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. 

Saturday, November 4, 2017

The Great Republican Tax Cut Hoax

The devil is always in the details, and the Republican Tax Cut proposal which was unveiled on Thursday November 2nd has changes buried within it that will affect a broad swath of tax-payers.  A large segment of the mass individual tax-payer population gets a bigger tax bill or nothing.  Using averages to sell the plan to the public is misleading.  I suggest checking how the personal exemption elimination while upping the standard deduction while eliminating many popular deductions affects your particular circumstances.  Many families of 4 who own a home with a high mortgages will lose ground if this plan becomes law. 

Meanwhile there is a big reduction proposed for corporate taxes from 35% to 20%.  It appears the plan is constructed to give Apple Inc. (AAPL), and multi-national companies a big pay-off for their prior transfer pricing shenanigans whereby the multinationals set prices of goods, services and intellectual property rights that constantly move between their national business units. In this scheme, which is widely used, a foreign parent (say a Chinese affiliate) charges a U.S. business unit an inflated price for an I-Phone, which allows the U.S. tax bill of Apple to be greatly reduced or potentially even eliminated. 

This transfer pricing practice is widely utilized by multi-nationals throughout the world to avoid paying U.S. taxes.  They can avoid the taxes as long as they do not repatriate these inflated profits to the U.S., which is precisely what Apple has been doing for years, particularly since the I-Phone took off in volume about 5 years ago.  Instead of paying their fair share of U.S. taxes, Apple has amassed $268B in cash and marketable securities, the majority of which is held in foreign custodian accounts in U.S. dollars.  (See Apple 10-K here)  This massive figure represents about $800 in cash for every American citizen. 

Buried deep within the Republican tax bill is a provision to attempt to correct this practice.  The provision would slap a 20% excise tax on goods and services multinationals routinely make on cross border transactions between business units.  Under the proposal, U.S. business units that import products, pay royalties or other tax-deductible, non-interest fees to foreign parents or affiliates in the course of doing business would either pay a 20-percent tax on these or agree to treat the amounts as income connected to their U.S. business and subject to U.S. taxes.

If this provision becomes law, many corporate tax experts believe multi-nationals would opt to avoid the excise tax by electing to pay U.S. corporate tax on all the profits related to products sold in the United States. (read here) These profits may include profits on activities conducted overseas, like manufacturing or research, which are also subject to foreign income taxes.  In other words, the door would close on a practice that for many years has sucked American manufacturing of goods for consumption in the U.S., particularly technology goods, textiles and autos, overseas.

This provision is a pivotal part of the Trump election platform targeted to discourage the practice of dodging U.S. taxes by shifting production overseas to lower tax and labor cost countries, and hoarding the savings by purchasing large quantities of U.S. Treasuries, which are in ample quantity because the U.S. National Debt has been indirectly ginned up by the large U.S. trade deficit. It is one big incestuous cycle that needs to end.

Here is the rub, and why I believe the Republican Tax Bill is a hoax.  This provision is likely never to be voted on or become law.  If it does, I will be glad to say I was wrong, because it is very badly needed to begin to correct a 25 year long fleecing of America that has reached unsupportable proportions today.  But the reason it will not become law is the resistance it is going to get from lobbyists representing the multinational companies who have become major beneficiaries of the process.  The provision could also be disruptive to debt markets as well as inflationary for U.S. consumers in the short to intermediate term.  Overall, however, in my assessment these would be small prices to pay in order to return the country to a more sustainable path for the long-term.

However, what is most likely to happen is the provision will be silently withdrawn from the proposed tax bill, and the 20% corporate flat tax could get passed without any strings attached.

Does anyone truly believe Apple is going to bring a substantial amount of jobs back to the U.S. now just because the corporate tax rate is lower?  I think there are two chances of this happening, slim and none, and slim has bolted out of the country.  All the proposed Republican Tax Cut  plan, without the 20% excise tax provision would do is provide a big welfare check to companies like Apple who are the primary driving force behind the US deficit ballooning to ever greater levels in the first place (not paying their taxes due, and reducing jobs of tax paying Americans).  As a result American citizens end up with politicians with pea sized brains trying to sell a tax cut sham to foist the burden of paying down the US debt, or at least keeping it under control, while Apple Inc. gets off paying very little and continues the practices that are currently in place.

Apple is just one of many well-known corporations who want this welfare check so they can pull even more money into their feudal coffers at the expense of everyone else, like (MSFT) (CSCO) (ORCL) (WMT) (PFE) to name a few.   Multi-national corporate elitists are the primary problem that needs to be dealt with in the Washington Swamp. 

Donald Trump ran on an election platform to fix this problem.  Instead the Republican tax plan that is more likely to actually become law would entrench a corporate welfare system that enriches foreign countries while dumping and ever greater burden on Americans citizens in the future.  Or, the reform tax plan may just not pass at all, leaving the status quo in place.

Beware if the Excise Tax Provision in the Republican Tax Cut plan is eliminated. – If so, then the plan will become a complete hoax pulled off on the American people.

Daniel Moore is the author of the book Theory of Financial Relativity: Unlocking Market Mysteries that will Make You a Better Investor.  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.

Thursday, November 17, 2016

Bill Gross is Wrong, Trump’s Policy Right for America at this Time

In his most recent newsletter, Populism Takes A Wrong Turn, Bill Gross, Portfolio Manager-Global Macro Fixed Income, argues that President elect Donald Trump’s policies will not actually remedy America’s problems, and will actually lead to lower GDP growth and higher inflation.  His negative assessment is summed up in the following quote, which actually blames the “idiot electorate” in his opinion, for the result:

“The Trumpian Fox has entered the Populist Henhouse, not so much by stealth, but as a result of Middle America's misinterpretation of what will make America great again.”

His argument against the Trump economic plan is as follows:
“Trump’s policies of greater defense and infrastructure spending combined with lower corporate taxes to invigorate the private sector continue to favor capital versus labor, markets versus wages, and are a continuation of the status quo.”

His argument totally discounts any simultaneous actions to create “fair” trade pacts which Trump campaigned on.  He portrays this activity as “negative policies revolving around trade.”  I suppose the idiot electorate sees this issue a little differently from the ground level.

Bill Gross obviously gets what is happening from an economic and government standpoint; but, unlike Trump's outrageous statements on the campaign trail that were successful in tapping many supporters in America, Gross is not connecting with many in the investment community with his rants, and certainly not many Americans who voted for Trump.  Maybe he should get on-board and ride the wave that is about to be created, rather than complain so much that things are not fixable.

Thursday, November 3, 2016

Stock Market Risk Measure Hits Caution Zone – 2016 Election Driving Volatility

This blog is an update to the article I published on October 25th, 2016: How Worried Should You Be about Your Investments Now?  The update is based on a review of the Financial Relativity Index metrics at market close at the end of October.  The changing metrics are both interesting and potentially ominous given the breadth of historical data on which the model has been derived.

The Financial Relativity Index as of October 31st shows the following:

The two changes in the index since the end of September are an increase in market risk to cautionary from green light status, and a continued degradation of the credit market indicator.  I wrote at length in my previous article on the credit market signal and how the deterioration in this particular metric has forewarned many business cycle driven economic downturns, and usually is a good leading indicator of a stock market correction.

The focus of this update is on the sudden jump in market risk as measured by the Financial Relativity Index.  Given the downward pattern which has formed off a new all-time high of 2190 in the S&P500 (SPX) on August 15, 2016, less than 3 months ago, there is a very good chance that the market is about to roll over into a much deeper decline for a much longer time period than it has in the previous 7 years.  The perfect storm to bust the market bubble formed over the last seven years may now be in place.

Tuesday, October 25, 2016

How Worried Should You Be about Your Investments Now?

Climbing the ‘Wall of Worry’ is a not so favorite pass-time of most investors.  Currently there is plenty to worry about.  Deutsche Bank could spark an international financial crisis.  Middle East wars in Syria and Yemen could cause disruption in energy supplies.  Central Banks, including the Fed, can change course on monetary easing policies, pushing up interest rates sparking investors to sell over-leveraged assets.  Ultimately such factors could combine to push the U.S. into recession, which post the 2016 Presidential election would not be an unusual occurrence.  Is it a random market event that so many U.S. market downturns coincide with major elections?  And I don’t just refer to the years 2000 and 2008.  Look at 1972, 1980 or even 1946, to name a few.  The passing of the baton to a new party or President almost never happens without some market turmoil.

Financial Relativity Index shows subdued immediate Market Risk 


A technical model that I use to gauge the risk of a major market down-turn currently is not showing signs of an imminent market breakdown.  Although there are several risks highlighted by the model, overall the market currently reflects only subdued risk.

The model as of September 30, 2016 had a reading of 4 on a scale of 20.  The low reading based on the factors assessed historically dating back to 1956 (month end data-points) put the market in low risk until, of course, something happens.  In this model, the usual signal is a year over year collapse in returns to investors.  The big moves downward have typically occurred after a quick spike in the market to a new all-time high, followed within 2-3 months by a down move that puts year-over-year returns in negative territory.  This signature market phenomenon is explained in detail in my book, Theory of Financial Relativity.

Wednesday, October 5, 2016

Number 1 Issue in the Upcoming Election facing Americans – Taxes plus Trade

I was reading an article published on the CNBC website on October 5, 2016 entitled, This plan brings $2.5 trillion in corporate cash home, and creates jobs.  I was struck by how the economic issue which underlies the argument for this plan may be the single most important issue for several generations.  If left unaddressed by the next elected President, the U.S. will continue to left on a path of perpetual decline.

On the surface, the plan explained in the article nails a good U.S. tax policy response which can potentially unravel the mess we are currently in as a country. But, the cash being hoarded overseas by multi-national companies has a couple of more elements than just the tax rate in the U.S. for corporations. Elements which oddly may not be remedied by a tax code change alone.

The economic issue the U.S. faces is structural, and caused by trade agreements which place the U.S. in the position of exporting jobs for the purpose of importing investment dollars for the U.S. debt. Not a good trade for average American workers who deserve to be able to make a living, but an excellent way for crafty U.S. politicians to try to rule the world.

The historical data clearly show this issue began to manifest itself in uncontrollable fashion post the signing of NAFTA, a hallmark Clinton agreement. Little wonder that the Clinton Foundation is so beloved by so many foreign governments and billionaires such a George Soros and media moguls with International, not American best interest in mind. Many of these "VIPs" can be found to have been given special access to the Clinton State Department as a part of this appeasement foreign policy strategy; not to mention that the Clinton's have scampered off with over a $100M in the process over the past 4 years through the Clinton Foundation, speaking fees, etc..

A change in tax policy may unravel the mess, but could create, at least in the short-term, nothing more than a run on the U.S. debt as the $2.5T in overseas dollar based cash, currently parked primarily in U.S. Treasuries, is sold to take advantage of a tax break windfall. The reason I am skeptical is because the tax policy did not create the problem in the first place, the trade agreements did.  Changing the tax policy only changes the financial flow of capital. Without a solid basis for investment in a U.S. economy which would remain severely disadvantaged by poorly structured trade agreements, the end result would very likely not provide the intended result.

I look for a Clinton Presidency, just like the Obama administration, to stand in the way of any move to unleash these overseas dollars. The basis for the Clinton campaign dollar largess is heavily indebted to those with an interest in the perpetuation of the fleecing of the average American citizen, and pushing the U.S. even more into debt. And, these campaign contributions want pay-back in the form of jobs for foreign, not American workers.  In addition, don’t look for any of these foreign interests to pay a dime of the multi-trillion dollar tax increases proposed in the Clinton economic plan.

My book, Theory of Financial Relativity, published in 2013, provides in-depth research in how and when the U.S. debt expansion became a serious threat to the growth and prosperity of the U.S. economy, and ultimately the wealth manifested in the value of the U.S. stock market.  Please consider reading the book if you want to understand why the tax and trade issue, in my opinion, is the single most important issue facing America in the upcoming election.

Daniel Moore is the author of the book Theory of Financial Relativity: Unlocking Market Mysteries that will Make You a Better Investor.  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.

Thursday, May 5, 2016

Puerto Rico Needs Restructuring, not a Bail-out

According to an article published by the Cable, Puerto Rico is nearing the Brink of Bankruptcy, the Puerto Rico commonwealth has $72B in debt, some of which it claims it can no longer service, and therefore will default as early as May 2, 2016.  The Island government is asking creditors to forgive up to 45% of the principal on certain loans so that it can recover financially.  The U.S. Congress is now intervening in the crisis with legislation being reviewed which would give added power to the Puerto Rico government to restructure its debts to the detriment of existing creditors.  The public airwaves are currently buzzing with “tell Congress no bail-out for Puerto Rico” ads.

Although a 45% haircut to lenders this large is unlikely, many of the Puerto Rico Financial Development Authority General Obligation bonds are trading for $0.20 on the dollar out of fear about what the outcome will eventually be in the current crisis.  Just why is Puerto Rico in so much financial trouble?  There is a combination of factors which have led up to the current circumstances in which the current government is very likely to run out of cash.  First, the country never really recovered from the 2008 recession.  Unemployment on the island is remains high at 11.6%, and the labor participation rate is less than 40%.  In other words, Puerto Rico’s 1.1M labor force is not big enough or growing fast enough to service the loans.  Adding insult to injury, the island population base is shrinking at a rate of -0.6% per year.

Why has the Puerto Rico economy been shrinking?  One of the major culprits has been the expiration of a federal IRS statue section 936.  The section established tax exemption for U.S. corporations that settled in Puerto Rico, such as large pharmaceutical firms, to allow its subsidiaries operating on the island to send money to the parent company federal income tax free.  The island economy has been in persistent decline since this statute was repealed by the Clinton administration in 1996.  As the manufacturing jobs have vacated the island, new job creating industries have not been forthcoming.

The ability of the island to generate cash for loan servicing is indeed dire, but the island government is not a total victim in this situation.  There are major inefficiency problems in collecting the Puerto Rico Sales and Use Tax, with estimates showing the Treasury is incapable of collecting up to 44% of the tax.  Additionally, public salaries are much higher than the private sector on the island.  Per capita income on the island is $28,850, and public workers generally are paid more than average with legislative advisors for instance making $74,000.

The island economy could also be much more resilient if public policy took better advantage of its natural resources, and depended less on imported goods.  Puerto Rico imports 85% of its food even though 94% of its land is fertile.  The islands geography has many rivers which could be used for hydroelectric power, and yet the island must import all its fuel (coal, natural gas, oil) in order to produce energy.  Renewable energy sources are also heavily under-utilized even though Puerto Ricans enjoy 65% sunshine on average every day, and wind rates average 22 mph.  From an energy standpoint, island residents pay $0.26 per kilowatt hour for electricity compared to $0.11 per kwh in the U.S.

Puerto Rico needs a long-term plan, not a Washington bail-out.  Creditors are very likely more than willing to work with the island government if it truly wants to address the structural issues which are making its financial situation worse by the day.  However, the role of Washington in this situation should be minimal.  The island doesn’t need major loan haircuts which destroy the capital investment process, it needs a long-term economic plan and new direction, neither of which is being put forward currently.  If Washington intervenes as desired by the Puerto Rico government, then who will be next in line – Illinois?

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.