Friday, February 16, 2018

Corporate Stock Buy-Backs Gone Wild


Spring break is an annual ritual for many in college.  A time for carefree abandonment where you are sure you are invincible and the crowd is your biggest ally.  And when I think about what is going on in the stock market as 2018 spring break approaches, I cannot help but imagine a large band of C-Suite Executives leading the party this year.  With the Tax Bill passed last December, corporate pockets are flush with extra cash, and they are just looking for a way to spend it.  According to President Trump, they are going to do the responsible thing - they will invest it in plant and equipment and create American jobs and the economy will flourish.

But Spring Break has never been about doing the responsible thing.  It is more about doing the irresponsible, and pushing it to the limits.  And in the year of freebies being released from Washington in the hope of responsible behavior, there is this Pollyannaish notion that the adults in the C-Suite will do the right thing.  Well optimism would be well founded if you believe that doing the right thing is taking the tax-cut windfall and continuing the trend of buying back your own company stock.


According to Bloomberg Intelligence, corporate buybacks are likely to jump 75% to $850B in 2018 after the passage of the Tax Reform Bill.  This would not only continue an already hot trend, but accelerate the activity to a new level well beyond the high reached in 2007.  And, in case you missed it, 2008 and 2009 came after 2007.

Which raises the important question, is excessive corporate buyback activity signs of a healthy stock market and therefore considered responsible behavior? 

Monday, February 12, 2018

Careful Buying the Dip after the Correction, You May Become the Moth to the Flame


In my latest financial market perspective article, Warning: Market Rout In Progress, Investor Discretion Advised, written on Thursday, February 8th after the stock market closed in ‘official down 10% correction territory’, I stated a view that the market would now be tested and a sell any rally (SAFR) rather than buy the dip (BTFD) psychology was likely to emerge.  The biggest challenge in the market in holding the recently achieved highs is that the broad stock market valuation has been driven well beyond its supportable valuation range given the size of the US economy and its current growth capability.   

The main reason that stocks have been able to move up to the high point it reached it reached on January 26th, 26,617 on the DJIA (DIA) and 2873 on the S&P500 (SPY), is the combination of extraordinary world central bank monetary stimulus over the past 9 years combined with the tremendous hype behind a new US government economic plan.  


The extremely fast move in the market into correction territory the first week of February is a sobering reminder to investors that there are pent-up speculative pressures embedded in the market that will need to be unwound as monetary stimulus is unwound.  This process is very likely not over after just 9 trading days.

Friday, February 9, 2018

Financial Market Jury Is Out On The Trump Economic Plan


Senate leaders unveiled a two-year budget deal on Wednesday, February 7th, 2018 that created a compromise in the heated budget negotiations between the Republicans and Democrats.  Less than two months after their $1 trillion tax cut, the House passed a resolution the following day that raised budget caps by $300 billion in the next two years, increased the debt ceiling and offered up more than $80 billion in disaster relief for hurricane-ravaged Texas, Florida and Puerto Rico.  President Trump signed the bill into law on Friday. 

There really is not any way to fund all the Trump budget requests without higher government fiscal spending given the Senate rules.  Once the Republicans put forward higher spending increase requests for their favored military lobbying constituencies, the democrats countered with their own increase requests.  In order to get the 60 votes required to pass the budget, the outcome was predictable.

What is so misleading about the whole situation is that the actual fiscal spending increase rate, in absolute terms over the past decade has only been 3.6%, and an even lower 2.6% over the past 4 years.  You would think with all the hype it was growing at 10 times that rate.  But, it is very telling about the economy in general when you look at the growth rate in fiscal spending over time, and its relationship to generating inflation (the debt also has a big impact, depending on where the debt is financed foreign versus domestic).

I have a table I recently created from some of my research I think you will find interesting.



You can draw your own conclusions from the data, but what I see is a country that has cut its tax base so far, that it cannot grow the government fiscal spending machine without borrowing more and more debt.  The trending result is lower domestic GDP as both real growth and inflation driven price pressures have moved lower through time. 

Slowing the Washington spending machine down in absolute growth terms, turning the FED loose with monetary stimulus (the Obama result), but without a large increase in the public debt from the end of 2013 until today (all the new debt occurred in 2009 and 2010, and much of it was consumed by the Fed and China) produced a hyper-inflated stock market, but tepid U.S. economic growth.

The Trump plan is changing the entire playing field - more fiscal spending in absolute and % terms, possibly a lower FED effective balance sheet (but definitely a lower absolute balance sheet as they allow Treasury holdings to run off their balance sheet) which means higher interest rates, and much higher growth in the US public debt.

I leave a question mark on the GDP forecast in the table because the jury is definitely out on how this new path will play out.  But I do know the realization of how this plan will actually be implemented in the financial markets is hammering longer term bonds, stocks and the US Dollar as of the first week of February 2018.  On a relative basis, the Trump plan might end up pushing the economy back toward an era similar from a mathematical perspective in relative terms to the 1970s. There is hope it will be the 1980s in the market, but I think the starting point for stock and bond valuations is too high.

Here is a look at what has happened to the stock market over the same periods covered in the table above.



Related Articles:


Daniel Moore is the author of the book Theory of Financial Relativity.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell. 

Wednesday, January 24, 2018

Weaker U.S. Dollar - Good for Trade but Toxic for Stocks


In January of 2017 as Trump was inaugurated as President, I published the following article - Will A Weaker Trump U.S. Dollar Be Toxic for Stocks?

Through the first half of 2017, the U.S. dollar (DXY) continued to trade around 100, the level it was when Trump entered office.  But beginning in mid-May 2017 the dollar started to trend progressively lower, and has broken down through a key historical average level of 90.

In an interview in Davos on January 24, 2018, Treasury Secretary Steve Mnuchin reiterated the Trump administration view that a “weaker dollar is good for trade.”   As shown in the real-time capture of the dollar trade at the moment of the remarks, the US dollar dropped, continuing its trend lower.



The relevant investment question is whether a weaker dollar is actually good for stocks (not trade!)?   Against a backdrop of an inversely correlated move in U.S. interest rates, as historical data published in the article shows, chances are very high that the market will collapse as the trend progresses.  There are three points in market history that reviewed in the article – The Nixon Dollar Shock, The Reagan Plaza Accord and the Bush / Snowden Policy. 

I strongly advise that you read the article if you are an investor interested understanding how market risk is fundamentally and rapidly escalating at the present time, and how long it took for the stock market to re-calibrate lower in response to very similar US President direct dollar moves lower in recent history.   Nothing has changed from a market analytical standpoint since the time the article was published.   What has changed is that the US Dollar is now weakening, stocks (SPY) (DIA) (QQQ) are substantially higher, and US interest rates (TLT) (SHY) (TBT) (IEI) are poised to move much higher as the Treasury has to enter the market to finance the Tax Reform Bill not just short-term, but for many years to come. 
 
Is this a toxic market scenario in the making?  In my opinion, very likely; it is just a question of when for stocks.  And, given that the stock market is starting from an inflated position relative to many market measures, the stock collapses after the post 1971 and 1985 dollar declines are the relative points in history most applicable to the current stock market set-up.

Daniel Moore is the author of the book Theory of Financial Relativity.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.

Wednesday, January 17, 2018

Laws of Financial Physics Temporarily Suspended


The business media was frenetic on Wednesday (1/10) about a story launched by Bloomberg in the early morning hours that China may slow or even cut-off its purchases of U.S. Treasuries. (Reuters, Bloomberg, CNBC).   The stock market had a knee jerk reaction downward, as the pre-market futures were down and the morning broader market stock trade was off up to -0.49% on the S&P500.


But once the Treasury auction was completed, the broader US equity markets resumed the relentless charge higher, as if the Laws of Financial Physics need not apply to stock investors at the present time.  At some point in time, investors are going to figure out that they are parking money in a zone where the Law of Gravity will eventually apply again.  However, for investors who can’t or don’t read the signs, I suspect the day of reckoning will be a brutal one this time around.

Tuesday, January 16, 2018

Fed Put Being Replaced by the Trump Put


The following statement made by President Trump in mid-October of 2017 sent many economic professionals into a tizzy.


“In the last 10 years they borrowed more than it did in the whole history of our country. So they borrowed more than $10 trillion, right? And yet we picked up more than $5.2 trillion just in the stock market, possibly picked up the whole thing, in terms of the first nine months in terms of values. So you could say in one sense we’re really increasing values and maybe in a sense we’re reducing debt.”

This bizarre statement, not unusual for Trump, sent many economic professionals into a tizzy.  It is preposterous, they contended, that movements higher in the stock market have anything to do with the ability of the U.S. government to amortize the National Debt, which has now surpassed $20T and climbing quickly since September 2017.  From an economic perspective, it is GDP that drives a country’s ability to service its IOUs, not the stock market casino.  But in the Trump world, fortified by a bevy of Wall Street advisors, the current view is that as long as stocks are strong, more debt is not bad for the USA.  Why the sudden change of tune?

The reason involves how the U.S. government, led by Trump and minions of structured finance geeks from Goldman Sachs and other investment banks are going to get the financial markets to free up enough capital to finance the Trump Tax Reform bill.   I call it the Trump Put.

 

Tuesday, December 12, 2017

Bitcoin Making a Mockery of the Capital Market System

When I wake up every trading day, I usually check the business news and its impact on the market outlook.  Lately there have been two consistent themes.  One, the DOW futures are trading higher.  I don’t know the exact number of times over the past year this has been the case, but it must be well over 80% of the time. 
 
The second theme is that Bitcoin is trading at another record high.  And on December 11th, with the launch of Bitcoin futures contracts on the CME, the price of Bitcoin surged yet again, and the futures traded up to the point that trading needed to be halted.


The markets for risky and speculative assets are in a trading frenzy unlike none I have seen in my lifetime.  Sure the stock went up rapidly in the 80s after the Reagan tax cuts.  But real economic growth in this time frame was 5-8%, and the gains relative to GDP and the falling level of interest rates made the stock valuation moves justified, at least until a breaking point was reached in 1987. 

The market experienced a similar euphoria in the late 1990s, only to be knocked down after the turn of the century.   Again, high rates of real economic growth coincided with the rise, and the advent of lower growth post year 2000 knocked the expectations for stock returns down, and the market fell.

The big difference with today’s market and these past experiences is the contrived nature of the market movements.  News about the economy means very little in the derivation of what investors should expect as a rate of return going forward.   There seems to be a complete disconnect across all markets.   Sure corporations publish their profit reports, and the level of earnings and the management outlook provide some degree of input into the process of determining how one stock stacks up against another in a relative valuation.  But, the Russell 2000 (IWM) is priced at 24x earnings!  And the DJIA (DIA) is up year over year over 30%.  High yield companies (HYG) are floating long-term bonds at 4%-5%.  And the 10 year Treasury (IEF) is stuck between 2.3% and 2.4% even though the Treasury is in the process of borrowing almost $1 Trillion over a 6 month period. 

These are return and valuation metrics which might be appropriate in a market rebound after a steep correction and hard recession.   But in today’s market, these turbo-charged market returns and valuations are a sign of a more serious problem in the financial markets.  And, the Bitcoin craze is leading the charge in making a mockery of the current state of the so-called free market system.

What basis do I have to say this about Bitcoin?  For starters, Bitcoin is not a real investment asset because it has no natural underlying rate of return.   It is scam founded on the same principles as

Wednesday, November 22, 2017

On a Relative Basis, Stocks are in the Red Zone

The U.S. stock market has rocketed higher since Donald Trump’s election in 2016.  The DJIA (DIA) posted a 28.9% year over year gain through October 31st, and so far in November has shown signs of continuing to move upward.  The rationale behind the market move is simple - stocks are considered a better value than the low interest rate bond alternatives.   

Since the financial crisis in 2008, interest rates have been suppressed for many years now because of Federal Reserve large scale quantitative easing measures, combined with similar bond buying actions by the European Central Bank and Bank of Japan.  The excess liquidity in the market has now inflated stocks to much higher levels.  The question remains, are the present market capitalizations of many companies sustainable?

With the election of Donald Trump, the business news media has become enamored with the idea that economic growth can be pushed much higher in the world as new Tax Reform legislation is passed in the U.S. and interest rates continue to remain historically low.  Therefore, the market commentary goes, stocks are the best investment, and investors need to “fear missing the chance for much higher returns.”

Anytime the market reaches these types of frenzies, it is best to look at relatively similar situations to see if the hype matches reality over a longer time horizon than 3 – 6 months.   As a guide to judge the relative value of stocks and bonds through time, and also to judge whether the market is overpriced, I look at the DOW relative to GDP.  Since 1990 the relative level of the DOW index to the US GDP (nominal) is plotted (gray line) in the graph below:


What you can see from the data is that the DOW:GDP line fluctuates through time, and as the market reaches peak time periods, such as the year 2000 and 2007, the measure approached and exceeded 1.0.  In fact the index was aggressively higher in the late 1990s.