• How to think about stock splits…
  • Why is tech so sensitive to interest rates?
  • Does this AI give us an unfair advantage?

Dear Reader,

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in technology. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week, be sure you submit it right here.

On Wednesday, I held my State of the Tech Market strategy session. Thanks again to those of you who took the time to join me.

As we know, the markets don’t always follow a predictable pattern. And my team and I are working at it no matter what the market conditions are. 

My goal is to help guide all my readers through any kind of environment, whether it be inflation, deflation, international conflict, or the kind of political shenanigans that we’re faced with today.

All of these factors – as well as concerns about rising interest rates – impact our investment decisions. And it’s important that we have a strategy in place, so we aren’t left simply reacting to every dip in the markets.

That’s why I spent time on Wednesday going over how we can prepare and even profit during this uncertainty. And I shared the one asset class that the wealthy have historically used to protect their money during these kinds of periods.

If anyone wasn’t able to attend on Wednesday, the good news is that a replay will be available for a short time. If you’d like to catch up, please go right here to watch.

This strategy session is one event you don’t want to miss.

Have a wonderful weekend…

Stock splits are in the headlines…

Let’s begin with a question on stock splits…

I received an email from your company stating that Amazon is doing a 20-to-1 stock split. Does that apply to stock I buy today, or did I need to purchase it prior to the announcement?

– John H.

Hi, John, and thanks for sending in your question.

Between Amazon, Google, and Tesla, there have been several notable stock splits in the news lately. So this is a good time to refresh readers on what exactly this means and how it works…

Amazon (AMZN) recently announced it will be doing a 20-for-1 share split that’s effective as of June 3, making the price of each share 1/20th of what it was immediately before the split.

That means for every share of Amazon we own as of June 3, we will receive 20 shares in our account. If we own five shares now, for example, we will own 100 shares after the split.

However, we should keep in mind that we will not suddenly own “more” of the company. It doesn’t matter if we have one share of AMZN for $3,000 or 20 shares each priced at around $150… We will still own the same percentage of the company as we did before the split.

And don’t be fooled. Some investors have been tricked into thinking that shares are “cheaper” just because they have a lower nominal price. However, that has no bearing on a company’s market cap or valuation.

That said, companies do tend to outperform the market after a split. Research shows stocks that split gain, on average, 25% over the following 12 months. That nearly triples the average stock, which gains 9% a year.

I suspect the added focus on Amazon will also bring attention to how undervalued the company truly is.

Amazon currently trades at an EV/EBITDA (enterprise value-to-earnings before interest, taxes, depreciation, and amortization) ratio of 26. This is near the valuation it had back in 2019.

We’ve held this company in our Near Future Report portfolio for the last two and a half years. During that time, the company has doubled its EBITDA… and we’re up 77.5%.

This is actually the second time that we’ve made great profits off of Amazon, despite the fact that it is worth more than a trillion dollars. The first time around, in less than a year, we made 32.5%.

These are the kinds of opportunities we look for in this research service. And I’d like to invite any new readers to learn more by going right here.

What to expect if rates go up…

Next, a reader wants to know more about higher interest rates…

I am a Brownstone Unlimited member and appreciate the service. Like many others, I am watching this market closely and noticed the strong negative reactions in the tech sector due to higher interest rates.

I recognize that you anticipate fewer interest rate increases by the Fed based on the political environment, but some of us may take a different view and would appreciate your thoughts on what to expect if a more aggressive approach to interest rates were used to control inflation.

Although higher interest rates are unfavorable to the broader market as well, why is the tech sector more sensitive to interest rates? Furthermore, given that the biotech sector has been beaten down so much, how would you expect this sector to perform in a higher interest rate environment?

– Michael M.

Hi, Michael, and thanks for being a lifetime subscriber. You’re certainly not alone in keeping a close eye on the markets… That’s one big reason I held last Wednesday’s State of the Tech Market event. (Any readers who missed it can catch the replay here.)

The reason that we see this short-term reaction to tech stocks due to the rising interest rates is due to the way that most Wall Street analysts estimate valuations. 

They use a technique, called a discounted cash flow analysis, that incorporates the weighted cost of capital. That cost of capital increases as interest rates increase. It has an outsized impact on discounted cash flow calculations and thus compresses valuations.

This impact however isn’t just in tech stocks, it is in any kind of growth stock… In some ways, it is an artificial effect.

This is especially true for well-run companies that don’t need to raise a lot of debt to grow their business. When a company is generating lots of free cash flow, the cost of capital just doesn’t impact its own business that much.

As for inflation, you’re right – I anticipate the Fed won’t raise rates as much as many fear in 2022. There are several reasons…

Midterm elections are coming up in November. Aggressive rate increases would negatively impact the stock market, which would be bad for the party in power. As such, the Fed will face a lot of pressure to not raise rates aggressively this year.

Likewise, as I wrote the other day, another factor is the fact that mortgage rates are already surging. The average 30-year fixed-rate mortgage has jumped to nearly 5%, when a year ago it was just over 3%.

The lenders are essentially telling the Fed, “If you raise the Fed Funds rate any further, we’re going way above 5%, and it’s going to get very ugly.”

Being too aggressive in raising rates would have a disastrous effect on the housing market. Those with variable-rate mortgages would struggle to make monthly payments, and the larger payments also use up disposable income which is not good for the economy.

Making matters worse, large jumps in the Fed Funds rate tend to have a very negative impact on stock markets. 

If interest rates for treasuries increase to an attractive level, large institutional capital would move out of equities and into debt, which is bad for the stock market. That is also bad for all voters’ brokerage accounts and 401Ks.

This is why this is such a sensitive political issue. “Forced” monetary policy changes that negatively impact every voter are not the right way to do well in elections.

And Michael, I actually agree with you and many others… I do believe that the Fed will have to make these adjustments in the Fed Funds rate to get inflation under control. My timeframe is simply different. 

I believe that the Fed will use the first two quarters of next year to try and calm – but not cure – inflation. That way, it can take the pain early, and then use the next six quarters to hopefully stimulate the market into a better environment into the 2024 elections.

Sadly, the reality is, national debt levels have now exploded, and there is no way that the U.S. can ever pay the money back… It has simply printed too much. 

And the U.S. will never default on its debt. That means that there is only one choice… a consistent and intentional expansion of money printing. The continued devaluation of the dollar is the only way to keep the game going.

My team and I are watching these dynamics like a hawk. I’ve never spent more time on government policy, geopolitics, and macroeconomics than I am right now.

This is obviously an evolving situation, so if anything changes, I will reach out to subscribers to let them know how to prepare. We will adjust our portfolios accordingly and may take more profits in advance of significantly higher rates.

And to address your final question… Biotech stocks can actually perform well even in the scenario that you mentioned. As you noted, the biotech sector as a whole has pulled back severely since last November’s highs.

The pandemic policies resulted in material delays for biotech companies working through clinical trials. When the trials were delayed, that meant that the data readouts were also delayed. 

There was no way for institutional funds to determine if the biotech companies were making progress. That meant that the institutional capital rotated out of biotech and into other sectors.

The SPDR S&P Biotech ETF (XBI) is down over 42% since February 2021. And in our Early Stage Trader portfolio, some companies are trading at valuations less than their cash on the books.

Simply put, many of these companies don’t have farther to fall. They could double or triple and still be cheap. 

And right now, it looks like the biotech sector has – as a whole – bottomed out in the first quarter… setting us up for what I believe will be a run this year.

The reason that biotech can run even in an inflationary environment is twofold. 

One sector of the industry is what I call “pre-product revenue,” which simply means that those biotech companies are still in the therapeutic development stage. It really doesn’t matter what is happening in the economy; as long as they are funded, they can keep making progress on their therapeutic pipeline.

The other reason is that when biotech companies do get a drug approved by the FDA, and it is effective, patients are going to use that drug no matter what the economic environment is.

Because of how the healthcare system works with insurance, the mass market will receive their medicines regardless of what is happening with the economy. And that means that when biotech companies build great products, they’re going to sell.

Is the Perceptron too powerful?

Let’s conclude with a question about the Perceptron…

I am eager to see the results of the “Perceptron.” It almost seems too good to be true. Time will tell.

I want to make sure the use of the Perceptron is completely legal and there are no laws that would prohibit its use. This almost appears to give your readers an unfair advantage on possible insider information.

I’m sure you would not offer anything that is questionable. Do I have any issues to be concerned about? Thanks.

– Joseph C.

Hi, Joseph, and thanks very much for writing in. 

That’s an interesting question and not one that I’ve received before. It made me chuckle, which I appreciate.

Ironically, all of my subscribers and teammates know that one of the reasons that I work so hard is precisely to give my subscribers an “unfair advantage” over Wall Street.

The market insiders have had the upper hand over normal, retail investors for decades, and I’m doing everything that I can to stack the deck in the favor of my subscribers and help make sure that they aren’t taken advantage of by the fast money.

To directly answer your question, there is nothing questionable about using powerful software to design a neural network, effectively making us smarter investors and traders. 

Hedge funds and institutional funds have been doing this for decades. And as you’ll note in my Neural Net Profits Primer, I explain why we have an advantage over the fast money with the Perceptron’s design.

The Perceptron doesn’t utilize any kind of insider information… That would be problematic, but it is something that we simply would never do at Brownstone Research. 

What we do, however, is work with massive amounts of data that no human, or team of humans, could possibly process manually.

The Perceptron – a neural network artificial intelligence (AI) – processes about 4 gigabytes of data from the world of cryptocurrencies every single day.

Even better, as it operates, it “learns” and improves itself. Here’s a simple description of how that works…

As the neural network trains on a set of data, it compares inputs and optimal outputs. And it recognizes which connections consistently produce more accurate results.

When the neural network finds these strong connections, it applies a higher weight to them. In contrast, it applies lower weights to connections that produce less accurate results.

And with each iteration, all weights are changed and the process repeats.

We can think of this as a living, evolving system. As more data is made available, the neural network will incorporate that data and update those weights as conditions change.

In our case, the Perceptron considers more than 200 data points every day for each cryptocurrency. Here are just a few:

  • Average Transfer Value

  • Addresses with a balance greater than 0.1 native units

  • Average Block Interval (in seconds)

  • Supply on Gemini

  • The number of Reddit subscribers on the asset’s primary subreddit

Collecting, analyzing, and creating a trading thesis based on 200 data points for every digital asset would be impossible for any human being. That is why we must deploy a neural network – the Perceptron – to analyze this data on our behalf.

And as we can see, there’s nothing illegal about this process. These data points come from readily available information.

Theoretically, anyone with the right resources could make their own Perceptron. Ours certainly isn’t the first in existence.

In fact, IBM created the very first perceptron system back in the 1950s:

IBM’s Original Perceptron

Source: computing.gov

Of course, this system is archaic by today’s standards… But the idea behind our own Perceptron has been around for quite some time.

So let me reassure any readers with concerns – our Perceptron certainly gives us an “unfair” advantage, but there is nothing questionable about it that would cause concern. It just makes us smarter and helps us grow our wealth.

We just issued our first sell alert for a 23% profit in 21 days. And we’ll have many more profit alerts to come.

I’d encourage any paid subscribers to read our Perceptron Primer report to learn more about this neural network. You can find that right here.

And if any readers are interested in learning how to join, go right here for more details.

That’s all we have time for this week. If you have a question for a future mailbag, you can send it to me right here.

Have a great weekend.

Regards,

Jeff Brown
Editor, The Bleeding Edge

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