The Greatest Trade Ever is the title of a book by financial writer Gregory Zuckerman.
It’s all about how US hedge fund manager John Paulson made a fortune (roughly $20bn in one year) by betting against US subprime mortgages before the market blew up.
It had everything a good trade should. It was contrarian. It was bold. It had a certain moral indignation about it (although that side of things is a lot more complicated once you really get into it).
And it made a ton of money.
No wonder everyone wants to find a similar trade. And now some investors think they’ve got it.
It hinges on the death of traditional retail…
The death of the shopping centre
The FT carried an article yesterday, entitled: Will the death of US retail be the next big short? Robin Wigglesworth details what some US investors see as the next killer trade.
Here’s the basic idea: online retail is taking ever more market share from offline retail. That means there is too much capacity in offline retail – too many shops, in other words. If you have too many shops, then that also means you have too many shopping malls. That’s a huge chunk of real estate that has just been rendered permanently obsolete.
According to Wigglesworth, PricewaterhouseCoopers has estimated that there is 24 square feet of retailing floorspace per person in the US. In Australia, it’s 11 square feet. Over in Europe, it’s just two to five square feet. In other words, there’s a whole load of wasted space.
And a lot of it is being shut down. “So far this year, the shuttering of 76 million square feet of retail space has been announced.”
So what’s your short? Bet against traditional retailers. Bet against the landlords who own the shops that are getting shut down. Bet against the mall operators who run the malls that are now half-empty and getting emptier.
It makes a lot of sense; it’s simple in its logical brilliance.
Imagine it: a world where we order everything online. A world where everyone has an Amazon Prime subscription (a huge number of Americans already do). A world where Alexa does your shopping for you, without you even having to think about it.
Malls demolished to be replaced by warehouses, or drone hives, or turned into reservoirs where Amazon can store objects in waterproof boxes and float them to the top when required (seriously, they’ve taken out a patent on this idea).
A ghost land where we all sit in our dwelling pods, our augmented-reality contact lenses drawing a barely palatable shutter over the heat-blasted world outside, fretting over why Alexa only ever talks to the fridge these days. Are they having an affair? Are they plotting against us? Getting paranoid. Better take some more of these pills Alexa says the GP prescribed.
Oops, got a bit carried away there. Just like markets have a tendency to do. And that’s why I’d be wary of this particular “big short”.
Mr Market can be a bit of a drama queen
Let’s be clear about something: the market is often right. You will not make money by taking knee-jerk positions against the market. You should approach the market with respect at all times because the market is cleverer and bigger than you are.
But the market is prone to turning into a bit of a drama queen when it comes to big picture uncertainty and future trends. The easiest way to deal with specific instances of uncertainty (which human beings and, I suspect, most other animals hate) is to extrapolate from what’s going on today.
It’s a hard trait to resist (I suspect it’s a big reason why chasing momentum is such a successful investment strategy). But extrapolation can run ahead of itself very quickly, and it often leads the market to price in an outcome that is either much further away than it expects, or that won’t happen at all – particularly once everyone gets on board the idea.
There’s no doubt that traditional retail is in a lot of trouble. But is there anyone on the planet who doesn’t know that? When the US subprime market was blowing up, a fair few people had a rough idea of what was going on, more than was perhaps evident at the time. But most people were still on the “long” side of that trade.
But everyone knows about Amazon. And everyone buys stuff online. And everyone can see that there are good reasons for that – almost every shopping experience I have is made better by using Amazon. Buying electrical goods in particular, is utter agony in a physical shop these days. You endure an hour of smarm from a hungover teenage sales assistant who then tries to sell you half a dozen guarantees you don’t need or a credit package you don’t want – why would you ever inflict that on yourself voluntarily?
So yes, online retail has lots of advantages. And it’s likely to keep getting bigger. But the question is always: how much of that scenario is reflected in the price, and how much of it is pure melodrama?
Here’s a hint. If you had $500bn to spend today, then at current market value, you could buy one Amazon. The same sum would fetch you two Wal-Marts. Wal-Mart’s most recent full-year revenue was $485bn. Amazon’s was $136bn.
Now, sure, Amazon is growing fast while Wal-Mart is running to stand still. But a twofer on Wal-Mart for the price of Amazon? That shows that this online vs offline is anything but a contrarian punt.
There’s another, bigger picture issue. The death of physical retail is in large part a zero-interest rate phenomenon. As the FT points out this morning, the rampant expansion of online retail “has been funded by investment that comes with very modest demands for immediate returns”.
In other words, zero-percent interest rates are what enable Amazon to get away with a business model which is built on turning the idea of “jam tomorrow” into a virtue. Jeff Bezos has as good as said to shareholders: “if we ever start paying out instead of constantly re-investing, then this business is over”.
Can that be sustained when the cost of capital rises? We’re likely to find out over the coming years as central banks gradually increase interest rates.
I’m not saying it’s time to pile into offline retailers – I haven’t done enough research – but I wouldn’t be keen to short them either.