The End Of Free Money Is Here - Are You Prepared?

March 20, 2018

The End Of Free Money Is Here – Are You Prepared?

  • Tesla’s equity might be worth zero.
  • Bitcoin is also in a downward trend, why?
  • There is still free money in some parts of the world.



Introduction

There’s one extremely strong wind of change blowing. The 9 year period of practically free money is ending and you should have a safe portfolio considering.

I’m going to put things into perspective by discussing Tesla, Bitcoin, tariffs on European cars, and Toys R Us. Let’s start with Tesla.

Tesla Is In Danger If Capital Markets Get Tough

It isn’t a secret that Tesla is burning through more than $1 billion in cash per quarter.

Figure 1: Tesla’s cash pit seems endless. Source: Business Insider.

So if the company doesn’t manage to reach its targets, it will need to find new cash sources which can be done by issuing bonds or by issuing new shares. If Tesla wants to invest in all the other projects that it recently unveiled, like the Tesla Semi and the Roadster, the need for cash will be even bigger. However, the Model 3 production hasn’t been in line with what has been hoped for which, alongside financial markets getting tougher, might put Tesla in a difficult position.

Figure 2: Tesla’s guided and actual Model 3 production. Source: Bloomberg.

So when a company is in such a tough spot and where cash is burning at a very fast rate, at some point investors will be forced to throw in the towel as profitability might be impossible to reach.

Figure 3: Bloomberg’s estimates of Model 3 weekly production. Source: Bloomberg.

Now, I don’t know when investors will turn their backs on Tesla, but the company has increased its liabilities exponentially in the last couple of years. At some point it will be clear that there is a big difference between the fancy promises and the actual delivery.

Figure 4: Tesla’s balance sheet – liabilities. Source: Nasdaq.

Tesla’s liabilities went from $7 billion to $24 billion in 2 years without giving any sign of profitability or sustainability. The only reason why Tesla has survived over the past 9 years is because of the free money that has been printed by central banks that has pushed investors to seek greater risks in order to increase their returns. Tesla’s main investors have practically unlimited pockets at this point in time.

Figure 5: Tesla’s main institutional holders. Source: Nasdaq.



At some point, those pension funds, hedge funds, etc., that are looking for any kind of return now will be more attracted by riskless assets like Treasuries which are yielding more and more, than to risky equity investments like Tesla. That will be the end of Tesla if they don’t somehow manage to become cash flow positive.

However, Tesla will survive as long as it can find financing. But another risk that few discuss with Tesla is cyclicality. In the next recession, car sales will fall also for Tesla.

Jim Chanos has described Tesla as worthless. I hope Musk manages to prove the world wrong and Tesla becomes a huge winner, but you should look at the risk reward perspective as the risks have started to rise. If you have other companies in your portfolio that are in a similar situation, you might want to reduce your exposure to them.

Toys R Us

I like to compare Tesla to Toys R Us. It isn’t about whether the investment is good or not, it’s about the trust the company can induce in investors. As soon as somebody backs out and others lose trust, the situation can quickly become a doom and gloom situation as has become the case for Toys R Us, which just declared bankruptcy.

Bitcoin

Similarly, Bitcoin has fallen from December highs to way below $10,000 and the stories are looking more and more like doom and gloom for the cryptocurrency.

As with other risky investments, the story is the same for bitcoin. When people find themselves with zero returns on savings, they are tempted to look for any kind of return and chase riskier assets. When safe assets give satisfying returns, risky assets fall incredibly quickly.

Higher Interest Rates

The main reason for the risks, price declines, and bankruptcies is the fact that interest rates are going up.

Figure 6: 1-year Treasury yield. Source: FRED.

Higher interest rates work like gravity on businesses and asset values. Don’t fight that trend. I’ll finish with some food for thought in relation to interest rates and tariffs.



Mercedes & BMW Should Be Taxed More

When interest rates are zero, money is free. So if a company can borrow at 0%, it has a huge advantage over a company that can borrow at 4.5% which is exactly the case with Daimler and Ford.

Figure 7: Daimler’s cost of capital is practically 0. Source: Daimler.

The point here is that Daimler has a huge advantage over Ford and as they compete globally, it’s far from a fair environment. To make things ok, the ECB should start with the stimulus but as they don’t plan to do crazy stuff, the U.S. will probably increase protections.

Conclusion

The financial environment is slowly but surely changing and the FED has told us that they will raise rates. As has been the case in the last 9 years, don’t fight the FED.



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