Amid Bear Market Bounce, Tech Bubble Begins to Burst

Wednesday, January 09, 2019
Mike Larson

Stocks have staged one heck of a rally off their Christmastime lows. The Dow Jones Industrial Average surged roughly 2,000 points from its intraday low on Dec. 26 through earlier this week, while the S&P 500 climbed about 250 points.

The catalysts? Soothing talk from Federal Reserve Chairman Jerome Powell about the future path of interest rates last week. That was followed by some happy chatter about U.S.-China trade talks this week.

Throw in the fact stocks were deeply oversold anyway, and voila! You have some pretty powerful ingredients for a sizable, short-term rally.

It's nice to see stocks regain some lost ground. Unfortunately for the bulls, this may not mean squat in the grand scheme of things. It’s likely just more “Squirrel Syndrome” stuff you shouldn’t let distract you.

No, the biggest news from a stock market standpoint was the failure of money-losing WeWork Cos. to get another huge infusion of cash from its lead investor, SoftBank Group.

Consider that Bloomberg called the $100 billion SoftBank Vision Fund "the tech bubble's financial backer of last resort." SoftBank's sudden change of heart toward WeWork offers a compelling argument that the bubble in the technology sector is beginning to burst.

If you haven’t heard of WeWork, it’s one of the world’s biggest tech “unicorns” — companies valued at $1 billion or more. It provides so-called “co-working facilities” where freelance, professional, and by-the-hour or by-the-gig workers rent small amounts of space to conduct important meetings, network, or just get out of their apartments.

Founded in 2010, WeWork has grown rapidly. It now operates more than 230 locations in 22 countries. The only problem? Like many of its fellow unicorns, it doesn’t make any money! That means it needs continual infusions of cash to fund the acquiring, remodeling, and marketing of buildings and offices.

In fact, WeWork managed to lose $934 million in 2017, then another $1.2 billion in the first three quarters of 2018. But thanks to the bubble in private and public tech markets, its valuation grew to a whopping $45 billion as of November.

Unfortunately for WeWork, the gravy train appears to be derailing. As both the Wall Street Journal and Financial Times reported this week, SoftBank was originally planning to shovel as much as $16 billion into WeWork in a new mega-funding deal.

But other investors who were asked to cough up money, including the sovereign wealth funds of Saudi Arabia and Abu Dhabi, reportedly balked. They felt WeWork’s $36 billion valuation was too high and that SoftBank was already too exposed to the firm (thanks to past direct and indirect investments of around $10 billion).

As a result, instead of a $16 billion investment, WeWork will get just $2 billion. That’s 88% less money, and a significant chunk of the dough will go toward buying out existing shareholders rather than funding the company’s ongoing, sizable losses.

What happens in the PRIVATE tech market invariably spills over into the PUBLIC tech market. That’s what makes this WeWork news so important.

You see, many of WeWork’s fellow unicorns are lining up at the public cash trough. They’re all hoping to launch multibillion-dollar IPOs to fund their own huge losses in 2019. Ride-sharing firms Uber and Lyft, and office software firm Slack, are among the leading candidates.

But many of 2018’s formerly “red hot” IPOs have crashed and burned in the after-market, leaving investors who bought into the hype nursing serious financial wounds. And even those who didn’t have to be looking around the metaphorical room and thinking “Do I really want to be the patsy who keeps funding never-ending operating losses at ever-rising valuations?”

So, I expect many proposed IPO deals in 2019 to get cut in size, cut in price, or fail to launch altogether. That, in turn, will force wing-and-a-prayer, no-profit-generating, tech companies with Dot-Com-era business plans to either get their houses in order ... or go broke.

A pessimistic view? No. It’s a realistic one, one that comes from an analyst who worked at a Dot-Com himself in the late 1990s and early 2000s. So, I urge you to ...

  1. Continue to avoid buying shares of money-losing companies either directly in their IPOs or in the aftermarket.
  1. Avoid investments like the Renaissance IPO ETF (IPO, Rated “C-”), which tracks the performance of companies that go public. It’s already down roughly 13% in the past year. But if I’m right, that’s going to be just the start of an even-bigger collapse.
  1. If you’re feeling more aggressive and are comfortable with the idea of targeting downside profits, consider adding an inverse ETF or two targeting the technology sector. The sharp rally over the past several days has all the hallmarks of a bear market bounce: Extremely sharp, extremely sudden, and extremely likely to run out of gas before too long.

ProShares UltraShort QQQ (QID, Rated “D”) is one I’m fond of. Just keep in mind that you have to “trade around” these types of positions given the longer-term tracking error of leveraged ETFs and the likelihood of sharp snapback moves like what we just saw. You’ll find guidance on how to do that, as well as specific BUY and SELL recommendations, in my Safe Money Report (which you can subscribe to by clicking here.)

Until next time,
Mike Larson

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