Friday, July 22, 2016

Keep on truckin'

I read are really good article this week that explains how the markets have become an incredibly large computer simulation that is virtually devoid of fundamental focus.

While I won't go into all the details here, I think it is a very interesting theory and one that I would love to see us test some day. 

Anyway, the point I'm trying to make is that we continue to separate from reality in the markets.  The latest example of this lies in a little followed stat called Class 8 truck sales.  These are large trucks used to make long hauls across the US.  In the latest data published for June, Class 8 orders were down 8% from May of 2016 and down 34%!! from June 2015 to their worst levels since June 2009.

Every time orders for these trucks has slipped 30-40% year over year a recession has commenced within 6 months.  I'm not yet ready to predict a US recession but I think it is very possible that by the time we head to the polls in November, we will be in a recession.

Given this backdrop remember that stocks are basically the most expensive they've ever been on a variety of metrics.  They say that they don't ring a bell at the top of the markets but I hear a lot of ringing in my head.

Mind the Non-GAAP

I think one of the cardinal rules of blogging is to never delve into the world of accounting or you risk losing like 97% of your readers but here goes...

We have a crisis in the financial world that is going under-reported.  The burgeoning industry of Non-GAAP earnings reports.  To begin with, let's define GAAP - Generally Accepted Accounting Principles - which dictates how companies and their CFOs recognize things like revenues, expenses, etc.  Without a common language and standards it is very hard to compare to companies.  These standards have been in place for roughly 75 years and while there is a move to adopt the more globally accepted International Financial Reporting Standards (IFRS), for the time being GAAP is still the standard for good corporate citizens.

Well, about 8 years ago a couple of trends started to emerge:

1) Tech startups with lumpy revenues and expenses started trying to smooth their income statements by reporting certain costs as "non-recurring" and reporting earnings as Non-GAAP. 

2) Large industrial players started charging off huge costs as one-time restructuring fees and also started reporting earnings as Non-GAAP.

The two poster children for these techniques are Solarcity in the tech world and Alcoa in the industrial world.  The problem with these definitions is that the companies and their investors have become addicted to the beautiful non-GAAP results that can be posted quarter after quarter. Consider that in the last 12 months Alcoa had a net loss according to GAAP of $500 million.  However, they reported $1 billion of "non-recurring, restructuring charges" and published a "non-GAAP" PROFIT of roughly $500 million. 

Now when it comes to issues like paying taxes or begging for another bailout from NY State, Alcoa will clearly point to their $500 million loss, but when they talk to investors they just say abracadabra and POOF! Hey, look at that we made $500 million last year!!

Now when it was just a weird solar panel company run by Lex Luther or a bit player in the aluminum market I let it slide but in the past few weeks here is a short list of the obscure companies that have reported Non-GAAP  nonsense -

Johnson & Johnson

These aren't startups or companies where liberal accounting should be the norm.  These principles are called GENERALLY ACCEPTED for a reason and the media and the investing public should demand more from public companies.

I believe that we could draw more attention to this issue if we started calling non-GAAP numbers by a new name which reflects that the numbers are in fact the opposite of Generally Accepted:

"Q1 EPS rose 12% according to Abnormal Accounting Principles"

"While GAAP revenue fell 2% it actually rose 6% according to the company's use of Questionable Accounting Principles"

To the SEC's credit they are starting to get more active in discouraging the use of non-GAAP reporting but until the media and analysts team up to ignore these faux reports, companies will keep up the non-GAAP games.

Okay - that's enough accounting talk for the next 6 months :)


Friday, July 15, 2016

We hold these truths to be self-evident...

that stocks and bonds cannot correlate forever.

Okay, so I'm paraphrasing a bit.  However, we are in the midst of a historic sequence in the markets which either:

a) will mean that every basic principal of investing is no longer valid or

b) will eventually reverse course

The premise that I'm referring to is that equities (stocks) are bought because they are a bet on future growth prospects.  You buy stocks when you think there will be increasing income earned by these stocks which will be reinvested to grow the business or returned to shareholders in the form of dividends.

You buy US government bonds as a safe haven in the storm when the economy is sending warning signs of recession and you are focused on capital preservation.

Well, the yield (interest rate) on the 10 year US Treasury bond fell to it's lowest level ever last week.  Not the lowest level of the decade or the past 20 years......EVER. 

This implies to those that studied ECON 101 that the prospects for the US economy are not very strong (the previous low was set during a period from 1940-45, the heart of the Great Depression).

Okay, but stocks also surged back to record levels in the US this week so clearly the prospects for earnings and dividends must be soaring as well, right?

Notice how these three measures moved in unison until the February stock market rescue.  Since that time earnings expectations for the S&P 500 have continued to tumble while stocks have resumed their meteoric rise. 

I often lament the loss of fundamental focus in the markets but this chart really conveys that message better than anything I could say or write.  While the traditional media likes to report to you the daily moves in the S&P and the Dow know that those numbers no longer correlate to what is happening in the real world. 

So, the question we have in front of us is - are bonds correct in telling us the global economy is unraveling or are stocks correct in telling us that everything is awesome? 

I'll try to offer some answers in a coming post.


Wednesday, July 13, 2016

Celebrate Good Times, Come On!!!

I've held off commenting for a bit because there is just so much information to share that I didn't know where to begin.  I'll do my best to chip away at a variety of topics over the coming weeks while trying not to flood your inbox with random updates.

Lions and Tigers and Brexit, Oh my...
Three weeks ago the world was told to hold its collective breath because the UK might be voting to leave the EU.  The night before the vote the gambling books in the UK (which are thought to have predictive powers) went sharply "all-in" on the Remain side of the bet.

Subsequently, reviews of those books seems to indicate that it was a few large bettors trying to move the market.  The thinking seems to have been "Hey, if we bet enough on REMAIN that it makes it seem like we have inside knowledge.  That will be reported widely and it will discourage the LEAVE voters from even coming to the polls."

The first half of that equation was correct - it was reported far and wide before the vote that "Remain seems all but a certainty based on late betting". However, the trouble with democracy is that you still have to actually have a vote and the LEAVE campaign pulled off the win with roughly the same percentages that were predicted in polls two weeks before the vote.

Uh-oh.  Didn't the Prime Minister of the UK David Cameron say that Brexit could effectively lay the groundwork for a new world war and waves of genocide around the globe?  The "Remain" camp had actively spread a campaign of fear that was focused on political, economic, social and societal upheaval if "Leave" won the vote.

Then, just when everyone expected a global market collapse, what happens?  The sharpest rally in the global markets in years.  7-10% around the world in two weeks!!!

If there is one consistent theme that I hope you've learned from my blog it is that when EVERYONE is certain of X, you can be assured that Y will happen. Markets were certain to collapse after the Brexit and instead the S&P and Dow have now hit new all-time highs.

Now as for WHY that is happening and what it means for the future...tune in tomorrow.

Tuesday, April 19, 2016

What a long strange road it's been...

I thought I'd take a moment to revisit what has transpired in the global markets over the past two months because it really has been unprecedented.

Back in mid-February the global markets were sitting on a razor's edge.  From a technical perspective if stocks fell another 1% they looked like they might fall 50%.  This technical backdrop was coupled with a fundamental picture that was deteriorating across the globe.  China, technology, oil, energy, pharma, everything was (maybe is??) entering a slowdown at the same time.  This had all of the hallmarks of a major 2008/2009 meltdown lining up again.

And then just as it seemed the stars had aligned something changed almost overnight.  The key catalyst that started the market's historic surge from February (up 14% in 2 months - roughly an 85% annualized rate of return) was the bounce in crude oil prices.

If you remember in February we were starting to see the first signs of retail gasoline prices cracking the $2.00 mark.  West Texas crude oil was hovering around $31/ barrel and the outlook was grim.  The world is awash in oil right now and central bank policies have encouraged many countries and companies to expand capacity beyond what the market can bear.  These companies and countries  need to keeps pumping oil to make their debt payments but this supply issue is coupled with another major problem -- the growth in demand for oil is falling right now.  Okay, so in a logical world you would say - supply is growing, demand is falling the price of this product should continue to decline.  However, we no longer operate in a world dictated by logic.

The oil markets are now heavily influenced by the same electronic trading platforms that have made a mockery of our stock markets.  These trading bots, for lack of a better term, are scanning every headline for a hint on the direction of crude oil.  Conveniently, at the moment when oil prices and the US stock market were on a razor's edge word began circulating that OPEC was going hold a meeting to discuss a production freeze in April.

The problems with this concept are many -

1) OPEC members are notorious cheats.  They say they will only produce X, yet they will produce x+10%.

2) OPEC's influence is waning in light of US/Canadian/Russian production.

3) You have to get parties that don't particularly like one another (Iraq, Iran, UAE, Saudi Arabia) to agree to terms.

However, the rumor of a meeting set off a buying frenzy in the oil markets which ultimately spread to other commodity classes (Why? No one knows, why ask questions, just BUY!!!).  This is an oversimplification but there are many stock programs that see the world through a simple lens of "if/then" relationships.

Since, oil prices were up that must mean demand was going up, right?

And if demand is going up, that means the global economy is picking up steam and that must mean stocks are set to rebound so....


Now, there have been other catalysts that have played a role - the Fed's unclear messaging, Japan's panic move to negative interest rates, etc - but the most significant and consistent driver of the oil and stock markets has been this idea that oil prices were going higher.

Every day brought a new rumor - "Russia says......", "Iran says......." "Saudi minister says......" and every headline brought more buyers.  Then a funny thing happened - they met this weekend and the result was no agreement on production.

Wait, WHAT!?!?! So, the 15% bounce in stocks and the 30% bounce in oil prices that were all driven by the premise of a major agreement on reducing supply has been a fraud?  Obviously, this means oil prices and stock prices are set to plummet, right?

Again, we are trying to apply logic to an illogical world.  Yes, the immediate reaction by the humans in the market was to sell both oil and stocks (oil slipped 5% and some global markets were off 3% immediately) but as the programs started kicking in around 9:45 am yesterday it was clear that this was not your father's market.  Stocks and oil prices ripped higher for the rest of the day until the Dow managed to end above 18,000 for the first time in 9 months.

So, that's the back story of the past 2 months, but let's consider what is going on in the US right now.

* Q1 GDP estimates are around 0.3% to 0.5% growth.  That's a round error away from being in contraction.  Seven years into the "recovery" the US is growing at about 1/10th of what would be considered healthy.

Well, you might say Q1 2014 and Q1 2015 were weak as well - true, but remember we blamed that weakness on a polar vortex and East Coast blizzards.  Who can we blame for this weakness in the wake of the warmest winter in 20 years?

*Freight shipments are weak and trailing even weak first quarters like 2015 and 2014.

* Look at some of the early results from huge US companies - IBM, Morgan Stanley, Goldman Sachs - the disconnect between these results and a stock market that is within a whisper of its all-time high is strange.

* I continue to believe that the real price of oil given the current supply/demand picture should be around $25/barrel.  When evaluating a forecast like that you have to ask yourself are you a bigger believer in the power of market fundamentals or Central Bankers?  The Central Banks have had a much more significant role over the past 7 years but over the past 100 years I'd say that fundamentals tend to win out.

To summarize - I'm feeling a little like Don Quixote at the moment because I know certain things to be true but the markets are telling me that what I know is wrong every single day.  Eventually, that may change but until then I'll be out tilting at windmills.


PS - I wrote this late at night and my spell check isn't working so please excuse any errors :)

Friday, February 12, 2016

Was Time Warner reading my blog?

Suddenly at 8:57 last night - bang! No internet, no TV, no phone.  That'll teach me to tell people how to avoid their silly rental fees. *

Later I found out that it wasn't just me, but for a moment I was ready to slip over to the side with people wearing tinfoil hats.

Speaking of crazy conspiracies...have you noticed 2.5% jump in stocks since yesterday afternoon?  This might be one of the world's greatest coincidences of all-time, but yesterday as the S&P 500 slipped right down to that critical 1812 number that was about to cause sell orders to flood the market when a strange oil headline crossed about the prospect of OPEC meeting to cut production.  This headline single-handedly saved the stock market as oil stocks spiked dragging everything else along for the ride.

Today we had a variety of headlines that seemed to indicate that the Fed was not seriously considering negative interest rates at this time (but Japan said that just one week before going to a Negative Interest Rate Policy).  This should have taken some wind out the market if they were hoping for more free candy from the Fed, but the computers that read the headlines missed the context and only picked up on the words Fed & Negative Interest Rates.  This sparked some more panic buying in the morning which beget more buying and the week was saved.

Now we have to deal with the fact that
* the oil headline that saved the market has been ignored by the only parties that really matter - Russia & Saudi Arabia (who appear to be ready to go to war in Syria against one another so I'm thinking they aren't in a real cooperative mood)

* the statement issued to the WSJ was sent around midnight in the middle east which seems a bit odd

* and even the WSJ questioned the validity of the production cuts, but no matter, the active traders had their best week in years and you get to sleep better this weekend as the stock market avoided collapsing for another week.


PS - don't buy any of the nonsense headlines that today's rally was sparked by strong US retail sales. They were wildly over-inflated by seasonal adjustments and if you believed those numbers you'd be selling stocks today because it would bolster the Fed case for raising rates further.

* A special note for Time Warner customers: They are starting the campaign to add a set-top box rental to your account.  If you currently just run the cable wire into the back of your TV, that will no longer work as of June 2016 and you'll need to get a device (like a $40 Roku) or rent a set-top box for $3/month from your friendly neighborhood cable behemoth. For someone like myself with 4 televisions in the house that is $12+/mth forever and I wonder if they'd ever raise the price of the rental? :)  I'm buying an HD antennae and if that provides an adequate signal I'll probably cut the TWC cord for good.

Thursday, February 11, 2016

Not trying to cause a panic, but it's time to FREAK OUT!

Just kidding, relax and take a deep breath.

Global markets are under severe pressure and the, sorry Technical market analysts are running the show right now.  If you remember last week I said the number that everyone on Wall St. was worried about was 1812.  This represents the low of the S&P 500 way, way back in Jan 2016 (yeah, three weeks ago) and it seems like the programs want to retest that number (futures are bouncing around but were 1814 last I checked).

A significant break below that level and I don't know what the machines will unleash but it may not be pretty.

So what's driving this latest move?  I'd guess it's some pretty vague "sentiment" like

* Concerns about Central Banks having few policy tools left


* Fed Chairwoman Yellen's comments yesterday which almost asked the market to crash.

Okay, so that's probably a bit extreme, but in a nutshell this is what the head of the Federal Reserve said -- if markets were to continue to swoon, the Fed could consider reversing its plan to tighten.  This is code for "if Wall Street wants more free gov't cheese in the form of lower rates or direct intervention, stocks need to go lower first".

The market and global economy are acting very much like they did in 2013 when I first saw signs of weakness.  What I did not expect was that the Fed would come to the rescue once again as soon as equity prices dipped.  The major investment houses are about to call the Fed's bluff again - will the Fed come to the rescue for the umpteenth time and more importantly, will it even matter to the markets?

Today might be a wild day as the Fed Chair Yellen will be speaking throughout the day while the markets continue to gyrate.

** Update: This is how crazy the markets have become - in the past 30 minutes before the markets have even opened, buyers have flooded the market assuming that this dip will be sufficient to induce the Fed to act and the futures are well off the lows of the morning.  Good luck trying to figure out how this relates to the actual value of a company anymore.  The stock market is just game of 1's and 0's for the computers.

One final note that I thought I should mention.  When it comes to predicting the outlook for global trade and by default global economic growth would you rather listen to an economist who has never worked outside of a university (ie, most of the current Fed Reserve Bank heads) or someone who runs the world largest shipping company?  Hmm, I'll take the shipping CEO for $200 Alex.....

Well, the CEO of Maersk (you see their containers EVERYWHERE) told the Financial Times yesterday that "It is worse than 2008. Oil is as low as it was in 08-09 and freight rates are lower.  The external conditions are much worse...." so, that's something to keep in mind.


Wednesday, February 10, 2016

Everything is fixed. Go back to your regularly scheduled program.

For the second time in 2 weeks the market stared straight into the abyss and bounced.  The bounce began on Monday when a determined set of programs bought stocks in consistent enough intervals to drag in other programs that use plain vanilla if/then strategies.

Overnight stocks soared on ........ insert random idea here -
Trump victory?
Clinton loss?
The German government promising to save Deutsche Bank?

However, the most likely cause is the one the markets can't seem to live without - Fed Chair Janet Yellen is speaking today.  So, the expectation is that she will utter something even beyond what is taken for granted now, the prospect of negative interest rates or QE4, but perhaps preemptively taking the next Fed rate hike off the table.

At this point the Fed's credibility is the asset that is in the most danger so it will be interesting to see how the market reacts, but right now they want to make money on the buy side so it's a green day for everyone (except Solarcity - YIKES!).