macroeconomic environment. Wal-Mart’s e-commerce sales were up 63%. Maybe the acquisition of Jet.com helped enough to make it worth it. It’s impossible to know what the sales would have been without the acquisition because we don’t know how Wal-Mart would have otherwise spend the money. What we do know is that despite this flashy number Wal-Mart will never be mistaken as a growth stock. Let’s look at the more important numbers now. Same store sales growth excluding fuel was up 1.7% which was a positive result for the 12th straight quarter. It was boosted by traffic growth of 1.3%. Same store sales growth was better in America as U.S. Wal-Mart had 3.3% growth, Sam’s Club had 2.3% growth, and Wal-Mart international declined 1.0%. Finally, Wal-Mart earned $1.08 per share which beat estimates by a penny. The stock is down about 10% from its all-time high in 2015.

Conclusion

The e-commerce industry is hot. It could be a risky area for long term investors meaning Amazon is a stock to avoid. The Wal-Mart quarter was solid which makes sense because the economy is strong. Q3 might be even better for the company because August had strong retail sales. We looked at Wal-Mart to get a gauge of the consumer, not to look at potentially buying it. If the economy stays solid and the jobs market is healthy, it will probably rise with the market, but I don’t have any insight into why it would outperform.

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