_____Macro BackdropOn the basis of current valuations, stocks project forward nominal returns of slightly under 7%. Markets have risen on the back of slow but steady global economic growth and trillions of dollars’ worth of asset purchases by (in recent years) the BOJ and ECB and low rates in virtually all developed economies. The Fed is gradually unwinding its balance sheet and raising rates, but the BOJ will more than compensate over the next two years by adding liquidity to the system due to Japan’s severe demographic challenges. The ECB is in the process of paring down asset purchases, but is likely to extend the program beyond on its current September 2018 expiration date. No ECB rate hikes are in the cards until at least 2019. With inflation remaining low due to structural forces (e.g., too much debt, aging demographics, productive resource underutilization, tepid price growth in home prices and autos, industrial overcapacity in China and India), the pace of Fed interest rate increases will be gradual and probably won’t get much higher than 2.0%-2.5%. The Fed currently estimates a terminal rate between 2.75% and 3.00%. Globalization also increases the effective supply of workers in the labor market, which pressures wages further. Moreover, the proliferation of e-commerce – and especially Amazon (AMZN), whose current strategy is industry disruption and market share uptake – allows consumers to be more sensitive to prices than they have in the past. These forces seem to be nonetheless underappreciated by central banks due to their excessive focus on the inflation-unemployment dynamic that accompanies the traditional business cycle. Most financial analysts expect long-term Treasury yields to increase, but won’t too appreciably. Bond supply is being added to the front of the curve, and demand will keep back-end yields fairly depressed. Investors know rates are going back down to zero when the cycle turns and therefore confidence in these instruments as market hedges will remain. Bond yields are low, making equities more attractive. A recession is unlikely within the next 12 months, so remaining long risk assets on a broad aggregate level continues to make sense. The recent ~3% drop in high-yield bond prices has essentially nothing to do with a drop in corporate credit quality; rather, it’s more a healthy minor drop to get compensation back in line with risk. High-yield is still a bit overvalued, as are equities, relative to the long-term risk/volatility associated with these asset classes. Returns are extremely unlikely to continue on their +16% y/y pace since the recession ended. They’re lucky to do half of that over the next ten years. The majority of the gains have also been concentrated among a few main tech players – FB, AMZN, AAPL, NFLX, GOOG(L) (the “FAANG” group), TSLA (valued highly due to perceptions of its ability to disrupt traditional auto and energy industries) and chipmakers AMD and NVDA. Fifteen companies in the S&P 500 (3% of it) have regularly been responsible for 50% of the index’s gains. By the end of 2017, which of these predictions will hold and which won’t? _____ Facebook (FB)Runs above $180. Facebook’s monthly active users of 2 billion has created a company currently worth over half a trillion dollars. Its business model relies heavily on advertising, which has pros and cons, and is continually pushing Google, which is great for the market. What can Facebook innovate outside of advertising to drive up value per user? Even if it fails to gain a major foothold in the media space or in other potential initiatives, the continuing expansion of the internet worldwide remains a strong tailwind. Its market is a natural monopoly and, as such, it has various untapped ways to monetize its base that is not yet reflected in the long-term valuation of the company. _____ Apple (AAPL) Runs above $170. Due to its dependence on the iPhone, Apple is a cyclical stock, and is also subject to a tech cycle (currently running toward the tail end of an upswing) and broader global cycle (relevant to all financial assets). Apple is a solid long-term pick but don’t expect another 60%-80% year. The company also averages 1-2 smaller acquisitions each month, which gives some level of venture capital exposure to shareholders. _____ Amazon (AMZN) Stays above $1,100. Amazon’s key focus at the moment isn’t profitability or cash flow, but rather expansion and industry disruption. Its venture into supermarkets and pharmacy provides better penetration into traditional brick-and-mortar outlets. Given its diversification and high-margin AWS business, it’s not essential that Amazon derives positive margins from industries in which its looking to make inroads, which is putting pressure on pure-play companies in its newly targeted sectors. Over time, if traditional chains are driven out this will provide Amazon with greater pricing power. It’s very much a long-term strategy. As such, it’s hard to make sense of Amazon’s valuation if one is to value on the basis of profit or cash flow. The market is currently betting on Amazon’s ability to steadily uproot players in entrenched industries and generate substantial pricing power down the road. It also has the highest corporate R&D budget of any company in the world at north of $16 billion per year. _____ Netflix (NFLX) Holds a range of $180-$200. NFLX is probably the most vulnerable in the FAANG group given where it still is financially and the competitive pressures that it faces. Streaming on-demand content will have a presence among AAPL, GOOG, DIS, T, VZ, DISH, CMCSA, and some private companies. NFLX can continue to capitalize on the general market trend of cord-cutting and package de-bundling. A $100 cable bill, in many cases, can allow consumers to pay for multiple services that are generally $10-$20 each. The key is differentiation and avoiding overlap with competitors. The company’s subscription-based business model helps pad the company’s lifetime revenue per customer, which is somewhere around $200. Assuming customer acquisition cost remains below whatever the breakeven level, it’s a workable business model. NFLX is still intent on expansion, so cash flow is a non-factor for the time being in favor of user growth. The company also has long-term plans of expanding its business empire to push theatres, among other traditional entertainment businesses. AMC, for example, has lost over half its market value in the past year due to anticipation of these nascent competitive threats. _____ Google (GOOG)(GOOGL) Stays above $1,000 (GOOG). Google’s bread-and-butter will always remain in search. If a company has strong competitive advantages in the sense of having the monopoly question figured out, is profitable, and has competent leadership, it might be a long-term buy-and-hold candidate. Google is not cheap at its current price and there’s a ton of active management money betting on it currently, but it has perhaps the best business model in the world and this has a lot of appeal to investors when value is extremely hard to find. It is also not done growing, due to its attempt to stay on top of emerging technological trends (e.g., ride-hailing, autonomous vehicles), and makes acquisitions at a pace similar to Apple. _____ Tesla (TSLA) Stays below $350. Tesla’s main issue is trying to scale market demand for its vehicles into profitability, which is difficult unless it can massively reduce battery costs. There is also massive competition in the EV space. Unlike Tesla, these other companies (Ford, GM, etc.) have profitable business lines that they can use to subsidize the non-profitable EV space. This means Tesla will continue to remain dependent on debt funding – a bad proposition considering it doesn’t make money – or equity dilution of existing shareholders. The EV industry is also heavily dependent on government subsidies and tax incentives. Oil would also have to be around $300 per barrel for EVs to compete with gas cars purely on economic merit. If Tesla were to branch into software or some form of margin-rich business, a path to profitability could be easier to envision. For now, it’s less clear that it’s a viable business. _____ Advanced Micro Devices (AMD) Holds a range of $10.00-$12.50. AMD, like Nvidia below, provides the components that make various electronic stuff work. A recent surge in innovation has helped its stock go from the sub-$2 level to $12-$15 most recently. It has recently consolidated and dipped. Competition is very high (leading to a recent surge in takeover attempts for scale/tech/pricing power), is dependent on the global tech cycle (which has benefited recently from various smartphone models coming on the market), and AMD is less capitalized than its main competitors Nvidia and Intel. A prospective Qualcomm / Broadcom merger would also create an Intel-like conglomerate on the market. For now, AMD’s financials are messy, which makes the stock speculative. A bullish bet on AMD is a bullish bet on its ability to satisfy the needs of the chip market as it relates to traditional graphics components, as well as meet demand in a market expecting greater influence from AI, machine learning, and self-driving vehicles. Because of its mediocre financial position and lack of capitalization relative to competitors, there are many skeptics. _____ Nvidia (NVDA) Stays above $200. Nvidia, like AMD, has surged since February 2016. NVDA competes with AMD in GPUs and produces system on a chip units (SOCs) with INTC and QCOM as its major competition. For those with an investing mindset and believe in the long-term trends of artificial intelligence, machine learning, and autonomous driving, NVDA and AMD might be good picks, with the former better capitalized and more financially robust. Just note that forward expectations are obviously a lot higher than they were 18 months ago and both are inherently cyclical businesses. NVDA has the safer financial profile, which the market has handily rewarded. Some consider NVDA to be the poster-child of the overvaluation of US equities. But with such a high premium in the market placed on industry disruption, emerging technologies, and yield-chasing in a low-yield world, to go along with a high-quality financials, the price is a natural manifestation of that combination. _____ Summary FB – >$180 AAPL – >$170 AMZN – >$1,100 NFLX – $180-$200 GOOG – >$1,000 TSLA – <$350 AMD – $10.00-$12.50 NVDA – >$200 _____ How many of these predictions come true by early November? Agree – 6 or more Disagree – 5 or less (For non-members, simply use StockTwits, Facebook, or Twitter credentials to vote)