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Why WeWorks woes works for markets

The Days Ahead: Non-farm payrolls and ISM numbers

 One-Minute Summary Constitutional crisis in the U.K., impeachment launch in the U.S., Chinese companies banned from U.S. stock listing, middle of the road economic numbers, oh, and a big merger called off (MO and PM)…that’s a lot to throw at markets. But stocks have held up at around with the S&P 500 at the 3000 level and a sell off on Friday on the China listings news. The price action is far from convincing though. Bonds had a good week even though Fed speakers put a damper on further rate cuts.

The GDP update confirmed we’re back in the 2% world. Estimates for Q3 are about the same. Housing did well. Personal income is slowing. Core PCE inflation, the one the Fed follows, was 1.8%. The target is 2% so that will keep the Fed steady. All pretty much in line with current thinking.

Markets are driven by the big stuff we mentioned in the opening. That’s a whole lot of unknowns but reminds us of one of our favorite stock market rules: Don't trade on headlines. All major markets are in a bit of a holding pattern but with solid year to date gains.

 1.     How’s Brexit doing? Ugh. We won't go through all the Brexit permutations, except to note that there if the current government leaves without a deal, it will break the law. The law is the Benn Act, and here it is. Basically, if the House of Commons (roughly, the House of Representatives) does not approve a deal, then:

“The Prime Minister must seek to obtain from the European Council an extension…”

 There is a constitution in the U.K. and its principles are documented in the Erskine May procedures. It’s about to be tested again. Right now, all and no options seem to be on the table but any compromise looks unlikely. Sterling took another hit. It’s down 16% since Brexit and a major reason why we continue to underweight international.

2.     What’s WeWork up to? Nothing good. Hey, we like noting more than a ripping success from venture capital to public markets. Bring on the unicorns, we say. But this one, a bit like Uber, was beginning to look like a “hey, come off it, you expect us to fall for that?”.

Quick background. WeWork is a property company with a tech spin. It has a great mission. And says things like “Community is our catalyst” and “We foster human connection through holistic happiness”. Great, why not. The basic business was buy some long term leases, make them funky and fun and rent them out on short-term leases.

Here the business plan:

Ok, one might say. “You're a landlord. I mean not to Dell and HP and Microsoft. Ha, no, that’s just for illustration purposes. But you're a landlord”

But as everyone in real estate knows, that means two things: 1) you need cash flow to pay the leases and 2) you need a ton of capital to pretty up the offices, advertise and lease them

And that was the problem. Its filing showed revenue of $3.2bn, expenses of $6bn and losses of $4bn. Against negative equity of $2.4bn. Again, fine until the banks say, “er, we’re getting a little nervous about your ability to pay us back. Help us out here.”

The help was to go public and raise new equity so they could go on buying long term leases, prettying up the offices and renting them at high, short leases. How do you value a company that sells $1 for 50cents? Tricky. The last round of financing valued the company at $47bn. The bankers were ready to go with an IPO of $50bn and the roadshow commenced.

That’s $50bn, which would make them the third largest real estate company in the country. Bigger than Simon Properties, which has $30bn in assets and $500m of income.

But then investors pushed back. And pushed back hard when they found out the CEO (Adam Neumann, don’t Google him, you’ll get depressed) had a $60m private jet, a Maybach, owned some of the buildings that WeWork leased, copyrighted the use of the word “We” and licensed it back to the company, took out $700m in loans and generally used the company as his personal piggy bank. He also had said he wanted to be the world’s first trillionaire and President of the World but, hey, gotta admire the stretch goal.

So, short story. The IPO is pulled. The new valuation may be around $10bn. Neumann steps down, largest shareholder, Softbank, says enough, new management, fires a lot of people and moves to Plan B.

Now, yes, ok, we laugh at these stories because the only people who got hurt were some VC guys and investment bankers (and staff, which is a problem). But this company nearly took $50bn off retail investors, funds and wealth advisers. From $50bn to maybe $10bn in a week. It’s great that investors said “enough” and we didn't see another dud IPO and investor losses.

And it also tells us that this market is very short on exuberance. There is no “throw money and ask questions later” like the late 90s.

Caution all round is a good thing.  

3.     Consumer confidence, still ok? Yes, but peaking. Consumer confidence is a precarious thing. It can prove ephemeral, driven by news, taxes, jobs, politics…just about anything that can leave people nervous. Last month we saw quite drop from 134 to 125 and a setback in the jobs plentiful less jobs hard to get index (a mouthful, but indicates confidence in the labor market).

It’s not a concern yet but discretionary spending on things like autos, furnishings and recreation are about 14% of GDP. Tariffs are the likely culprit here with the people the “expecting things to worsen over next 6 months” index at a six-year high (h/t Pantheon Economics).

Consumer confidence is not a leading economic indicator. It’s just that it may lead to lower retail sales and home buying.  It’s all part of the gradual slowdown. Bond yields fell. A textbook response.

 4.     Bubble Update. One of the things we like about the current market is that are no real bubbles. We've written about these along the way, here, and the criteria for a bubble here. We made one exception: Venture Capital (VC).

VC used to be about funding gritty start-ups and as soon as they were fledglings, kick them out of the private nest into public markets. But since around Facebook time, it’s been start them out as a gritty start ups, fund billions of dollars until the companies own 100% of their market and then kick them out to the unknowing punters on the street.

Yes, Lyft, Uber (taxis), Snap (photos) and Slack all bombed. Last week it was the turn of Peloton (down 18%) and Smile Direct (down 40%).

We don't think there’s a knock-on effect to the public markets. That's a good thing.

Bottom Line: Remember that oil price scare last week? It's  liked it never happened. Oil is back to where it was two weeks ago. Markets have big things on their mind but can't decide which direction to take. We'd say that’s going to go on for a while.

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“I wish I had never invented the labradoodle

 Artist: Sonia Delaunay (1885-1979)

  --Christian Thwaites, Brouwer & Janachowski, LLC

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

RIP Robert Hunter - Birdsong