The Dumbest Dumb Money Finally Gets Suckered In

Authored by John Rubino via DollarCollapse.com,

Corporate share repurchases have turned out to be a great mechanism for converting Federal Reserve easing into higher consumer spending. Just allow public companies to borrow really cheaply and one of the things they do with the resulting found money is repurchase their stock. This pushes up equity prices, making investors feel richer and more willing to splurge on the kinds of frivolous stuff (new cars, big houses, extravagant vacations) that produce rising GDP numbers.

For politicians and their bureaucrats this is a win-win. But for the rest of us it’s not, since the debts corporations take on to buy their own stock at market peaks tend to hobble them going forward, leading eventually to bigger share price declines than would otherwise be the case.

The ultimate loser? The only people traditionally willing to buy in after corporations are finished overpaying for their stock: Retail investors, of course.

Let’s see how it’s playing out this time.

First, corporations spent several years elevating stock prices with share repurchases. Note the near perfect correlation between the two lines:

Now they’re scaling back their purchases:

Saying Bye to Buybacks

(Wall Street Journal) – Companies in the S&P 500 are on pace to spend the least on buybacks since 2012

 

Large companies are repurchasing their shares at the slowest pace in five years, as record U.S. stock indexes and an expanding economy propel more money out of flush corporate coffers into capital spending and mergers.

 

Companies in the S&P 500 are on pace to spend $500 billion this year on share buybacks, or about $125 billion a quarter, according to data from INTL FCStone. That is the least since 2012 and down from a quarterly average of $142 billion between 2014 and 2016.

 

Buyback activity among top-rated nonfinancial debt issuers, many of which have regularly borrowed money to finance share repurchases, declined for the third straight quarter in the July-to-September period, according to Bank of America Merrill Lynch. Meanwhile, mergers and acquisitions among that group of companies had their biggest quarter of the year, analysts at the bank said.

 

Factors including high stock price, historically high share valuations and uncertainty over the future shape of the tax code mean that “companies may be less likely to favor buybacks over other uses of cash in 2018,” analysts at Goldman Sachs Group Inc. said in a report this week.

And – here’s the really sad part – individual investors are taking up the slack:

The emboldened retail investor may be a new catalyst to help take stocks higher — for now.

(CNBC) – “The level of enthusiasm about the market … has been building. We’re seeing more individuals come in,” said Liz Ann Sonders, chief investment strategist at Charles Schwab.

 

Sonders said she’s anecdotally seeing signs of more individuals putting money to work in the stock market in the last several months, after years of skepticism and concerns about “every variety of doom and gloom.”

 

She says she is getting fewer investors asking about bubbles or about what’s the next shoe to drop.

 

“I think it’s finally starting to suck people in … emotionally, and actually it’s hard to judge why now all of a sudden, but maybe it’s because of how persistent the move has been with so little volatility on the upside and on the downside,” Sonders said. “This year has been different. This kind of year pulls people in.”

 

Retail brokers have been reporting an influx of accounts. Charles Schwab, in its earnings release, said clients opened more than 100,000 new brokerage accounts a month in the third quarter, making for a record-breaking 10-month streak of new accounts topping 100,000. Its rival, TD Ameritrade, said on its earnings call last month that new accounts, asset inflows and other indicators are at the highest since the financial crisis.

What’s frustrating about this is the repeating pattern of government creating conditions in which smart money (that is, the guys who donate big to political campaigns) is allowed to get in early, make huge profits, and then hand the bag to regular people who aren’t connected or sophisticated enough to see what’s happening. The rich, who are or will soon be shorting the hell out of this market, get richer and the rest see their hopes for a decent (or any) retirement dashed one more time.

And the political class wonders why voters don’t like them anymore.

Can You Do A Backflip? Because This Robot Can

Since being founded in 1992 with funding from DARPA, robotics company Boston Dynamics has unveiled one nightmarish robotic creation after another. But the company outdid itself this week when it introduced the latest iteration of its ‘Atlas’ robot.

The company caused a stir after publishing a video on YouTube showing the hulking humanoid robot jumping across platforms of varying heights and even perform backflips on command - some of the most advanced capabilities demonstrated by any bipedal robot.

If you’re wondering how this seemingly trivial ability portends imminent warfare between mankind and the machines, then you need to ask yourself: When was the last time you did a standing backflip?

Unless you’re a gymnast, the answer is probably never.

Unsurprisingly, the video inspired a cascade of commentary about humanity’s impending obsolescence:

 

we dead pic.twitter.com/lUys7DptdZ

— alex medina (@mrmedina) November 16, 2017

 

 

The robots are evolving into crossfit bros https://t.co/SOO9bvuoHU

— Turkducklephant (@despoondent) November 17, 2017

 

Though apparently there are still some mundane tasks that Atlas has not yet mastered...

 

Don"t worry too much about your jobs if you saw that robot doing a backflip - this is the same lad trying to stack a shelf pic.twitter.com/L8vkn91UBD

— Mike Bird (@Birdyword) November 17, 2017

 

Boston Dynamics also made headlines earlier this week by introducing a polished dog-like robot that sits somewhere along the slope of Freud’s "Valley of the Uncanny"...

The robot is called the SpotMini. The company has released few details about it other than a promotional video showing it trotting across a grassy field and the teaser text “Coming Soon”.

Meanwhile, an international group of scientists have seemingly taken a cue from Elon Musk and are demanding that governments take steps to regulate automated lethal weapons systems before the technology comes into its own, purportedly to prevent the plot of the Terminator series from unfolding in real life.

It’s been a big week for the robots, sure. However, while humanoid robots like Atlas are becoming more adept at completing tasks in the physical world, their cousins on Wall Street still can’t quite figure out how to buy the fucking dip.

 

The Truth About Wall Street Analysis

Authored by Lance Roberts via RealInvestmentAdvice.com,

Turn on financial television or pick up a financially related magazine or newspaper and you will hear, or read, about what an analyst from some major Wall Street brokerage has to say about the markets or a particular company. For the average person, and for most financial advisors, this information as taken as “fact” and is used as a basis for portfolio investment decisions.

But why wouldn’t you?

After all, Carl Gugasian of Dewey, Cheatham & Howe just rated Bianchi Corp. a “Strong Buy.” That rating is surely something that you can “take to the bank”, right?

Maybe not.

For many years, I have been counseling individuals to disregard mainstream analysts, Wall Street recommendations, and even MorningStar ratings, due to the inherent conflict of interest between the firms and their particular clientèle. Here is the point:

• YOU, are NOT Wall Street’s client.


• YOU are the CONSUMER of the products sold FOR Wall Street’s clients.

Major brokerage firms are big business. I mean REALLY big business. As in $1.5 Trillion a year in revenue big. The table below shows the annual revenue of 32 of the largest financial firms in the S&P 500.

(The combined revenue of the 32 largest firms last year was in excess of $1 Trillion with the revenue of the 97 financial firms in the S&P 500 bringing in $1.5 Trillion.)

As such, like all businesses, these companies are driven by the needs of increasing corporate profitability on an annual basis regardless of market conditions.

This is where the conflict of interest arises.

When it comes to Wall Street profitability the most lucrative transactions are not coming from servicing “Mom and Pop” retail clients trying to work their way towards retirement. Wall Street is not “invested” along with you, but rather “use you” to make income.

This is why “buy and hold” investment strategies are so widely promoted. As long as your dollars are invested the mutual funds, stocks, ETF’s, etc, brokerage firms collect fees regardless of what happens in the market. These strategies are certainly in their best interest – they are not necessarily in yours.

But those retail management fees are simply a sideline to the really big money.

Wall Street’s real clients are multi-million, and billion, dollar investment banking transactions, such as public offerings, mergers, acquisitions and bond offerings which generate hundreds of millions to billions of dollars in fees for Wall Street each year.

In order for a firm to “win” that business, Wall Street firms must cater to those prospective clients. In this respect, it is extremely difficult for the firm to gain investment banking business from a company they have a “sell” rating on. This is why “hold” is so widely used rather than “sell” as it does not disparage the end client. To see how prevalent the use of the “hold” rating is I have compiled a chart of 4625 stocks ranked by the number of “Buy”, “Hold” or “Sell.”

See the problem here. There are just 2.8% of all stocks with a “sell” rating.

Do you actually believe that out of 4625 stocks only 124 should be “sold?”

You shouldn’t.  But for Wall Street, a “sell” rating is simply not good for business.

The conflict doesn’t end just at Wall Street’s pocketbook. Companies depend on their stock prices rising as it is a huge part of executive compensation packages.

Corporations apply pressure on Wall Street firms, and their analysts, to ensure positive research reports on their companies with the threat that they will take their business to another “friendlier” firm.  This is also why up to 40% of corporate earnings reports are “fudged” to produce better outcomes.

Earnings Magic Exposed, an article written by Michael Lebowitz last year, provides details on the games played on Wall Street when it comes to forecasting corporate earnings. He summarized the article as follows:

Consider the ploy that companies and Wall Street are using to fool the investing public.

• First, they grossly overestimate earnings for the upcoming year. By overestimating earnings, they tout financial ratios based upon inaccurate expected earnings and sell investors on a bright future. How many times have analysts claimed that forward looking price to earnings ratios are constructive for price gains? How “constructive” would they be if the expectations were reconciled to reality and lowered by 75%?


• Second, they progressively lower expectations prior to the earnings release so that financial results are effectively underestimated. The same analysts that peddled double digit earnings growth a year earlier somehow can now claim that earnings are better than they expected.

If actual earnings varied somewhat randomly from above expectations to below expectations, we would likely fault the analysts and corporations with being poor forecasters. But when such one-directional forecasting errors routinely and consistently occur, it is more than bad forecasting. At best one can accuse Wall Street analysts and the companies that feed them information of incompetence. At worst this is another pure and simple case of institutions gaming the system through a fraud designed to prop up stock prices.  Take your pick, but in either case it is advisable to ignore the spin that accompanies earnings releases and apply the rigor of doing your own analysis to get at the veracity of corporate earnings.

Wall Street Needs You To Sell Product To

When Wall Street wants to do a stock offering for a new company they have to sell that stock to someone in order to provide their client, a company, with the funds they need. The Wall Street firm also makes a very nice commission from the transaction.

Generally, these publicly offered shares are sold to the firm’s biggest clients such as hedge funds, mutual funds, and other institutional clients. But where do those firms get their money? From you.

Whether it is the money you invested in your mutual funds, 401k plan, pension fund or insurance annuity – at the bottom of the money grabbing frenzy is you. Much like a pyramid scheme – all the players above you are making their money…from you.

In a study by Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp it is clear that Wall Street analysts are clearly not that interested in you. The study surveyed analysts from the major Wall Street firms to try and understand what went on behind closed doors when research reports were being put together. In an interview with the researchers John Reeves and Llan Moscovitz wrote:

“Countless studies have shown that the forecasts and stock recommendations of sell-side analysts are of questionable value to investors. As it turns out, Wall Street sell-side analysts aren’t primarily interested in making accurate stock picks and earnings forecasts. Despite the attention lavished on their forecasts and recommendations, predictive accuracy just isn’t their main job.”

The chart below is from the survey conducted by the researchers which shows the main factors that play into analysts compensation.  It is quite clear that what analysts are “paid” to do is quite different than what retail investors “think” they do.

“Sharp and Call told us that ordinary investors, who may be relying on analysts’ stock recommendations to make decisions, need to know that accuracy in these areas is ‘not a priority.’ One analyst told the researchers:

 

‘The part to me that’s shocking about the industry is that I came into the industry thinking [success] would be based on how well my stock picks do. But a lot of it ends up being “What are your broker votes?”‘

 

A ‘broker vote’ is an internal process whereby clients of the sell-side analysts’ firms assess the value of their research and decide which firms’ services they wish to buy. This process is crucial to analysts because good broker votes result in revenue for their firm. One analyst noted that broker votes ‘directly impact my compensation and directly impact the compensation of my firm."”

The question really becomes then “If the retail client is not the focus of the firm then who is?”  The survey table below clearly answers that question.

Not surprisingly you are at the bottom of the list. The incestuous relationship between companies, institutional clients, and Wall Street is the root cause of the ongoing problems within the financial system.  It is a closed loop that is portrayed to be a fair and functional system; however, in reality, it has become a “money grab” that has corrupted not only the system but the regulatory agencies that are supposed to oversee it.

Why You Need Independence

So, where can you go to get “real investment advice” and a true consideration of the value of YOUR money?

Thankfully, starting at the turn of the century, the rise of independent, fee-only, financial advisors, private investment analysts, research and rating firms began to infiltrate the system. 

Here is an example of the difference.

As an independent money manager, I use valuation analysis to determine what equities should be bought, sold or held in client’s portfolios. While there are many measures of valuation, two of my favorites are Price to Sales and the Piotroski f-score among others. I took the same 4625 stocks as above and ranked them by these two measures.

See the difference. Not surprisingly, there are far fewer “buy” rated, and far more “sell” rated, companies than what is suggested by Wall Street analysts.

Here is something even more alarming.

Just after the “dot.com” bust, I wrote a valuation article quoting Scott McNeely, who was the CEO of Sun Microsystems at the time. At its peak the stock was trading at 10x its sales. (Price-to-Sales ratio) In a Bloomberg interview Scott made the following point.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees.That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?

How many of the following “Buy” rated companies do you currently own that are currently carrying price-to-sales valuations in excess of 10x?

So, what are you thinking?

As more and more “baby boomers” head into retirement the need for firms that can do organic research, analysis and make investment decisions free from “conflict,” and in the client’s best interest, will continue to be in high demand in the years to come.

This is particularly the case when the next downturn occurs and the dangers of passive ETF indexing and robo-advisors are readily exposed.

Independent advice can help remove those emotional biases from the investing process that lead to poor investment outcomes over time. There are a raft of advisors with the the right team, tools and data, who can spend the time necessary to manage portfolios, monitor trends, adjust allocations and protect capital through risk management.

The next time someone tells you that you can’t “risk manage” your portfolio and just have to “ride things out,” just remember, you don’t.

You, and your money, deserve better.

Citi's "Scariest Chart" Prompts Concerns About Holding American Equities

This year through June 5, 7,561 M&A deals were announced, the lowest count since 2013, according to S&P Global Market Intelligence.

While M&A volume reached a record $2.055 trillion 2013, the volume has slipped in 2016 to just $1.7 trillion.

As RealInvestmentAdvice.com"s Lance Roberts notes, given the length and maturity of the current economic expansion, tighter monetary policy in the U.S. and a lack of legislative agenda moving forward in Washington, there is further risk of M&A support being pulled from the markets.

And Tobias Levkovich, the chief US equity strategist at Citi, appears to agree that there is potential problems ahead...

"In some respects, one of the scariest charts to look at currently is the number of announced mergers & acquisition deals over the past year or two,"

"M&A lawyers argue the "uncertainty" factor, which has come about recently, given some unpredictable aspects of the new Trump administration, has been the issue. It only may explain the last six months, but the trend has been poor for about two years or more.

In the past, there has been some correlation with the S&P 500 and thus it could generate more legitimate fears than some of the other excuses that are put forth for not wanting to buy American equities."

Despite surging CEO confidence, it appears their money is not being put where their mouth is in terms of betting on the long-term future (that stocks are clearly trying to price in from some utopia).

What "The World's Most Bearish Hedge Fund" Thinks Of The Trump Presidency

October was not a good month for the "world"s most bearish hedge fund" Horseman Global Management, which suffered another steep drop, losing 5% in the month, and down 5.5% YTD. Absent a rebound in the last two months of the year, Horseman is set to have its worst year since 2009. Alas, with Horseman"s net exposure a whopping -84% (if fractionally more bullish than the -100% recorded in early 2016) as a result of an equity short and a bond long, November does not appear overly promising for the fund"s investors. Unless, of course, the market swoons as both yields and the dollar continue surging (as DB warned), and Horseman does have the final laugh.

That, however, would be surprising considering that some of the most prominent billionaire mega-bears, such as Carl Icahn and Stanley Druckenmiller, both quikcly flopped to bullish in the aftermath of Trump"s election, on just one catalyst: more debt resulting in more stimulus, and (hope) for more growth.

Yet Horseman refuses to change its thesis. Why? Instead of guessing, here is the answer straight from the "Horse"s mouth" - the following excerpt from the latest letter to investors by CIO Russell Clark lays out what the gloomy hedge fund believes will be the outcome from a Trump presidency.

Your fund fell 4.96% last month. Losses came from the bond book, the forex book and the short book. The long book made money.

First Brexit and now the Trump triumph has left many supporters of open liberal economies despairing. They feel that the world is turning in on itself and that perhaps a darker less safe world is emerging. And perhaps they are right.

But in many ways, the great western democracies of the world, the UK and the US are working as they should. It is plainly obvious that large parts of the population in both the UK and the US feel that the system has not worked for them, and they have voted for change. And those voters have had their voices heard and change is on the way.

Undemocratic regimes in the rest of the world look on in either horror or bemusement at the changes in the UK and US and congratulate themselves that their system is so safe and stable. And yet, the reality is that if the political system cannot provide the change that people seek, then eventually and inevitably, revolution becomes the only option for change. And revolution always extracts a very high price on those that have been in power.

When thinking about a possible Trump victory, I perceived that the USD could be very weak, and that this weakness would lead to treasuries also being weak as foreign investors dumped their holdings. What has happened is that domestic US investors have reappraised their views of US domestic growth upwards, and have dumped treasuries to buy equities, and the US dollar has been very strong.

While the stated aims of the Trump administration are very pro-growth, to me the actual effects seem likely to disappoint. Plans to allow more drilling will be dependent on a much higher oil and gas price. Scrapping car emission standards whilst good for SUV makers, will unlikely reverse the falling demand for cars due to high levels of auto debt. Lower taxes and more infrastructure spending may well be bullish for growth, but need to be balanced against the sell-off in the long end of bonds, which will have a negative effect on housing and with DR Horton reporting weak numbers makes, I feel growth will disappoint in the short term.

The more apparent of the negative aspects is that higher bond yields are starting to cause some financial pressure in Hong Kong and Chinese interest rates. If a trade war, becomes more likely, then a large Chinese devaluation also becomes more likely. Furthermore, the Trump win makes the break up of the Eurozone far more likely in my mind.

After Brexit, being short equities and long bonds was a fantastic trade for a week or two, but then reversed quickly after, causing severe pain for those that had reacted to the market quickly. I think the Trump win has seen many investors sell defensive positions and buy cyclical positions. I suspect they will come to regret that. Your fund remains long bonds and short equities.

* * *

Steepping away from Trump, here is Clark"s asset allocation and sector breakdown, and what appears to be a wager that Trump is about to end the record wave of industry consolidation in a move straight out of Teddy Roosevelt"s playbook:

This month losses in the short portfolio, in particular from the European and Japanese banks and the automobile sectors, were partially offset by gains in the banks and oil sectors in Brazil and the defence contractors in the long portfolio.

In the US the value of announced mergers and acquisitions (M&A) reached $337 billion in October, making it the biggest deal-making month ever. 2015 was the biggest M&A year ever globally with total deals of about $4.3 trillion dollars (source: Bloomberg). High M&A activity may give the impression that the economy is robust, but in our opinion it merely reflects a sluggish economic environment as companies struggling to grow their revenues and profit margins organically, and turn to mergers and acquisitions instead.

QE monetary policies have supported M&A activity by allowing ample availability of funding, as investors searching for yield are eager to buy corporate debt and drive credit margins lower.

M&A activity causes a decrease in the number of firms and an increase of their respective market shares. This can result in significantly reduced competition between firms. In economic theory, when a few large firms dominate a market there is the potential to engage in collusive behaviours such as deliberately joining together in cartels in order to increase prices. In extreme cases a company that becomes too dominant develops the power to influence market price, run competition out of business or not allow competitors to emerge. Once enough other companies are bankrupt or bought off, the remaining company can stop improving its product, lower the quality and raise prices as much as it wishes, because consumers have no choice.

It has been argued that some companies with large market shares can employ what game theorists call a “trigger strategy,” whereby they signal to their competitors that if they lower their prices, they will start a vicious retail war. If a rogue player refuses to play the game, it becomes the target of an aquisition, not because it makes great products, but because owning it allows an oligopolist to raise prices.

Another detrimental effect of low competition to the consumer was illustrated by an article in The New York Times entitled ‘Arbitration Everywhere, Stacking the Deck of Justice’, about the rise of private arbitration clauses in consumer services contracts, which allow large companies to avoid the court system and prevent consumers from joining together in class-action lawsuits.

The Herfindahl-Hirschman index ("HHI") measures market concentration by industry and is used by regulators when reviewing mergers, values between 1,500 and 2,500 are defined as “moderately concentrated,” while values above 2,500 are defined as “highly concentrated”.

The US beer market has a high HHI of 2696, it is dominated by one large producer, whose current market share is 46%. The company recently made a large acquisition, but subsequently was forced by the Department of Justice to sell part of the acquired business as the combined market share of 70% would have resulted in almost monopolistic conditions.

At the turn of the 20th century, Teddy Roosevelt became president. He realised that for capitalism to maintain popular support, the monopolists and oligopolists of his time had to be taken on, and his presidency was driven by Trust busting. This set of policies looks set to re-appear.

The fund maintains short positions in airlines, banks, and certain consumer staples, primarily because we think that margins will remain under pressure due to the macro-economic environment and specific sectoral issues (please refer to Russell Clark’s Market views). These are not monopolistic sectors, however they are concentrated, should competition increase at some point, stock prices could de-rate even further.

Finally, here are Horseman"s Top 10 long positions as of this moment. Alas, the far more useful, top 10 shorts, are not public.