Monday, March 30, 2015
Why The Mania Is Getting Scary—-Central Bankers Are Running A Doomsday Machine
by David Stockman • March 30, 2015
If you need evidence that we are in the midst of a lunatic financial mania, just consider this summary from a Marketwatch commentator as to why markets are ripping higher this morning:
“The dovish comments from both Fed Chairwoman Janet Yellen and People’s Bank of China Governor Zhou Xiaochuan are giving markets a big lift, and in the absence of negative data or news, I imagine this will continue to buoy the markets throughout the session,” Erlam said in emailed comments.
Yellen said gradual hikes are likely this year, but that the central bank will movecautiously……. the PBOC governor said he saw “more room” for China to ease policy if the economy stays soft and inflation continues to weaken.
Its just that frightfully simple. If any of the major central banks anywhere on the planet ease or even hint they might, the robo machines and day traders unleash an avalanche of buy orders and the stock averages jerk higher.
Indeed, Zero Hedge captured the motion succinctly this AM. In keeping with Bernanke’s inaugural blog revelation that 98% of monetary policy consists of “open mouth” operations, the markets leapt upwards on cue. That is, if central banker jaws are flapping, then buy!
What this means is that this third immense financial bubble of the current century will keep inflating until central bankers stop banging the “stimulus” lever or the bubble finally crashes under its own weight. The latter will surely happen, eventually—- and the potential carnage can be readily approximated.
Last time, global equity market inflated to a peak of $60 trillion in aggregate value before they plunged to barely $25 trillion during the post-Lehman meltdown. Now they have been pumped back to the $80 trillion mark by the sheer recklessness of the world’s central bankers, but this time the underlying economic advance has been even more artificial and unsustainable; it amounts to little more than a temporary outgrowth of the explosion in public and private credit since late 2008. At the same time, the bubble has been spread to virtually the entirety of the world’s $200 trillion credit market owing to the nearly universal embrace of massive central bank bond-buying under QE.
Yet do the central bankers have even the foggiest clue that they are sitting on a potential $50-$100 trillion financial market implosion? That the mother of all meltdowns lurks around the corner?
Not these boneheads. They have ripped all the stabilization circuitry out of financial markets, thereby completely disabling honest price discovery. That means they have destroyed the shorts, extinguished fear, obsoleted fundamental analysis, drastically cheapened the cost of hedging and offered speculators unlimited opportunities to shoot fish in a barrel by front-running their announced bond buying and currency manipulation campaigns. In short, they have showered speculators with stupendous windfalls, displacing self-correcting two-way financial markets with rigged gambling casinos in the process.
The immense damage visited upon the machinery of financial markets is sitting there in plain sight. The endless six-year buy-the-dips run of the S&P 500 since March 2009, for example, would be impossible in an honest free market. So why do they ignore the dangers, and stubbornly plow forward clutching to ZIRP, N-ZIRP, QE, forward guidance and all the other tools of central bank stimulus?
The utterances of the duo who kicked off today’s rip make absolutely clear why the central bankers will never stop stimulating. They have embraced a spurious “inflation deficiency” doctrine, and have thereby, in effect, lashed themselves to the wheel of a doomsday machine.
To wit, massive central bank financial repression is the actual cause of deflation. In the boom phase of the expansion it leads to unsustainable public and private borrowing which finances artificial spending by households and governments and excess investment in private mining, processing, manufacturing, transportation and distribution capacity, as well as public infrastructure. Then eventually comes the crack-up phase when the borrowing ends or diminishes, causing cascading reductions in output, prices, profits and incomes throughout the economic chain.
Thus, Governor Zhou Xiaochuan’s threat to unleash more stimulus owing to the specter of “deflation” in China borders on the comical. The very deflation about which he frets was caused by the runaway money printing campaigns of the PBOC over the last several decades—-campaigns which produced monumental price and credit inflation in China, and which were then transmitted and amplified throughout the world economy, and especially China’s supply base in the EM
In the process, the latter caused massive overinvestment and malinvestment in private industry and public infrastructure alike. The “deflation” that Zhou professes to fear is thus the result of price cutting by companies battered by too much debt and too little business, and the inexorable cooling of artificial demand for the materials and services needed to build empty apartments, malls and cities and hideously redundant highways, airports, subways and bridges.
Indeed, the PBOC is threatening to chase its own tail. If China’s traditional high level of consumer inflation is abating, its because of the drastic cooling of the oil-energy complex and the iron ore-metals complex—–trends which, in turn, originate in the sharp and unavoidable slowing of China’s construction and investment mania.
So there you have it. The People’s Printing Press of China has been running red hot for more than two decades, and has fueled the most fantastic credit bubble in human history. Total credit market debt outstanding in China at the turn of the century was $2 trillion; now its 14X higher at $28 trillion.
Even more fantastically, China’s nominal GDP has barely doubled—-from $5 trillion to $10 trillion since the 2007. Yet its credit market debt—-public and private combined—-has increased by $21 trillion, or by 4X the gain in money GDP.
This is downright monetary insanity, but in response to modest cooling of its construction frenzy, its chief central banker could think of only one thing: moar ease! Apparently, a 7X increase in PBOC’s balance sheet since the turn of the century is not enough—–even when it only adds fuel to the deflationary fires.
Needless to say, during the past year the signs that China’s house of cards is tottering have become omnipresent. So this is where the doomsday machine comes front and center. China’s credit addicted financial system has just channeled the central bank’s liquidity injections to the stock market in response to Beijing’s attempts to administratively rein-in shadow banking system excesses, and particularly, the so-called “trust loans” to developers and commodity speculators.
Accordingly, the Shanghai A Shares index is up 81 % in the last nine months fueled by margin loans and an explosion of retail stock market speculation. Never has there been a more pathetic march of the lemmings toward their doom.
Janet Yellen’s pronouncements last Friday were no more sensible. Rhetorically waving her arms at the bogeyman of too little inflation, she proclaimed the following:
That said, we must be reasonably confident at the time of the first rate increase that inflation will move up over time to our 2 percent objective, and that such an action will not impede continued solid growth in employment and output.
That is sheer gibberish and rationalization. There is not an iota of evidence that 2% inflation will cause any more growth in output and employment than will 1.6% inflation—–the actual rate of CPI change over the past year. Worse still, there is absolutely no chance that “open mouth” policy at the Eccles Building will have any impact on what amount to downright trivial short-term wiggles in the measured CPI.
Indeed, the very idea that the US economy is suffering from insufficient inflation is a Keynesian canard that defies empirical reality and common sense. As we demonstrated last week, the rate of real GDP growth has slowed to 1.1% since the turn of the century or to less than one-third of its historic growth rate. And that’s despite a 9X increase in the Fed’s balance sheet—-from $500 billion to $4.5 trillion during the last 15 years—-and far more inflation than main street households could reasonably tolerate, given the tepid rate of wage growth during that period.
And it doesn’t matter how you measure it. Inflation has been high on a cumulative basis, and the median household income has been going in the wrong direction.
CPI and PCE Ex Food and Energy Since 1987- Click to enlarge
In short, the US economy has not suffered from an “inflation deficiency”. As shown above, the price level has actually doubled since the Greenspan era of monetary central planning incepted in 1987.
Likewise, there is no shortage of “aggregate demand” that can be remedied by continued “monetary accommodation”. The welcome. modest abatement of consumer price inflation in recent months reflects the epochal deflation now underway around the planet——the inexorable correction of the monetary boom that has been fueled by central banks since the 1990s.
By insisting that monetary accommodation can fill-up an imaginary bathtub called the US economy until it reaches the brim of full employment and precisely 2.000% change in the PCE deflator over some arbitrary time frame that remains forever undefined, the Fed is engaging in an act of monumental folly. And one which is now being replicated even more egregiously by the rest of the world’s convoy of money printing central banks.
That’s the equivalent of a doomsday machine. The central banks will ease and talk of easing until the third great bubble of this century reaches brobdingnagian extremes. Then the carnage will commence. Again.
The Bottom’s Not In——Why This Market Is Dumber Than A Mule
by David Stockman • March 29, 2015
They were trying to put in a bottom—–again! The sell-off earlier this week amounted to the sixth sizeable “dip” since November 20—-so the market’s ingrained reflex was back at work all afternoon, trying to scoop up the “bargains”.
But the roundtrip to the flat-line shown below is not a classic “wall of worry” and its not a “bottom” that’s being put in. This market is dumber than a mule, and the nation’s central bank and its counterparts around the world have made it so.
The plain truth is that six years of torrential money printing and worldwide ZIRP have not happened with impunity. On the one hand, massive, sustained and universal financial repression caused an artificial growth and investment boom in much of the world, especially China and the EM, which has now run out of steam and is visibly and rapidly cooling.
There is probably no better proxy for the global investment boom than the spot price of iron ore because it captures China’s massive infrastructure construction spree and the waves of mining, shipbuilding, steel-making and construction materials spending that it set off all over the world. But this huge tidal wave has now crested, leaving behind the worst of both worlds——cooling demand and still expanding supply.
For the first time since around 1980, China’s steel consumption is projected to fall in 2015——with demand slumping from 830 million tons last year toward 800 million tons, and that is just the beginning as China’s credit-fueled construction frenzy finally comes to a halt. In fact, during the boom that took iron ore prices from a historic level of around $20-30 per ton to a peak of nearly $200 in 2011, China’s iron and steel capacity grew like topsy. Production capacity expanded from about 200 million tons at the turn of the century to upwards of 1.1 billion tons at present.
Yet this year’s decline of demand to around 800 million tons does not begin to reflect the coming adjustment. That’s because there is still a residual component of one-time demand in that number that is in no way sustainable. Even if the pace is slackening, the Chinese are still building high-rise apartments which will remain empty and airports, roads, rails and bridges that are hideously redundant. Eventually that will end because even the red capitalist rulers in Beijing are terrified of China’s towering mountain of debt——$28 trillion and still rising by hundreds of billions every month.
Yet underneath this one-time explosion of demand for steel, aluminum, copper, concrete and the rest of the materials slate is something called sell-through demand. The latter reflects the sustainable level of demand for replacement of long-lived assets like bridges and shorter-term durables like cars and appliances. In the case of steel, that sustainable “sell through” demand level could be as low as 500-600 million tons or hardly half of China’s steel production capacity.
The emerging global deflation has already brought the spot price of iron ore under $60 per ton—-or back to where the latest credit-fueled boom cycle commenced in March 2009. The consequences of that are visible, among many other places, in Australia’s burgeoning depression and the slide of Brazil into its worst two-year economic slump since 1930-1931.
Yet there is still a long way to go because of the investment cycle time lag: New capacity to mine, transport and deliver water-borne iron ore is still surging because it was ordered years ago when the global boom appeared to be endless. So not only will iron ore prices continue to erode at the commodity level; their plunge is also a proxy for a similar excess downstream capacity to make steel and the coming flood of surplus or “dumped” supplies on the global market.
Today Bloomberg had an excellent update on the imports flooding into the US owing to the strong dollar and China’s rapidly weakening internal demand. From a level of less than 50 million tons annually two years go, the run-rate of China’s fire-sale steel exports is already above 100 million tons and heading much higher. As shown in the graph below, this has already caused the domestic steel industry utilization rate to plunge, eliciting a rising tide of lay-offs, plant closures and steel company profit warnings.
And then the rolling adjustment will move downstream from steel to the fabrication and manufacturing industries. In short, there is an unprecedented global industrial deflation brewing that is the downside of the central bank driven boom. That is, we are now plunging into the crack-up phase of the great central bank monetary deformation. Indeed, the idea that the US is immune to this and that it has somehow decoupled from the global economy is downright farcical.
Perhaps that’s why yesterday’s extremely downbeat industrial order report came as such a shock to the talking heads. Self-evidently, they have been drinking the Fed’s Cool-Aid or they would have noticed long ago that we are not in any “recovery” worthy of the name. How could it be when real industrial orders are still 10% below their average pre-crisis level?
Real Durable Goods Orders Ex Aircraft and Defense – Click to enlarge
Needless to say, there is plenty more evidence where that came from. In fact, the Atlanta Fed’s so-called “nowcast” of GDP is essentially a running tabulation of the “in-coming” data that eventually flows into the GDP report. With yesterday’s latest iteration of data, the outlook for Q1 is now down to 0.2%.
And this is why there is a big financial storm coming. The Fed and other central banks are now out of dry powder and credibility. The only thing happening at this point is a currency race to the bottom. They have no capacity whatsoever to arrest the epochal deflation that is gathering force all around the planet.
So here’s the buy the dip history during which the central banks destroyed price discovery, short sellers and economic sanity itself. They rendered the markets as dumb as a mule, capable of nothing more than reflexively buying the dips.
It will take awhile, but eventually the robo-traders will desist, the day-traders will be broke and the fast money will get short—–once it becomes clear that “escape velocity” was a myth, the global recession has arrived and the central banks are firing blanks.
Grexit risk continues to rise. Greece’s 5yr default probability jumps to almost 80%.
Submitted by IWB, on March 30th, 2015
Read more at http://investmentwatchblog.com/grexit-risk-continues-to-rise-greeces-5yr-default-probability-jumps-to-almost-80/#XavWE7RSm4f87rLU.99
2) Friday's bottom 17,579 is another wave 1 and we are finishing another wave 2 today.
3) Friday's bottom was end of wave 4 and we are going to new ATH.
We should know something by end of day which option the market is taking. GL
Thursday, March 26, 2015
Warning: Wall Street will keep repeating the same hype, piling it on thicker, deeper, until they finally trigger another meltdown, another crash like 2000, 2008, 1929. Stop listening to Wall Street.
Submitted by IWB, on March 26th, 2015
by James Quinn
The stock market topped out in January 2000 and proceeded to fall 40% over the next 32 months. Here is what the “experts” had to say at the time. You could fast forward to 2007 and the same idiots were saying the same things, before the market proceeded to drop 50%. Turn on CNBC today and many of these same shills are mouthing the same gibberish. At least they are consistent assholes.
March 1999: Harry S. Dent, author of “The Roaring 2000s.” “There has been a paradigm shift.” Poor Harry, the New Economy arrived, so did a long recession.
August 1999: Charles Kadlec, author, “Dow 100,000.” “The DJIA will reach 100,000 in 2020 after “two decades of above-average economic growth image: http://images.intellitxt.com/ast/adTypes/icon1.png with price stability.”
with price stability.”
October 1999: James Glassman, author, “Dow 36,000.” “What is dangerous is for Americans not to be in the market. We’re going to reach a point where stocks are correctly priced … it’s not a bubble … The stock market image: http://images.intellitxt.com/ast/adTypes/icon1.png is undervalued.”
December 1999: Joseph Battipaglia, market analyst. “Some fear a burst Internet bubble, but our analysis shows that Internet companies image: http://images.intellitxt.com/ast/adTypes/icon1.png … carry expected long-term growth rates twice other rapidly growing segments within tech.”
… carry expected long-term growth rates twice other rapidly growing segments within tech.”
December 1999: Larry Wachtel, Prudential. “Most of these stocks are reasonably priced. There’s no reason for them to correct violently in the year 2000.” Nasdaq lost over 50%.
December 1999: Ralph Acampora, Prudential Securities. “I’m not saying this is a straight line up. … I’m saying any kind of declines, buy them!”
February 2000: Larry Kudlow, CNBC host. “This correction will run its course until the middle of the year. Then things will pick up again, because not even Greenspan can stop the Internet image: http://images.intellitxt.com/ast/adTypes/icon1.png economy.”
April 2000: Myron Kandel, CNN. “The bottom line is in, before the end of the year, the Nasdaq and Dow will be at new record highs.”
September 2000: Jim Cramer, host of “Mad Money” on CNBC. Sun Microsystems image: http://images.intellitxt.com/ast/adTypes/icon1.png “has the best near-term outlook of any company I know.” It dropped from $60 to below $3 in two years.
“has the best near-term outlook of any company I know.” It dropped from $60 to below $3 in two years.
November 2000: Louis Rukeyser on CNN. “Over the next year or two the market will be higher, and I know over the next five to ten years it will be higher.” Markets kept losing for a few yearsl
December 2000: Jeffrey Applegate, Lehman strategist. “The bulk of the correction is behind us, so now is the time to be offensive, not defensive.” Another sucker’s rally.
December 2000: Alan Greenspan image: http://images.intellitxt.com/ast/adTypes/icon1.png . “The three- to five-year earnings projections of more than a thousand analysts … have generally held firm. Such expectations, should they persist, bode well for continued capital deepening and sustained growth.”
. “The three- to five-year earnings projections of more than a thousand analysts … have generally held firm. Such expectations, should they persist, bode well for continued capital deepening and sustained growth.”
January 2001: Suze Orman, financial guru. “The QQQ, they’re a buy. They may go down, but if you dollar-cost average, where you put money every single month into them, I think, in the long run, it’s the way to play the Nasdaq.” The QQQ fell 60% further.
March 2001: Maria Bartiromo, CNBC anchor. “The individual out there is actually not throwing money at things that they do not understand, and is actually using the news and using the information out there to make smart decisions.”
April 2001: Abby Joseph Cohen, Goldman Sachs image: http://images.intellitxt.com/ast/adTypes/icon1.png . “The time to be nervous was a year ago. The S&P was overvalued, it’s now undervalued.” Markets crashed for 18 more months.
. “The time to be nervous was a year ago. The S&P was overvalued, it’s now undervalued.” Markets crashed for 18 more months.
August 2001: Lou Dobbs, CNN anchor. “Let me make it very clear. I’m a bull, on the market, on the economy. And let me repeat, I am a bull.” And down it went.
June 2002: Larry Kudlow, CNBC host. “The shock therapy of a decisive war will elevate the stock market image: http://images.intellitxt.com/ast/adTypes/icon1.png by a couple thousand points.” He also predicted the Dow would hit 35,000 by 2010.
by a couple thousand points.” He also predicted the Dow would hit 35,000 by 2010.
Read more at http://investmentwatchblog.com/warning-wall-street-will-keep-repeating-the-same-hype-piling-it-on-thicker-deeper-until-they-finally-trigger-another-meltdown-another-crash-like-2000-2008-1929-stop-listening-to-wall-street/#EVMXR07usLIBEqo4.99
GREXIT: DRAGHI TIGHTENS NOOSE ROUND VICTIM’S NECK, BUT HE’S A SCAFFOLD SHORT OF A HANGING
Submitted by IWB, on March 26th, 2015
BY JOHN WARD
image: http://hat4uk.files.wordpress.com/2015/03/walliamsgagpt.png?w=812 Walliams in hot water following latest Little Britain stunt
Walliams in hot water following latest Little Britain stunt
Good morning, Happy Thursday…leap from the bed bright-eyed and bushy-tailed for more updates on how the squeaky-clean Union of control freakery functions.
Yesterday was Independence day in Greece, and so the ECB chose to celebrate it by shortening the lead on banks there: they’ll now no longer be able to increase their holdings of Greek sovereign debt image: http://images.intellitxt.com/ast/adTypes/icon1.png , and so the latest sums suggest Greece will have no money at all by April 20th.
, and so the latest sums suggest Greece will have no money at all by April 20th.
Less time, and yet more lists to come up with – this time by next Monday: run about, work-work, take planes image: http://images.intellitxt.com/ast/adTypes/icon1.png , busy-busy and…DONG! Oh dear, Mr Tsipras, I’m afraid you’ve run out of time.
, busy-busy and…DONG! Oh dear, Mr Tsipras, I’m afraid you’ve run out of time.
Reuters was once more pumping up the drama by telling its grecophobic audience that the ECB’s exposure to Greek debt is €150bn and oh my, how shameless those greasy little idlers are in bankrupting the central bank image: http://images.intellitxt.com/ast/adTypes/icon1.png with their spendthrift, tax-evading ways.
with their spendthrift, tax-evading ways.
But as Reuters and every other finance site on the planet knows full well, you can’t bankrupt a central bank. The exposure could be €150 trillion, and it would simply go down as another asset ready to be called in at some future date, future nuclear conflicts notwithstanding. And let’s face it, after an atomic war, not many are left standing.
At last, Bloomberg sticks a toe out of the closet and fesses up to the myth of Grexit. However, desperate not to disappoint the bloodsuckers, Big B goes through a number of scenarios suggesting that yes, despite there being no way legally for it to happen, ways could be found to ensure Athens winds up in the closet: the water closet that is…on its way down to the sewers where, in Greece, not even lavatory paper dare venture, let alone the euro.
But the various Bloomberg potential outcomes contain small inaccuracies like ‘Bad blood leads to Greece’s departure from the European Union’. Well, yes…but that would take two years minimum without a treaty change. And ‘Greece separates from the euro area in a messy default’ which (as the authors already established) isn’t possible.
There are days when I wonder what Bloomberg’s hiring policy is, but rarely wonder about Spiegel: I know it is the world’s first robot-written magazine. Following on from yesterday’s Slogpost about white elephants in the Spanish hacienda, this latest effort from the two-way mirror is a classic:
image: http://hat4uk.files.wordpress.com/2015/03/spiegelspain2.png?w=812 Yes, multiple fraudster and ClubMed front-stabber Mariano Comfort&Joy has pulled Spain back from the brink of something or other. This leaves him with only the rise of Podemos, Spain’s worthless property mountain and 239 empty banks image: http://images.intellitxt.com/ast/adTypes/icon1.png to think about….along with just the three separatist movements within his borders.
Yes, multiple fraudster and ClubMed front-stabber Mariano Comfort&Joy has pulled Spain back from the brink of something or other. This leaves him with only the rise of Podemos, Spain’s worthless property mountain and 239 empty banks
to think about….along with just the three separatist movements within his borders.
Listen – that Rajoy Goy – now there vos a painter….one country, 239 banks and 87 airports, all in red – three years. Oiveh!
Read more at http://investmentwatchblog.com/grexit-draghi-tightens-noose-round-victims-neck-but-hes-a-scaffold-short-of-a-hanging/#tyiiDdoWE73O5esQ.99
Wednesday, March 25, 2015
Australia is "well and truly" disposed to become a member of the China-led Asian Infrastructure Investment Bank, Prime Minister Tony Abbott said today, although he wants to know how much power Beijing would hold in the institution before making a formal decision. Australia, South Korea and Japan are the notable regional absentees from the bank, while U.S. allies Britain, France, Germany and Italy announced earlier this month that they would join the AIIB, despite Washington's misgivings.
In the five years after the financial crisis, CEOs at large U.S. companies collectively realized at least $6B more in compensation than initially estimated in annual disclosures, a Reuters analysis shows. The reason for the windfall: the soaring value of their stock awards. The S&P 500's total return (including dividends) of 166% - from the end of 2008 through Monday - has some investors re-evaluating how they judge compensation plans. In some cases, they say CEOs may be benefiting from the bull market even when their performance might be weak.
Unless it secures fresh aid, Greece risks running out of cash by April 20, a source told Reuters, leaving it little time to work out a deal with its EU creditors. Earlier this week, Greek PM Alexis Tsipras discussed reforms with Germany's Angela Merkel and promised to present a detailed list of proposed overhauls by Monday, but new pressures are popping up. Yesterday, the ECB instructed Greece's largest banks to refrain from increasing their exposure to Greek government debt, posing a severe challenge to the nation’s government.
Greek Delegation to Visit China, Boost Exports
By MarEx 2015-03-24 13:14:29
Senior Greek ministers will start a four-day visit to China on Wednesday to try to boost bilateral investments and export trade, the government in Athens said on Tuesday.
The March 25 to 28 visit by Deputy Prime Minister Yannis Dragasakis and Foreign Minister Nikos Kotzias will be the first to China by the left-wing government since its election in January. Chinese Premier Li Keqiang and Greek Prime Minister Alexis Tsipras talked on the phone last month and discussed sending a delegation to China to prepare for a visit by Tsipras.
Li had said Greek-Chinese relations had "enormous prospects," urging Tsipras to back a port project.
China's Cosco manages two of the cargo piers at Piraeus port, which serves Athens. Under a privatization scheme last year, it was shortlisted, along with four other suitors, as a potential buyer of 67 percent in the port, Greece's busiest. Greece's government, elected on pledges to stop privatizations and roll back austerity, has halted the sale of the port.
Kotzias is scheduled to meet his Chinese counterpart Wang Yi on Wednesday. Dragasakis will meet one of China's vice premiers - Ma Kai - on Friday.
Greece will run out of money by April 20 unless it receives fresh aid from creditors, a source familiar with the matter told Reuters on Tuesday.
Tuesday, March 24, 2015
John Hussman: Monetary Policy And The Economy: The Case For Rules Vs. Discretion
Mar. 23, 2015 12:57 PM ET
Excerpt from the Hussman Funds' Weekly Market Comment (3/23/15):
Last week, the Federal Reserve Open Market Committee (FOMC) began its statement on monetary policy indicating that recent data “suggests that economic growth has moderated somewhat.” While the Fed removed the phrase that “it can be patient in beginning to normalize the stance of monetary policy”, the Fed’s weaker view of the economy prompted an immediate retreat in Treasury yields, an abrupt drop in the foreign exchange value of the U.S. dollar, a surge in stock prices, and an upward spike in the dollar price of gold and oil. The basic thesis of all of these moves is that the Fed may wait longer before increasing the rate of interest that it pays to banks on idle cash reserves (viz., “raising interest rates”).
We agree – partly. As I noted a week ago, “From my perspective, it remains unclear whether the Fed will resist the temptation to defer hiking interest rates, given what we observe as a deteriorating economic landscape.” The problem for investors is that along with the initial moves in Treasury yields, the dollar, stocks, gold, and oil that followed the FOMC statement, we also saw credit spreads widen rather than narrow last week, while our measures of market internals continue to show divergences that indicate a shift investor preferences toward increasing risk aversion.
Since mid-2014, when we completed the awkward transition that followed my 2009 insistence on stress-testing our methods against Depression-era data (see A Better Lesson than “This Time is Different”,Setting the Record Straight and Hard Won Lessons and The Bird in the Hand for a full review), I’ve emphasized that the response of the financial markets to overvalued conditions, and to Fed policy, is conditional on whether investor preferences are risk-averse or risk-seeking. While we do expect that the FOMC will be much slower to raise rates than some members would prefer, we strongly believe that the singular focus on interest rates is misguided in the first place. The following comments from early February (see Expect a Decade of 1.7% Portfolio Returns from a Conventional Asset Mix) draw the crucial distinction, and capture the central lesson that should be drawn from our own experience.
My impression is that while recent slowing is likely to deter the Fed from raising the interest rate on reserves, the enthusiasm of investors about this possibility is misplaced. In a context of widening credit spreads, extreme equity overvaluation, and divergent market internals, weaker economic evidence adds to downside concerns far more than the prospect of a continued zero interest rate compensates. The chart below shows the cumulative total return of the S&P 500 restricted to the same market return/risk classification that we identify at present. The small pullout shows recent quarters, with a sequence of quick but modest losses, a larger loss last October, and more recent churning action. While we’ve observed a recovery from the October low, such short-term behavior is not particularly uncommon, and similar churning has been indicative of top formation in previous instances (e.g. 1957, 1972, 1999-2000, and 2007). These choppy periods have generally been overwhelmed by the steep average market losses associated with these conditions.
I’ll emphasize as usual that our focus is decidedly on the complete market cycle, and we have no intention to dissuade investors from other personally suitable, well-understood and historically-informed disciplines. Our main advice for passive investors is to maintain your discipline, but also – please – make sure that your portfolio allocation is well-aligned with your investment horizon, that you recognize in advance and fully anticipate the likelihood of a few market losses during the coming decade in the 30-50% range (as Jack Bogle also encourages), and that you recognize that rich valuations after extended advances and record highs imply much more conservative assumptions about future returns than depressed valuations do. Investors that only become “enlightened” to espouse a buy-and-hold strategy after long market advances, who anticipate strong long-term gains from elevated valuations, and who limit their concept of “loss” to a shallow 20% decline, are often the same investors that abandon that strategy by the end of the cycle.
It's useful to remember that passive investment strategies can seem nearly infallible after a multi-year advance half-way through a market cycle, and extreme valuations can seem irrelevant precisely because they have become extreme without consequence (recall 2000, 2007 and a litany of other cyclical peaks). Still, the completion the market cycle often results in a dramatic turn of the tables in the standing of buy-and-hold approaches relative to risk-managed alternatives.
Meanwhile, understand that the transition from our pre-2009 methods to our present methods created a muddy connection between two spans of data: 1) The span until early 2009, when I doubt there was any question about the effectiveness of our discipline and; 2) the period since mid-2014, when we’ve been defensive for reasons much the same as we were prior to the 2000-2002 and 2007-2009 collapses. The muddy part is the intervening transition from our pre-2009 methods to our present methods of classifying market return/risk profiles (again, see A Better Lesson than “This Time is Different”). The fact is that both our pre-2009 methods and our present methods of classifying market return/risk profiles would have encouraged a constructive and often aggressive outlook during much of that transition period.
Monetary policy and the economy – the case for rules versus discretion
The real-time estimate of first quarter real GDP growth published by the Atlanta Fed dropped again last week to just 0.3%. Broader measures are consistent with this deterioration, retreating considerably and in a familiar sequence that typically begins with market internals, credit spreads and industrial commodities; followed by the new orders and production components of regional purchasing managers indices and Fed surveys; followed by real sales; followed by real production; followed by real income; followed by new claims for unemployment; and confirmed much later by payroll employment (See Market Action Suggests an Abrupt Slowing in Global Economic Activity).
It’s still not obvious that the recent economic deterioration will continue, but a further retreat in the purchasing manager’s index below 50 and a drop in the S&P 500 below its level of 6 months ago (about the 2000 level), coupled with already widening credit spreads and the absence of a steep yield curve, would complete a recession warning composite with much stronger implications. Though we warned of the 2000-2001 and2007-2009 recessions as they began in real-time, and quarters before they were broadly recognized, we also had persistent economic concerns between 2010 and 2012 that were at least deferred by monetary bazookas aimed at bringing future consumption forward as much as possible. We were in good company with Lakshman Achuthan at ECRI(the only other organization we know to correctly give early warning in both of those prior recessions). Neither I nor Lakshman (to my knowledge) see enough evidence to warn of a recession at present. My sense is that should we both warn of a recession in the future, dismissing those concerns as “crying wolf” will probably result in being eaten first. For now, suffice it to say that the economic data is going the wrong way, and the sequence of deterioration is familiar.
Will a continuation of zero interest rates encourage a stronger economy? We can’t deny that grand announcements of projectile money issuance have, in recent years, been able to bring forward enough demand to spur a quarter or two of stronger economic growth. Yet even those episodes have been short lived. It’s often argued that “we can’t know what the economy would have done without extraordinary monetary policy,” but that’s not really true. One must remember that much of the economic recovery that occurs after a recession is ordinary mean reversion, and we can get quite a good sense of the baseline “counterfactual” using statistical tools such as vector autoregression. These allow us to estimate the economic activity that would have been expected solely on the basis of non-monetary variables. As we showed last week (see Extremes in Every Pendulum), economic growth in recent years has actually beenslower than one would have predicted based on lagged values of non-monetary variables such as GDP growth and employment. We don’t dispute that the Fed had an essential role in providing liquidity to cash-strapped banks during the crisis, but the change in accounting rules by the FASB in March 2009 (abandoning the need for banks to mark their assets to market value) is what ended the crisis, not extraordinary monetary policy.
Why Yellen & The Feds Are Bubble Blind——They Apparently Believe Wall Street’s EPS Scam
by David Stockman • March 23, 2015
Surveying the Fed’s handiwork during last week’s press conference, Janet Yellen noted that all was awesome except that stocks were now slightly “on the high side” of their historical range. You can say that again!
In fact, you can say that any one capable of uttering such tommyrot has been totally bamboozled by Wall Street’s sell-side con artists. Yes, the latter surely need to be monitored by the Feds. But that would be the kind of “Feds” who operate Uncle Sam’s non-elective hospitality facilities.
Take the Russell 2000 stock index. That’s smack dab in the Fed’s wheelhouse because upwards of 90% of the sales and earnings of the Russell 2000 are from domestic sources. So among the various market indicators, the small and mid-cap stocks which comprise the index should best capitalize the good works emanating from the Eccles Building. After all, the masters of the world’s reserve currency domiciled there profess no interest in the dollar’s exchange rate and aver that they can micro-manage the US economy because it is a closed bathtub not impacted by wages, prices and capital flows from abroad.
Well, the Russell 2000 closed at a new all-time high on Friday. At its index value of 1266 it is now up 260% from is post-crisis low. Undoubtedly, the nation’s labor-economist-in-chief believes that’s all to the good. But then surely no one told her it represents a valuation multiple of just about 90X LTM (latest 12 months) earnings reported by the 2000 companies which comprise the index, and which were certified as accurate by 4,000 CEOs and CFOs on penalty of jail time.
The mystery of how the Fed remains so stubbornly bubble blind—-just like it did during the dotcom and housing bubbles—is thus revealed. The self-evident reason is that the purported geniuses who comprise our monetary politburo drink the Wall Street Cool-Aid about forward ex-items EPS.
In the case of the Russell 2000, this Wall Street confected version of the EPS multiple as of last Friday was 19.9X—–or just like the lady said, a tad on the high side but nothing to sweat about. Why not keep the pedal-to-the-metal awhile longer?
But here’s the thing. We have a yawning gap here. After sell-side analysts got done tracing their all-seasons hockey sticks several quarters into the future and finished deleting any expected charges to earnings that might plausibly be dismissed as “non-recurring”, the implied forward ex-items EPS for the Russell 2000 disseminated by Wall Street was exactly $63.87 per share.
By contrast, the actual 4-quarter GAAP result through December 2014 reported to the SEC was $14.18 per share. Needless to say, to blithely ignore this blinding difference—as surely Yellen did—-is an egregious dereliction of duty.
And the reason is this: The Fed has caused two thundering stock market bubbles and crashes already this century—–which resulted in $8 trillion and $10 trillion of devastating losses, respectively. Moreover, these cliff-diving crashes happened suddenly and were consummated within a matter of months, meaning that the Wall Street insiders and fast money traders got out and then returned to scavenge the bottom, while the main street homegamers took it in the chin twice.
So you would think that people who believes a few places to the right of the decimal point on the CPI make a big difference might wonder about $14 per share versus $64; and, most certainly, investigate whether this yawning GAAP is some type of temporary aberration or simply par for the course in the casino.
Indeed, they most surely should wonder about the following: One year ago, the LTM GAAP earnings for the Russell 2000 was exactly $14.10 per share for CY 2013. So the $14.18 per share reported for 2014—– on GAAP earnings numbers that you won’t go to jail for—-means thatthe Russell 2000 has gained the munificent sum of eight pennies or 0.6% during the past year.
That’s right. America’s hometown stock index is trading at 90X based on an earnings growth rate of less than 1%. A tad “on the high side” indeed.
Moreover, none of the Wall Street defenses for using the forward ex-items profit figures can withstand serious scrutiny. The casino has become so corrupted and bubbled up that the numbers are not worth the paper they are printed on.
Consider a brief history of Wall Street’s ex-items projection for S&P 500 earnings for CY2014. Exactly two years ago, that figure was about $125 per share. At the time, it was just another case of look ma, everything’s normal.
The S&P was then trading at 1560—–so the implied two-year forward multiple was 12.5X. By one year-ago, the Wall Street hockey stick had shrunk to $120 per share—–which then represented just 15.5X the nine-month forward earnings figure for 2014 based on an index price of 1870.
Needless to say, any CNBC talking head would have told you that these multiples were completely normal and that stocks still had “room to run”. And that part would have been true. Last Friday the S&P 500 closed at 2108 or up by 35% from two years-ago and 13% from March 2014.
Alas, the ex-items earnings figure for 2014 is now actually recorded, and its the part which isn’t up. All those bottoms-up hockey sticks turned out to be a tad optimistic because the number actually came in at $113 per share or 10% lower than its two-year ago outlook. And as to the GAAP stay-out-of-jail version of profits, the number for 2014 came in at $102 per share.
So it turns out the S&P 500 is being capitalized at 20.6X actual GAAP EPS. Other than during recession quarters, the only time the S&P multiple was recently even close to that was in Q3 2007, when the LTM multiple was 19.4X. Even the Fed heads recall what happened next.
And, no, the difference between honest GAAP earnings and Wall Street’s ex-items version is not a matter of subjective preference. Non-recurring charges for asset write-offs, goodwill reductions, employee severance and other so-called restructuring costs are real expenses that consume cash and/or destroy corporate capital. For any given company honest GAAP earnings can be “lumpy” from period to period, but that can be solved by amortizing, not eliminating, these charges.
And as to the S&P 500 basket as a whole, even the “lumpy” canard is not really an issues because for many years now the difference between GAAP earnings and ex-items profits has ranged consistently between 8-15%. The lumps wash out when it comes to the entire index.
Over any reasonable period of time, however, this 8-15% gap adds up to some real money. During the eight years encompassing 2007 through 2014, in fact, GAAP earnings reported to the SEC by the S&P 500 companies have cumulated to about $5 trillion—–while ex-items earnings ballyhooed by Wall Street have totaled around $6 trillion. There is a distinct possibility that this $1 trillion difference is not just a rounding error when it comes to valuation!
More importantly, as the Fed’s bubble cycles get long-in-the-tooth, the forward ex-items hockey sticks tend to get steeper; and over the decades, the creativity of the sell-side in deleting “non-recurring” charges has gotten considerably more acute. Accordingly, comparisons of today’s ex-items multiples with purported long-term average multiples is a proverbial case of apples and oranges.
Some sense of that is evident in the graph below, which is based on trailing earnings on a GAAP basis. It shows that as of June 2014, the median PE multiple for all NYSE stocks with positive earnings was at an all-time high——even exceeding the lofty heights of the dotcom bubble years.
And that’s not the half of it. In today’s Fed sponsored casino there are far more companies with negative earnings and large capitalizations than in those benighted times decades ago when “price discovery” still existed. So that brings us to the stupendous biotech bubble that even Yellen claims to have recognized back in June of 2014.
Since then the NASDAQ biotech index is up another 50%—–bringing the index to 6X its March 2009 bottom. But even then the real valuation absurdity is not fully apparent on the surface. As Zero Hedge documented the other day, the 150 companies in the index have a collective market cap of $1.06 trillion, but only $21 billion of LTM earnings, implying a PE multiple of 50X.
But rollover Russell 2000—–you haven’t seen nothing yet. The 5 big cap biotechs in the index—-Gilead, Amgen, Shire, Biogen and Celgene—had net income of $25.5 billion during the most recent LTM period—-or well more than the index total. If you add in the next 20 positive earners, you get to $30.5 billion of net income or 145% of the $21 billion reported by the entire basket of 150 companies.
So the internals shape up this way. The Big 5 had a market cap of nearly $550 billion or did last Friday before today’s Gilead stumble which took the index down by about $20 billion. And the next 20 traded at a collective value of $230 billion, meaning that the market cap of the top 25 companies in the index (which accounted for 145% of total earnings) was about $780 billion.
Needless to say, the math here implies something rather astounding.Namely, that there are 125 companies in the NASDAQ biotech index which are valued at $280 billion, but posted aggregate losses of nearly $10 billion in the most recent LTM reporting period.
So yes, Janet, there is a bubble in biotech and its a doozy. It amounts to well more than one-quarter trillion dollars of bottled air. Its a direct result of six years of free ZIRP money to the carry trade gamblers and Wall Street’s self-evident confidence that the Fed is petrified of a hissy fit and will not hesitate to keep the juice flowing indefinitely—– even if it’s called a 25 bps increase in the money market rate, eventually.
The stupendous extent of the biotech bubble—and its merely representative—–can be seen in the free market contrafactual. That is to say, what would these 125 negative earners in the biotech index have to generate when they grow-up in order to earn-out there current $280 billion market cap?
Well, the Big 5 trade at 21X earnings and with $68 billion of combined revenues they reported a five-year sales growth rate of 16.5% per annum. So when you get to quasi-stable maturity even in the Fed’s casino it takes one small sized mountain of sales to earn even a middling sized multiple. But whoops——half of the big 5 LTM profits were accounted for by Gilead, which had an LTM net profit rate of 49% on $25 billion of sales. By contrast, the more typical net income margins of Biogen and Amgen were 30% and 25%,respectively.
Even more to the point, the net income margin of the next 20 companies—–represented by names like Mylan, Alexion, Biotechnic and Luminex was 17.5%, while the PE multiple of these earlier stage companies was a frisky 47X. And frisky is indeed the correct term because their 5-year revenue growth rate was only slightly higher than the Big 5 at 21%.
In short, give these 125 cash burning negative earners and virtually salesless biotechs a grown-up PE multiple of 20X and a net income margin of 20%. That means they would need to generate $70 billion of sales from today’s cold start. Good luck with that, and with the near ZIRP discount rate that is implied by the amount of time that would be required to get from here to there.
Indeed, speaking of the amount of time required to get from zero to 60 mph, Elon Musk has finally explained why Tesla is worth $35 billion. That is, despite the fact that it has never generated a dimes of net income; has in fact posted net losses of $1.4 billion since Goldman started flogging it in 2007; and can’t possibly compete with the likes of Toyota and BMW in scaling up to the mass market volume that is implied in its current infinite multiple.
It turns out that Musk believes Tesla is actually peddling a death trap, and foresees a world in which the testosterone-riven rich men who buy his vehicles today will be prohibited from even driving their own cars. Stated differently, he is now admitting that the market is capitalizing his driverless car vision——-to go along with his Mars Shuttle and warp speed trains:
So what happens when we get there (to driverless cars)? Musk said that the obvious move is to outlaw driving cars. “It’s too dangerous,” Musk said. “You can’t have a person driving a two-ton death machine”.
No less than investment guru Jim Cramer now gets the joke. Back in early February, Cramer issued his own broadside:
“Clean up your act, Musk—Tesla’s a total disaster!…….. No way the balance sheet can support the investment needed……. Musk confirmed that it will be spending staggering amounts of money on capital expenditures….. Where the heck is this money going to come from?”
That about sums up the “high side”. The Fed is driving a two-ton bubble machine, but has no clue that it has become a financial death trap.