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The Pandemic Boom Goes Bust

Published 01/29/2022, 05:00 AM
Updated 07/09/2023, 06:31 AM

The Pandemic Boom Goes Bust

Welcome to the great fiscal hangover.

Over the last 18 months, the U.S. economy enjoyed the greatest stimulus infusion of all time. More than $5 trillion was borrowed and injected directly into the pockets of consumers and businesses. This unleashed a consumption binge of unprecedented proportions. Americans bought so much stuff, we literally clogged up both domestic and international supply chains.

But there’s a reason why stimulus often gets compared to taking drugs. It produces a temporary high, followed by a painful hangover. And that’s precisely what’s coming in 2022, as the U.S. economy faces an epic mean-reversion in consumption:

We all learned at an early age that there’s no such thing as a free lunch. The same applies to economic policy. Sure, we created a tremendous boom by injecting trillions of borrowed dollars into the economy over the last 18 months… but at what long-term cost?

The Inflation Bill Comes Due

The bill from yesterday’s stimulus binge is showing up in the form of higher prices across the board. With inflation running at 40-year highs of 7%, the cost of living is rising faster than incomes. After enjoying a short-lived surge, inflation-adjusted wages have now reversed course, recently dropping by the most in over 40 years:

It’s no surprise why U.S. politicians are panicking, blaming “greedy corporations” for today’s higher prices. They know that the following chart of crashing consumer sentiment - now below the COVID lows - spells a death knell for their re-election prospects:

Consumer Sentiment

Of course, corporations didn’t suddenly wake up and become greedy in 2021. Rising prices are the expected and natural consequence of conjuring up trillions of dollars and flooding it into the economy.

More and more Americans are waking up to this fact. At some point, voters will start asking: what’s the point of all this stimulus, if it only ends up making us poorer? That’s why we’re seeing pushback from people like Senator Joe Manchin, refusing to vote for more reckless debt-financed stimulus spending. This rejection of more reckless fiscal stimulus is best for the long-term health of the economy and country. But like withdrawing from any drug, the initial stimulus withdrawal will create a lot of pain in the short run.

The backlash against inflation is forcing the U.S. Federal Reserve into tightening monetary policy, just as we’re seeing the early signs of a slowing economy - a disastrous combination for risk assets across the board.

Weak Manufacturing and Retail Sales Data Indicates a Slowing U.S. Economy

The graphic below from Morgan Stanley research details the growing body of evidence indicating a substantial slowdown in the U.S. manufacturing sector:

Meanwhile, collapsing real wages and consumer sentiment is showing up in the retail sales data. In December, the U.S. consumer posted a -2.3% decline in retail sales on an inflation-adjusted basis. This reflects the biggest retail sales decline since the Global Financial Crisis. Real disposable income in the U.S. is now tracking below the pre-COVID trend. In other words…

The U.S. consumer has given back all of the temporary stimulus-driven income gains and more.

Such is the nature of debt financed stimulus. After all, we didn’t create any new wealth. We simply pulled forward from the future. And now, the future has arrived.

The financial markets have been sending off warning signals of this coming fiscal cliff for months now. In the bond market, the spread between short and long duration Treasuries - a key measure of future growth expectations - indicates that U.S. economic growth entered into a consistent decline after peaking with the last round of stimulus checks in Q1 2021:

Yield Curve
The stock market is sending off its own warning signals, through a growing number of high-profile single stock blow ups. The latest disaster du jour comes from fitness equipment maker Peloton Interactive (NASDAQ:PTON).

Peloton Shows the Pandemic Pull Forward is Over

Last Thursday, Peloton shares plunged by 25% after the company announced a production halt for its bikes and treadmills, citing softer than expected demand.

The drop caps off an 85% share price wipeout over the last 12 months.

Of course, there were plenty of warning signs for those who cared to look. Perhaps the biggest red flag was the share selling spree among corporate insiders, who dumped $500 million in Peloton stock in the months leading up to Thursday’s price collapse.

These insiders apparently knew then what we all know now: Peloton’s windfall from stimulus checks and stay-at home orders in 2020 was a one-time boost that simply pulled forward a lot of future demand into a 12-month sales blitz.

By Q2 of 2021, the great pandemic pull-forward in Peloton demand began pushing back. Here again, growth peaked with the last stimulus checks that went out the door in Q1 2021:

Peloton Sales

The problem with the share prices of pandemic winners like Peloton, Zoom (NASDAQ:ZM), DocuSign (NASDAQ:DOCU) and countless others was that Mr. Market extrapolated a one-time demand surge into the indefinite future.

At its peak, Peloton commanded a ludicrous $50 billion valuation, reflecting a sales multiple exceeding 10x. The narrative followed the share price higher, as Wall Street conjured fantastic notions about the company earning software-like margins at scale, with a seemingly infinite TAM (total addressable market) to grow into.

Of course, after an 85% share price decline, it all seems so obvious. Peloton is nothing more than a commoditized, low-margin hardware manufacturer with no moat and a limit on its growth prospects. For the first nine months of this realization, the share price suffered a slow burn of smart money selling to the dip buyers. The slow burn phase was then followed by three months of sheer capitulation:

Peloton provides a great case study for the speed and scope of wealth destruction possible when delusional Wall Street narratives born from a mania meet financial reality during the subsequent bust.

Can we think of any other high-profile businesses selling low-margin, commoditized hardware products, but which command a delusional software-like valuation multiple exceeding 10x sales? Stocks where the business has heavy exposure to the coming mean reversion in consumer demand, and where insiders have recently liquidated billions of dollars in stock?

Oh, right - Tesla (NASDAQ:TSLA).

Tesla - the Next 90% Share Price Wipeout Candidate

Tesla reported blow out numbers across the board in its recent fourth quarter earnings report on Wednesday - beating on sales and earnings. But observe the stock reaction - down over 11% the following day.

The apparent catalyst for the weakness was the revelation that Tesla has zero plans to introduce any new models in 2022. That's a big problem for a company priced as if it will soon take over the entire global auto market - a difficult task with just four vehicle models. Such is life in the stock market when you're priced for perfection.

Consider the following…

From 2019 to 2021, Tesla’s sales roughly doubled from around $50 billion to just under $100 billion. And over the same period, Tesla’s valuation ballooned from $50 billion to over $1 trillion. So, we’re talking about a car company trading at a 10x sales multiple.

Need I say more?

The stock is priced as if it will take over the entire global auto market. Any hint that this bull case is off the table, and the stock could immediately re-rate in line with your average car company, trading at a sub-1x sales multiple (i.e. 90% lower).

Of course, I fully appreciate that the bulls have plenty of elaborate narratives to justify why Tesla should trade like a world-class software monopoly with 80% profit margins and unlimited future growth prospects. But that was the whole point of the Peloton example - these are the stories that get invented to justify price action during manias.

In my mind, the only real factors that matter for Tesla’s share price are crowd psychology, price momentum and money flows. The bet here distills down to one question: does today’s mania have more room to run, or is it about to go bust?

Unfortunately for Tesla shareholders, all signs point towards bust in 2022.

Peak Money Flows = Peak Mania

Earlier I showed how trillions of fiscal stimulus dollars went into record U.S. goods consumption over the last 18 months, and how that’s a big problem when the mean reversion hits in the coming year.

But there was another key area where the fiscal stimulus funds poured into: financial markets. The chart below shows how the inflows into the U.S. stock market last year exceeded the sum total of the past 19 years… combined:

And just like we’re starting to see in the real economy, I believe we’ll see a similar mean reversion in money flows in 2022 - which the chart above shows may have already begun.

Tesla was one of the primary beneficiaries of the chart above. In perhaps one of the greatest market timing feats ever, Tesla entered into the S&P 500 in December of 2020 - just before a record liquidity tsunami washed over the U.S. financial markets.

But now, with the fiscal stimulus taps shut off, money flows have peaked and started reversing. It should also come as no surprise that the broader stock market, along with Tesla, has stopped going straight up and become much more volatile in recent weeks.

Looking beyond just equity market inflows, Tesla shares also benefited from the greatest speculative option frenzy of all time.

I (along with many others) have covered in great detail how surging call option volumes can create a “gamma squeeze”, which creates artificial buying pressure from option dealers hedging out their gamma exposure in the underlying share price (see more here).

To make a long story short, I believe Tesla benefited from the massive amount of stock required for option dealers to hedge their risk as monthly call option volumes exploded from 1.5 million in September of 2019 to nearly 40 million contracts in November of 2021:

But again, this call option frenzy is the stuff of a manic market environment. As the liquidity tide recedes in a world where boom turns to bust, Tesla shares could face an epic unwind of the greatest gamma squeeze of all time. We may have already seen the start of this process, with Tesla shares peaking precisely with the peak in call option volumes in November of 2021.

Stay tuned for more updates, as this could become a critical piece of the story not just for Tesla shares, but for the broader financial markets going forward.

For now, here’s the bottom line: anyone looking at Tesla’s business fundamentals as the key driver for the share price will find themselves increasingly confused in 2022. Fundamentals could very well continue improving for Tesla, and the share price could still lose 90% of its value as the speculative money flows reverse course.

Finally, it’s not just the story stocks like Tesla and Peloton that are vulnerable in today’s market. We’re starting to see selling pressure hit the former market generals - the FANNGs - another giant warning sign for today’s bull market.

Market Generals Starting to Drop

One of the leading indicators for a market transitioning from boom to bust is a sharp deterioration in the most speculative stocks. Last year was a textbook example, as the market’s most speculative cash burning companies - including the recent string of low quality IPOs, SPACs and virtually every holding in the ARK Innovation ETF (NYSE:ARKK) - flipped from market leaders in 2020 to market laggards in 2021:


ARKK and Spac boom turns bust

Jeremy Grantham describes this late cycle phenomenon as the “confidence termites” eating away at the outside of the bull market, before making their way into the foundation. For much of 2021, money moved away from these speculative stocks into the blue chip mega cap leaders - notably the FAANNG+ (Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), Nvidia (NASDAQ:NVDA), Alphabet (NASDAQ:GOOGL), etc.) stocks.

But here’s the troubling sign for bulls - the confidence termites have now made their way to the former mega cap market generals, starting with Netflix.

After posting weak guidance for future subscription growth in its latest earnings report, Netflix dropped by more than 20% in a single day. The stock is now down over 50% from the highs made as recently as November 2021:

In the last few weeks, we’ve seen the selling pressure creep into the other generals. Most notably, shares of stalwart Amazon have shed 25% from their recent highs - and that’s despite any real meaningful fundamental news.

Add it all up, and both the macroeconomic fundamentals, money flows, and momentum in today’s market should give investors plenty of caution going forward. The fiscal hangover and spiking inflation will continue pressuring consumption in the real economy. Meanwhile, we’ll likely see a reversal in the record money flows that helped inflate the stratospheric valuations in today’s stock market.

We’re already seeing the first signs of boom turning to bust, and that’s before the Fed will soon start tightening monetary policy into a slowing economy. That’s a recipe for lower earnings growth, a slowing economy, and lower valuations.

The takeaway: don’t expect 2022 to look anything like 2020 or 2021.

This article was originally published at the Ross Report.

Disclaimer I am short Apple call spreads, and have no positions in other stocks or instruments mentioned.

Latest comments

Wow! What an eye opener!!! So then what was Tesla’s forward guidance?
Good point...but consumer sentiment is a lagging indicator...if you go to 2008 the consumer sentiment was at it's lows AFTER the crash happened...meaning that when consumer sentiment is at some post crash recessionary pivot point the market recovers. In my opinion it would be scarier if consumer sentiment would be at a pivot high because normally that is when Mr. Market attacks...in the most least expected moment. That is why the famous saying goes be greedy when others are fearful and be fearful when others are greedy. Inflation is a big problem and sooner or later it will catch up...perhaps next year but for now there is a high likelihood a short recovery. Good analysis thank you.
*high likelihood of a short term recovery
Yes but big difference. Consumer sentiment in 2008 was low due to skyrocketing layoffs and high unemployment. Right now you have VERY tight labor markets and most companies struggling to hire. The reason consumer sentiment is so low is due to high constant inflation hitting pockets + wage inflation still playing catch up to real inflation as a lot of companies trusted Powell when he said inflation would already have peaked like 4 months ago...If anything QE / Stimulus cheques were all spent in 2021 and right now people are spending more for less so company profits will start falling in Q3...
Well if consumer sentiment is at the low AFTER the crash happened and right now the indexes like the S&P (which most people buy in their retirement accounts) is down less than ten percent, does that not mean sentiment can go lower AFTER the S&P goes down further?? I belong to several facebook stock groups and there are still too many "buy the dip" or at least "dont sell the rip" posts because people think "stocks always go up". Most of the people in the market today were not around in 2008 and especially the tech bubble bursting in 2000. All they know is ten years of the fed pumping in money and a bear market lasts maybe a month and then the fed comes in, pumps in a couple trillion dollars and the market goes back up. Thats the sentiment I am looking at. Stock buyer sentiment is what people should look at and that is no where near a bottom.
thank you so much for your analysis.
Balanced well written article, unfortunately published after the horse has already bolted from the stable. Could be more pain short term but overall things should stabilize in few months
I very much appreciate this informative and helpful review of our macroeconomic situation - thank you1
There is space between boom and bust. in fact, the market always go in the middle way.
Dr. Jerome Bubble will have to get off the stimulus lion 🦁 sooner than later without getting eaten alive 😂by the lion 🦁
The US federal reserve emboldened people such as Putin to use the profits from inflation against their political, social and economic enemies.
The US Federal reserve is solely responsible for the Ukraine situation. The US Fed may have to slam the break really hard to avoid the Ukraine invasion and to send Russian troops and US stocks and the bulls back to their home bases
With all the free money from gov, they basically just "postpone" the crisis which should have happened in 2020. So if fed take back the money, i think we will at least go back to precovid level.
this article is a month and a half late. Everything has already crashed. Time to go back up.
i think you habe not seen a crash yet. people not having seen 2008 or 2000( me neither in this case) see every correction as a crash ;)
 It's not even a market correction for the S&P 500 and Dow Jones which are down by 5-7% = a dip (a correction must be 10%+, while a bear market is seen when 20%+ fall). Only the Nasdaq is in correction territory, with the S&P close to one all last week before rising on Friday.
 When every share is hitting new highs you have peak demand, i.e. maximum cash available. Sure you will still have buyers on the way down but not nearly enough to reverse the momentum. It's death by a thousand cuts on the way down, so don't try to catch a falling knife. If you want to invest shift to another asset class. Some commodities still have upside.  Just ask yourself, why should a bull stock market resume now? The days of Covid subsidies are over so consumer demand is shot and so is free money. Good luck if you bet against the incoming tide, and don't be fooled by a small blip on Monday!
bad examples of stocks falling. all the examles given are companies that would make more money when there are lock-downs or when people cannot see one another face to face. as the pandemic is becoming endemic and people will be going back to normal, those products will be used less therefore their value will decrease.
If they don't crash the market asap, midterms will be completely lost over inflation. The common person cares nothing about stonkers but hates inflation.
My opinion is from being an active Spot Forex Trade and Living in Gary, Indiana near Chicago, Illinois, and retired Funeral Director & Embalmer since 1985.  No one can predict the future living through the Inflation of the early 1970s when I was a child.  Joe Manchin is wrong being a voting Democrat since I was 18 years old.  I would worry about Russia now and what will happen to Palladium & Platnum and the semi-conductor market.  We need Infrastructure repair and Build Back Better and America has always and will be Great.
Why not mention how inflation and global supply is also because of Covid casuing all parts of the economy to stop because workers are sick or not willing to risk dying/killing family members.You absolutely can not blame inflation entirely on stimulus.
Why not mention how inflation and global supply is also because of Covid casuing all parts of the economy to stop because workers are sick or not willing to risk dying ***family members.You absolutely can not blame inflation entirely on stimulus.
You cannot print your way to prosperity
I usually don’t post often but I will say that it was nice to read this article because it narrates the last few years events with some educational analysis. I like the analogy of injecting too much and then getting a hangover. Everything needs balance and this is a fact that applies to everything in this universe and there will always be a correction no matter what. Well done!!
What Ross says will happen will happen only when the US federal reserve will slam the break really hard. The US fed caused so many crisis including the Ukraine situation. the US federal reserve will have to slam double hard to break, no ABS no antilock, you will feel and see nothing but the 18 Wheeler in your rest view mirror
Great article, but you are wrong on Tesla. Not just a car cimpany with traditional car company margins. Do the math on its self-driving monthly subscriptions.
Most have done the math, actually, 10'000s of analysts' whole job is crunching numbers and the majority see Tesla as overvalued (over half of the analysts have a hold or sell call on the stock at current prices). The Tesla price is basically priced with a 5-year outlook & 50%+ growth rate year after year being maintained. Its also priced with zero trade escalation between China and USA over the next 5+ years. China sales account for a large % of current and future growth projections. As delays in opening its German Plant + New Pick Up Truck show - it won't hit perfection. I like Tesla long-term but Zero chance would I buy at current prices. Esp as Musk is now prioritizing pet projects like AI Robots instead of getting other projects already started over the line. Maybe if / when drops under $600...
Plus Tesla doesn't have traditional car company margins YET. Ford has pivoted really quickly to EV and while it said it would be manufacturing 400,000 EV cars by 2025 in 2020 - it now says it will be at 600,000 by the end of 2023. It is also far ahead of Tesla in its pick-up truck range (so unless Musk wants to throw more things at car windows that don't break lol). Toyota also entering aggressively while even Apple is looking at entering the ev market by 2025.
Thank you for the Enlightenment.The facts, all the facts and nothing but the facts all blended with a very readable style. How utterly refreshing !!
Agree with the others. Best article I've read in a long time. Thank you for the detailed analysis.
In addition to the trillion of dollars in one time stimulus you also had the monthly child tax credits. This has 2 big problems. 1. It helped keep inflation higher through the end of 2021. 2. Is still to come when people are expecting the same tax returns as last year to pay down debt and they find that the can't because of lower returns. This will bring bigger pullbacks in spending in 2022 and the normal tax return consumer boom will be deflated this year.
Interesting!!!
The US Federal reserve is solely responsible for the Ukraine situation. The US Fed may have to slam the break really hard to avoid the Ukraine invasion and to send Russian troops and US stocks back to their home bases
That makes absolutely no sense
That is why you are called the American ha ha ha very daft
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