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.