Looking For Inflation In All The Wrong Places

Authored by John Rubino via DollarCollapse.com,

A policeman sees a drunk man searching for something under a streetlight and asks what the drunk has lost. He says he lost his keys and they both look under the streetlight together. After a few minutes the policeman asks if he is sure he lost them here, and the drunk replies, no, and that he lost them in the park. The policeman asks why he is searching here, and the drunk replies, “this is where the light is”. — The Streetlight Effect

The drunk in the above story is an idiot, of course. But no more so than modern economists who can’t find inflation because they’re looking only at the part of the economy covered by their government’s Consumer Price Index.

But gradually, grudgingly, a handful of mainstream economists do seem to be figuring out that the soaring value of stocks, bonds, real estate, fine art, collectibles and cryptocurrencies is a legitimate sign of a depreciating currency and future instability.

Inflation, in other words. From yesterday’s Morningstar:

Lack of inflation is a global issue

(Morningstar) – The lack of inflation is a global issue. Unemployment is at cyclical lows in the US, Germany, and Japan, yet in each of these countries there is only small evidence that wages are picking up. No doubt globalisation and technology are common factors that have helped constrain wages across countries.

The de-synchronised nature of the recovery until now has also capped inflation in countries whose currencies have appreciated on cyclical outperformance. From here, however, common global uplift should help neutralise some of these inter-country effects, and allow domestic conditions to play out more powerfully.

 

Central banks have been puzzled by the lack of inflation, but have not stepped away from its management as the primary goal of policy.

 

However, they’ve responded to the way QE’s impact has been much stronger in financial markets than the real economy by making financial conditions a larger part of their thinking, even if they’ve not formalised this in policy frameworks.

 

With inflation projected to lift and financial markets strong, we expect central banks to continue to gradually tighten.

 

Year to date, bond yields have drifted lower and curves are flatter, while credit spreads have continued to tighten.

 

Valuations of fixed-income assets have moved further into expensive territory with few exceptions. Term premium is close to historic lows and credit spreads at post-GFC tights.

 

Given this backdrop, our process continues to suggest defensive positioning remains appropriate until better value is restored. We see higher inflation and/or a faster pace of policy tightening as possible triggers.

This acknowledgement that soaring asset prices are kind-of-sort-of inflation is definitely progress, though the struggle it took to get there was obviously considerable.

A single paragraph stating that asset bubbles constitute an especially destabilizing kind of inflation and therefore caution is advisable going forward would have made the point in a fraction of the time.

But it’s better than nothing. And who knows, maybe it’s the start of a trend.

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.

"They Can And Should Do More" Australian State Slams Banks With $280 Million Tax

Australian bankers are furious after the country’s smallest state levied a “surprise” tax on the country’s five biggest banks that could siphon off $280 million in profits during its first four years on the books, according to Reuters.  The tax was imposed by South Australia, which is struggling with the country’s highest unemployment rate and thanks the banks should be doing more to pitch in.

The decision, which provoked “howls of outrage from the sector,” represents an added financial burden on the largest banks beyond a $4.2 billion federal tax that was imposed last year - not to mention the country"s record-low interest rates.  The banks, struggling with low public favorability after a series of scandals and unified support in the country’s legislature, accepted that tax with minimal pushback. However, some are already threatening to pull investment as a form of retaliation.

The head of the Australian Bankers Association Anna Bligh called the tax "an outrageous cash grab without policy substance". Westpac Banking Corp and Australia and New Zealand Banking Group said the move could provoke a backlash from banks as they could decide to curtail investment in the state.

South Australian Treasurer Tom Koutsantonis said the five banks, which together collect about $30 billion in profit annually, can and should do more to help boost employment and contribute more to the state"s economy. The tax revenues will be used to fund job-training programs, Koutsantonis said.

Australia’s bankers fumed, saying they already do enough to prop up the country’s economy.

"All businesses will rightly question the political risk associated with investing in a State with a Government prepared to unfairly target an industry that has played a significant role in supporting its lagging economy," ANZ Chief Executive Shayne Elliott said in a statement.

The decision provoked speculation about whether the country’s other four states would impose similar taxes, with at least one analyst suggesting that at least a few states will.

"I would say it is definitely on the cards for other states," said Morningstar analyst David Ellis said. "For any cash-strapped state it looks like it is just an easy option."

However, he said it was unlikely that the country"s largest state, New South Wales, would impose a similar tax because it had a strong budget surplus and would want to maintain Sydney"s reputation as an Asia-Pacific financial services hub.

The tax will be equivalent to 6 basis points on 6 percent of the assets being taxed by the federal government. Koutsantonis reasons this is fair because South Australia’s economy accounts for only 6% of national GDP.

Some Of The Funds Losing Billions In Puerto Rico's Historic Bankruptcy

In the aftermath of Puerto Rico"s historic bankruptcy, a clearer picture of losses accrued by U.S. mutual funds on their holdings of Puerto Rican debt is beginning to emerge: the WSJ has calculated the red ink at as much as $5.4 billion over the last five years on total holdings of $14.6 billion.  Wall Street"s paper of record lists the funds who have piled up losses, both realized and unrealized, on the trade. These include: Franklin Resources, Oppenheimer, Vanguard, Goldman Sachs Asset Management, Western, Lord, Abbett, AllianceBernstein and Dreyfus.

Of these, Franklin and Oppenheimer are the biggest losers, according to Morningstar data cited by the Journal. Oppenheimer has lost as much as $2.1 billion, and Franklin as much as $1.6 billion. That"s compared with AUMs of $230 billion and $741 billion, respectively.

Meanwhile, six other fund families managed by Vanguard, Goldman, Western Asset, Lord Abbett, AllianceBernstein Holding and Dreyfus have racked up between $100 million and $200 million in losses each.

Of course, in the grand scheme of the funds" AUMs, the losses so far are negligible, so before retail investors assume that Meredith Whitney"s prediction is finally coming true, resulting in another muni fund panic, it is worth recalling that all these funds have at least $100 billion each in muni-bond assets under management.  Furthermore, these investors are likely in better shape than some of their hedge fund colleagues as the damage done to mutual funds, and by extension the retirees and middle-class savers to which they cater, will be an important factor in the court-mandated restructuring of the island"s debt, which begins Wednesday with a hearing in San Juan.

As a reminder, earlier this month, the island"s governing body petitioned for - and its federal oversight board approved - its own version of bankruptcy protection under Title III of a rescue law passed by Congress late last year. 

The mutual funds will have a greater incentive to agitate for maximum recovery especially since they purchased debt closer to par values.  Mutual funds were the most heavily invested in Puerto Rican debt, tempted by attractive yields - 8% at the last issuance of GOs in 2014 - along with an exemption from federal taxes.

* * *

Meanwhile, Bloomberg reports that as the island"s restructuring progresses, creditors of Puerto Rico"s insolvent government development bank today agreed to accept losses by exchanging their bonds for new securities, moving the island another step toward restructuring its crushing debt load. Under the agreement, bondholders would exchange their debts at 55 percent, 60 percent or 75 percent of face value, depending on whether they elected to receive higher interest payments or the prospect of a greater recovery through debt with less legal claim to the bank’s cash, according to terms disclosed in a bond filing.

The deal comes less than two weeks after Puerto Rico initiated bankruptcy-like proceedings, giving it power to have debts dismissed in U.S. court if creditors don’t voluntarily agree to accept less than they’re owed. Puerto Rico has already reached a similar agreement with creditors of the government electric company and officials have said they intend to continue negotiating with investors.

"This agreement is an example that the government is regaining the credibility it had lost over the past few years,” Rossello said. “We are satisfied with this agreement.”

Debt could be issued for first-lien bonds at 55 percent of par with 7.5 percent coupons, or 60 percent of par with 5.5 percent coupons. Those electing for subordinate bonds would get 75 percent of par and coupons of 3.5 percent. New issuer will receive assets of GDB, with a book value of $5.3 billion.

Despite the enforced bondholder haircuts, the agreement would allow creditors to recoup more of their investment than current trading prices suggest. Government Development Bank bonds due in August traded Monday for an average of 24.3 cents on the dollar.

The negotiation has a long way to go: Governor Ricardo Rossello said at a press conference Monday that 45% of bondholders have so far consented to the restructuring. Under the federal emergency rescue law that allows for Puerto Rico to legally cut its debts, any voluntary agreement must be approved by a two-thirds vote of bondholders.

Today"s deal included the so-called ad hoc group, comprised mostly of hedge funds managed by Avenue Capital Management, Brigade Capital Management, Fir Tree Partners and Solus Alternative Asset Management, as well as local bondholders.

And speaking of hedge funds, as we documented previously, here"s a rundown of the other biggest losers, which include a handful of hedge funds and bond insurers - not to mention the Puerto Rican people, about half of whom live in poverty and will likely be forced to cope with cuts to basic services mandated by an austerity regime not unlike those seen across Europe.

• General Obligation bondholders include: Aurelius Capital Management, Autonomy Capital and Monarch Alternative Capital LP,


• Sales tax revenue-backed (Cofinas) bondholders: Scoggin Capital Management, GoldenTree Asset Management, Merced Capital, Tilden Park and Whitebox Advisors have held Cofinas.


• Bonds insurers: roughly $12 billion of the island’s $70 billion in outstanding debt is insured. It will be up to the bond insurers to fill the gap when interest and maturity payments are missed. Insurers backed a wide swath of bonds from Puerto Rico, complicating the island’s ability to prioritize payments. Among the companies with the biggest exposure to Puerto Rico debt include Ambac Financial Group, National Public Finance Guarantee Corporation, Assured Guaranty Ltd. and Financial Guaranty Insurance Company.

PR"s constitution requires the government to pay back GO bondholders in full, and the island has already offered a restructuring that favored GO bonds, over COFINAs, which are backed by tax revenue. However, other recent municipal bankruptcy cases have seen GO investors accept huge losses, according to data from Moody"s Investors Service.

• In Harrisburg, Pennsylvania, bondholders took a 25 cents on the dollar haircut


• In Stockton, California, the haircut was 50 percent.


• In Detroit, where pensioners suffered losses of about 18 percent, bondholders were slapped with a 75% haircut, taking home just 25 cents on the dollar.

Despite this, Moody"s rates PR"s GO and COFINA debt on equal footing, forecasting holders of both securities will recoup between 65 and 80 cents on the dollar, higher than the less than 35 cents expected for holders of debt from Puerto Rican agencies like the Government Development Bank.

With much left undecided, it"s pointless at this stage to anticipate how long this case may take, and what any final settlement might look like; nobody can say for sure whether the courts will find that they have the legal authority to issue a ruling. At some point, the Supreme Court may need to make a ruling.

Stock investors, for one, appear to be biding their time: While Detroit"s decision to file for bankruptcy back in 2013 shook markets, the Puerto Rican newsflow has barely registered outside of muniland.

Are US Taxpayers Now On The Hook For Risky Wall Street Real-Estate-Backed Bonds?

Authored by Mike Krieger via Liberty Blitzkrieg blog,

I’m fairly certain very few of you have heard of broker price opinions, or BPOs, but it’s something I think we should all become aware of given the influence of BPOs in the market for valuing residential real estate securitized bonds.

Before we get to that, let’s revisit a little contemporary American robber baron history. In the immediate aftermath of the U.S. financial crisis, financial oligarchs immediately got to work helping Main Street climb out of the Wall Street created ditch by buying foreclosed homes from hordes of newly destitute Americans and then renting them back to those same people.

I wrote many articles about this trend over the years, starting with the January 2013 piece, America Meet Your New Slumlord: Wall Street. Here’s an excerpt:

Well they aren’t really your “new” slumlord in the sense you have been debt slaves to the financials system for decades.  What I really mean is that it is now becoming overt and literal.  Literal because financiers are now the main players in the real estate market and are buying all the homes ordinary citizens were kicked out of over the past few years.  Yep, we bailed out the financial system so that financiers with access to cheap credit can buy up all of America’s real estate so that they can then rent it back to you later.

Fast forward a few years, and private equity is frantically packaging these real estate rental properties into bonds. In order to value the real estate collateral you need some sort of appraisal, but the normal process of actually looking at properties is seen as too costly and time consuming, so market players are cutting corners by using “broker price opinions,” or BPOs.

As Bloomberg reports, this practice is coming under increased scrutiny and for good reason:

U.S. securities regulators are investigating whether bonds backed by single-family rental homes and sold by Wall Street’s biggest residential landlords used overvalued property assessments.

Radian Group Inc.’s Green River Capital unit is one of the market participants that received a request for information from the Securities and Exchange Commission in March about broker price opinions, or BPOs, the company said in a regulatory filinglate Friday. Green River provides BPOs that are used to value real estate in securitizations.

The agency has been looking at whether BPOs were wrongly inflated, and similar letters were sent to other companies, potentially serving as a starting point for an industrywide probe, according to a person with knowledge of the matter. The person asked not to be identified because the matter is private.

Green River is one of several firms that provide BPOs to the units of private-equity firms and other investors who bought up hundreds of thousands of properties in cities across the U.S. after the housing bubble burst. Many of them focused on distressed homes whose owners were evicted during the Great Recession.

Never forget, what’s good for Wall Street is good for Main Street! Also, they hate us for our freedoms.

Broker price opinions are a cheaper and less-stringent way to evaluate what a property is worth than an appraisal. Property valuations are a sensitive subject in the housing industry because regulators said inflated appraisals contributed to the housing bubble a decade ago.

The biggest private-equity landlords, led by Blackstone Group LP’s Invitation Homes, have sold more than $15 billion in bonds since 2013 backed by some 120,000 rental homes, according to data from Morningstar, and many of those deals were valued using BPOs. One recent bond deal tied to Invitation Homes was backed by guarantees from U.S. taxpayers.

Please tell me this is a joke.

The BPOs are key elements in securitizations, determining basic figures such as how much rent to charge tenants, how much leverage and risk is embedded in the deal and how much investors could recover if the bonds go sour. Many of the securities were assigned AAA grades and sold off to investors such as pension funds.

Is this 2006 or 2017?

No here’s where it gets truly disturbing.

In traditional real estate deals, these opinions help establish sales prices, but in these bond deals, they help estimate how much could be recovered in a liquidation. Some analysts say the BPOs they don’t take into account a possible plunge in home prices, and the values tend to be more optimistic than a full appraisal. Unlike appraisals, BPOs also aren’t necessarily done by a licensed professional, nor does the inspector always go inside to look around, which is standard procedure for an appraisal.

In one April securities offering of about $944.5 million, Green River submitted BPOs that relied on “drive-by” evaluations, and homes were “assumed to be repaired and in good condition,” according to a deal prospectus issued by Fannie Mae. The BPO “is not intended to be a representation as to the past, present or future market values of any of the properties.”

The underlying mortgage in that deal, tied to rental properties owned by Invitation Homes, was guaranteed by Fannie Mae. That’s the first time a taxpayer-backed home finance company has guaranteed such a loan. Freddie Mac is also looking into getting involved in the market by providing its guarantee.

When private equity landlords opted to use BPOs instead of appraisals in their securitizations, some investors expressed skepticism and bond graders applied discounts to the BPOs. Moody’s Investors Service, for example, applied a 15 percent haircut to BPO valuations when grading a transaction last August, citing inherent risks of using BPOs on residential properties instead of an appraisal.

I’m sure it’ll be fine, and if not who cares? The U.S. taxpayer is always available for a good fleecing.

Does The Reality Of "It's Different This Time" Get Tested This Week?

Authored by Mark St.Cyr,

If you were one of the myriad analysts, next-in-rotation fund managers, tech commentators, et al paraded across the financial/business media over this past week – you had a good week. The narrative of “earnings beats” together with the so-called “relief rally” emanating via the French elections helped propel the argument.

However, if one (once again) peered passed the headlines of Non-GAAP reporting alchemy that would make Issac Newton envious one could clearly see that all was not “gold.”

Both Amazon™, and Alphabet™ (aka Google™) beat handily, and yet, a few questions emerged via my reasoning. First:

Has Google Ad revenue benefited from an increasing advertising pie? Or, are we seeing the first hints of rotation from platform to platform as advertisers dump one for another in a desperate attempt to obtain some form of return for their social or digital ad dollars?

It’s possible it could be the latter, and if so it spells “it’s different this time” just like it has before. i.e., circa early 2000.

The reasoning for this is simple: Twitter™.

As I have stated on more occasions than I can count, the one company to watch for clues into what is the entire “tech” or “Silicon Valley” health of the “ads for eyeballs” model is Twitter. And this once songbird of everything that was/is “The Valley” did something that is the anathema of what is presumed to be the “holy of holies” metric for the entire genre. To wit:

But not too worry, for this is reported as an earnings “Beat” when using Non-GAAP metrics. Yes, declining (again – declining!) ad revenue is reported as “Good News!” The only person I can see with more wonderment across his face than the ghost of Sir Issac is that of Bernie Madoff as he watches all this from a cell wondering “And I’m in here for what precisely?”

Then, of course, there’s Amazon.

After disappointing reports over the past two quarters Amazon (once again) rocketed to new heights as the headlines of “Beat”, “Smashed” and every other exclamation known-to-man was used to report it raced across the media. And yet, if you looked closely, again, there are a few issues contained within that should make those who are closing their eyes and hitting the “Buy” button horns-over-hooves concern.

1. Guidance for operating income in Q2 is expected to be between $425 Million and $1.075 Billion compared with the $1.3 Billion in the same quarter last year.


2. Amazon’s total operating income was $1 Billion for this Qtr. AWS (i.e., their web services) made up $890 Million of this. That means nearly all of Amazon’s operating income was generated via the division most people who use Amazon haven’t even a clue exists. (I’ll add to that most 401K holders also.)


3. This puts their Current P/E ratio at near 190 times earnings (187.4 via Morningstar™ as of 4/27/17)

Moreover, as I posed the idea of “What if?” into the “ads for eyeballs” assumptions earlier; what does one takeaway when viewing the current rocket ship ride of Amazon? For if personal spending is supposedly DOA as was reported via the latest GDP report (e.g., worst since 2009) and GDP is now reported to be an abysmal 0.7% (not a typo) what’s fueling this?

Hint: It’s an outlier, or said differently: It’s nothing but what’s known as a “Momo Play.” To view it as anything representative, or as a “gauge” of current economic health (As I heard many a talking-head try) is as I’ve stated before – an abject lesson for wanting to be blissfully, ignorant. (Always remembering this is my opinion, for who knows where this “rocket ship” can travel.)

So with the above for context the issue at hand is: “Now what?”

The real trouble, in my estimation, lies with precisely where we might be in regards to “the markets.” By all rational objective reasoning, backed with the lessons which should be held front-and-center from not just the dot-com crash, but also the financial crisis of ’08. One can’t shake the feeling that we’re precisely (once again) on that knife’s edge. And just the mere fact of the “markets” precariously balancing on that “edge” is beginning to draw blood. The tell-tale signs are everywhere. Below are only a few of the ever-growing list…

• How does a GDP report of less than 1% allow any sane person to state, “Improving economy?” Trick question, it doesn’t unless you work on, or report on/for Wall Street.


• How does the reflation trade transfer into a better economic outlook when all of the proposals so far have resulted in DOA status?


• Explain the reasoning why U.S. “markets” rally off the news of a French primary, all the while its own Navy has sent an armada to the Korean peninsula threatening a nuclear standoff? “Bueller?”


• What data (or better yet – logic) is the Federal Reserve using that warrants hiking rates twice in 90 days into an abysmal GDP report when its main reasoning for any/all monetary policy protocols are supposedly “data dependent?”


• If one of the reasonings behind the Fed. hiking was to allow for the cutting if (or when) there was another emergency: How does that happen when the $Dollar is currently going in the exact opposite direction than it should as it hikes? Does that not imply the Fed. could by that very fact be the catalyst of a run n the $Dollar?


• And if so? What then?

These are just a few of the very real questions that are now permeating the once “it’s different this time” argument for belief. The problem with it is – that’s what always gets said right before reality comes roaring back with a vengeance.

I can’t make this point enough: Only since the election of Donal Trump the “markets” have been on a rocket ride straight up. Before that moment (i.e., October) the Fed. Chair herself was musing the idea that the only way to heal the lasting effects still within the economy was to possibly run a “high pressure” policy stance. (i.e., uber-dovish)

That “ride” has (once again) allowed for the proclamation of the NASDAQ™ hitting never before seen in human history highs. (e.g., 6000+) All against a backdrop of declining GDP, along with declining revenue and more from many of its once star players. All while not accounting for (in my opinion) the effects of those 2 rate hikes. These have yet to be both factored, as well as felt, in the current “market.”

As of right now the “hopium” trade that is a direct result of the Trump “reflation” trade is still self-propelling – but it’s quickly running out of fuel as evidenced by not only none of the campaign promises being passed (i.e., Obamacare repeal and others) but a 1 week resolution was needed as to not shut the government down.

And the “markets” closed where?

Hint: Right back to where they were before when I stated “You are here.” And things have not gotten better, as a matter of fact, they are worse – far worse. (e.g., Unless you are one of those who like to buy-the-potential-nuclear-war-dip that is. And if so, take solace in your decisions, because the President keeps suggesting the idea is closer by the day.)

What the Fed. has unleashed into the “markets” via their ever evolving iterations of QE and its ever grateful HFT frontrunning brethren (see the now resigned Richmond Fed. president Lacker for clues) has been the only fuel as to power the markets where they now stand. What they’ve also done in unison is make everyone oblivious to the inherent dangers within.

Hedging and more has been a fool’s errand, and for many, an abject lesson in not only losing money, but status. (See the Hedge Fund industry for clues.) However, what might be even more indicative of that intervention is none other than the tech space, with all its unicorns, deca-corns, and even super-corns (yes, that’s now an actual term in “The Valley”) suddenly coming up lame in the unicorn stables of “Cha-ching!” Not to mention the IPO disasters and disappearance of those “Crushing it!” stock valuations. (See Snapchat™ for clues.)

This is where the beginning signs for caution are raised for anyone paying attention. And they are there – in spades. But there are also other areas to watch that help back up the hypothesis. And one of the first to show stress when things are not going as well as planned in “tech” land is: The Russell 2000™ e.g., the small business index.

The Russell is not only not showing the exuberance of the others, it’s beginning to show all the signs of rolling over. That is something to take notice in conjunction with the tech sector as it hits ever higher highs. How that dichotomy resolves is anyone’s guess at this moment. But trying to ascertain any clues is of a paramount importance in my opinion.

Another key earnings report that may give far more light than anyone estimates is coming up on Wednesday. That, of course, is Facebook™.

As of today all the estimates are that they’ll handily beat and some analysts are raising their targets. It’s very well they could, especially in today’s world of earnings reporting alchemy. However, one thing which caught my attention was the sudden touting a few weeks back that they had hit “5 Million advertisers.” Small businesses noted as the “key driver.”

“Sound great!” many are saying, and, in-truth, it is a worthy milestone. However, I see the timing as possibly a little suspect, here’s why… (I make this point for it has become near laughable how nearly all upcoming “tech” earnings reports now suddenly coincide with an ever-growing list of preceding announcements of grandiose ideas that are alluded to be right around the corner (like next week!) of flying cars, self driving trucks, rocket rides to space, virtual reality, just to name a few.)

Facebook as of late has been in the news with nothing but negative reports with a slew of horrendous acts being broadcast via their platform. e.g., Rape, kidnapping, beatings, and others. One of the concerns over all this (apart from the issue itself) was a possible backlash from potential advertisers. And who could blame them, and there lies the possible rub…

As I implied with the sudden “5 million” hoopla, what I’m asking is this: Is the addition of these stated 1 million plus new small business advertisers a replacing (therefore a diversion as to squash attention) for the potential of 1 or 2 (or more) large buyers who may have pulled ads?

In other words, if they’ve added so many “new” small business users – shouldn’t the ad revenue explode this report with all things being equal? I believe this is the metric to watch for.

How the numbers break down should be interesting. Google showed its own problem (via Youtube™) seemed to have been a one-off with no real impact. That said, I don’t think that comparison is the same for Facebook should the numbers show otherwise.

We shall see.

If there is a “hiccup” in Facebook’s reporting, coinciding with a realization that the reflation trade is all but DOA along with much of the legislation that was supposed to make it so. I believe we could be in for a very, very, interesting week ahead.

Then again, if a nuclear showdown does persist even more so than today?

I guess the “Buy The Nuclear Annihilation Dip” nonsense is back on.

Will The Fed Dump Bonds In The Open Market?

According to William Dudley, the president of the Federal Reserve bank of New York, we might see the Federal Reserve reducing the size of its balance sheet sooner rather than later. Whilst Dudley seemed to have been hinting at just letting the securities on the balance sheet mature and take the cash out of the market (rather than reinvesting the proceeds), this isn’t the only option on the table.

On the exact same day when Dudley discussed the size of the balance sheet of the Fed, the president of the St Louis Fed, Bullard, also launched his own idea. Rather than just slowly reducing the balance sheet of the central bank by not reinvesting the proceeds from securities which reach their maturity date, Bullard openly discussed the potential to just sell the assets.

Source: St Louis Fed

As you can see on the previous image, the total size of the Fed’s balance sheet is approximately 4.5 Trillion, and figuring out how to reduce it perhaps isn’t the worst idea to investigate. After all, by selling securities on the open market, the Fed will be taking more (easy and cheap) cash out of the market as well. So technically and theoretically, selling (hundreds of) billions in assets on the market could have a similar impact as a rate hike.

After all, selling debt securities will reduce the price of those securities and thus increase the yield to maturity. And this could immediately solve another problem the Fed has been facing.

According to Morningstar, the flattening yield curve is worrying investors, as the spread between the 10 year bonds and 2 year bonds has decreased to just over 1.1%. This could indicate that ‘either the economy is slowing down, or the riskier asset classes are overpriced’.

Source: St Louis Fed

This might very well be true. Due to the cheap money policy of the Federal Reserve and its European counterparts, it became extremely cheap for companies to issue debt. For most robust and strong companies this was a real blessing as the lower interest rates allowed them to cut the interest expenses, which boosted the bottom lines of these companies.

Unfortunately the ultra-low yields (with some companies being able to issue debt with YTM’s of close to 0%) pushed some investors into a ‘yield-chasing’ mode, buying whatever they could to increase the average interest income in their portfolios. This blind yield-chasing has led to some very undesirable results as now even the companies without investment-grade debt quality were able to secure funding.

Source: Bloomberg

And this puts the entire economic system at risk again, as reducing the liquidity in the markets will have  a double undesirable effect. First of all, due to the higher interest rates and higher spread, the demand for sub-investment grade securities will decrease (as the yield-chasing appetite will be reduced); and this could (and very likely will) have a negative impact on the survival chances of those companies. And of course, should they go belly-up, the debt holders very likely won’t recoup their original investment, creating a new round of investment losses and a further contraction in available liquidity as the risk appetite will undoubtedly decrease as well.

Whatever the Federal Reserve wants to do next, it should think long and hard before acting as it won’t be easy to repair the damage...

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How The Obama Administration Quietly Bailed Out Private Equity Landlords At The Expense Of The Middle Class

Authored by Yves Smith, originally posted at NakedCapitalism.com,

So how much did Blackstone promise to give to the Obama library for this huge grift, um, parting gift?

As regular readers may recall, private equity firms piled into buying foreclosed single family homes on the belief that if the government (in this case, Fannie and Freddie) was selling, they wanted to be buying. And they also convinced themselves that technology would somehow allow them to manage geographically dispersed single family homes, which is inherently a hand-on business, more efficiently than mom-and-pop or small scale operators, many of whom had a cost advantage by having some of the principals provide services (as in doing their own plumbing and electrical, so effectively “buying” those services at wholesale prices).

The most disciplined operators did well by getting in early and buying only very discounted properties, so that they had a good cash on cash return on the rentals. It would be attractive for them to hold long term, which would also give them lots of latitude regarding an exit. The lack of time pressure would mean they could sell the homes individually, even through “rent to own” deals with the higher credit quality tenants.

But many of the early entrants kept on buying long after prices were bargain basement, and it was clear due to the press reports of widespread mis-management and tenant abuses that they were cutting corners on maintenance due to having underestimated costs and complexity. Any real estate manager will tell you that running down the asset is foolhardly.

The logical time to start to exit was 2014, but the private equity property owners were whacked by the Bernanke taper tantrum. The most straightforward exit was to turn the properties and the management compan into a REIT, but only a couple of deals got done before that window closed. The next strategy was rental securitization, which we regarded as a terrible idea given the awful track record of mortgage servicing, and that a rental securitization involved much more in the way of moving parts that mortgage servicing. Again, a few transactions got out the door, but the market foundered after a Blackstone securitization saw a big drop in rental income in the quarter immediately following the public offering.

So in its waning hours, the Obama Administration gave a completely unjustified bailout to private equity landlords, that Fannie Mae is guaranteeing the income of all but the bottom tranches of Blackstone’s latest rental securitization.

Let us stress that there is absolutely no policy justification for this. The mission of the government sponsored agencies is to promote home ownership, not to give real estate speculators a “get out of losses or underwhelming returns for free” card. Even worse, rather than forcing the private equity industry to take some well-deserved lumps for miscalculation, it will encourage them to continue to compete with lower-income prospective homeowners for purchasing properties. That means it will be even more difficult for young people to buy homes. Lambert has pointed out repeatedly in his stats wrap in Water Cooler that real estate markets are suffering from a shortage of homes. Having private equity continue to be on the prowl for lower priced properties that they know they can unload from an economic perspective means that the pauperization of the middle class is now official policy.

Even though this guarantee clearly had to have been worked out during the Obama Administration, Blackstone did not make it public until it updated its filing with the SEC this week. It looks an awful lot like the timing was designed to make sure that the disclosure came after the new Trump team was in charge, meaning Obama would be unlikely to face the criticism he deserves, and the Trump Administration would be certain to let the deal stand.

*  *  *

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street

Invitation Homes, the 2012 buy-to-rent creature of private-equity firm Blackstone, and now owner of 48,431 single-family homes, thus the largest landlord of single-family homes in the US, accomplished another feat: it obtained government guarantees for $1 billion in rental-home mortgage backed securities.

The disclosure came in an amended S-11 filing with the SEC on Monday in preparation for Invitation Homes’ IPO. Invitation Homes bought these properties out of foreclosure and turned them into rental properties, concentrated in 12 urban areas. The IPO filing lists $9.7 billion in single-family properties and $7.7 billion in debt.

Some of this debt will be refinanced with the proceeds from the sale of the $1 billion of government-guaranteed rental-home mortgage backed securities.

The government agency that has agreed to guarantee the “timely payment of principal and interest” of these “Guaranteed Certificates,” as they’re called, is Fannie Mae, one of the government-sponsored entities (GSE) that has been bailed out and taken over by the government during the Financial Crisis.

This is the first time ever that a government-sponsored enterprise has guaranteed single-family rental-home mortgage-backed securities, issued by a huge corporate landlord. It’s an essential step forward in financializing rents: taxpayer backing for funding the biggest landlords.

Government guarantees allow the mega-landlord to sell these securities at a lower yield and thus offer landlords like Blackstone’s entity even cheaper financing for future home purchases, and thus lower costs and greater profit potential.

During the next severe economic downturn, Fannie Mae and its sister Freddie Mac would need between $49 billion and $126 billion in taxpayer bailout money, according to the stress test conducted by the Federal Housing Finance Agency. The results were released in August last year. So why fret about one more billion?

Blackstone is the trailblazer in financializing rents. It pioneered the post-Financial Crisis buy-to-rent scheme, explicitly encouraged at the time by Fed Chairman Ben Bernanke and the Department of the Treasury, as they were trying to bail out the banks by finding willing and able buyers for foreclosed homes – big institutional buyers that could feed at the nearly-free money-trough the Fed had put out there.

And Blackstone was a trailblazer in the next logical step: issuing the first rent-backed structured securities in November 2013. The deal was collateralized by rental income from 3,207 homes. Moody’s, Kroll, and Morningstar – all paid by Blackstone – rated nearly 60% of the securities AAA. The remaining tranches carried lower ratings. The deal flew off the shelf. Now all larger buy-to-rent companies are using rent-backed structured securities for funding.

This too is going to happen with government guarantees on rental-home mortgage-backed securities. It’s a sweet deal for the issuer: low-cost funding, made possible by government guarantees, is always welcome. Other corporate landlords will follow in Blackstone’s footsteps.

Not all of it will be guaranteed by the government: To satisfy “credit risk retention requirements,” Invitation Homes “would purchase and retain the Subordinate Non-Guaranteed Certificates,” amounting to 5%, or $50 million, of the $1 billion in securities. That’s all the cushion the taxpayer has before losses begin to hit home, so to speak.

The GSEs were founded to promote homeownership by subsidizing it with at first implicit, and since the Financial Crisis explicit, government guaranteed mortgages. But this deal represents a big shift: now, in a delicious Wall-Street irony, the government subsidizes the largest landlords and enhances their profits from renting out single-family homes that individual homeowners had lost during the housing collapse and foreclosure crisis.

There is a darker side to corporate ownership of single-family rental homes and the financialization of rents: soaring evictions, according to the Atlanta Fed, which explicitly blames the Fed and Bernanke. Read…  Evictions by Wall-Street Mega-Landlords Soar, Financialization of Rents Cause “Housing Instability”: Atlanta Fed

Malls Owners Rush For The Exits As Mall-Backed CMBS Defaults Soar

Last week we wrote about the epic collapse of the Galleria Mall at Pittsburgh Mills which sold for $100 after once being appraised for $190 million shortly after being opened in 2005 (see "Pittsburgh Mall Once Worth $190 Million Sells For $100").  Unfortunately for mall owners, while the Pittsburgh Mills Galleria is an extreme example, crashing mall valuations are hardly an anomaly these days.  In fact, just a few weeks ago Commercial Real Estate Direct wrote about the Foothills Mall in Tuscon, Arizona which was valued at $115mm in 2006 and backs a $75mm CMBS loan but recently appraised for just $18mm...or just a slight 75% loss for lenders.

As pointed out by the Wall Street Journal earlier today, mall CMBS defaults are up all across the country with liquidations up 11% YoY.

In the period from January to November 2016, 314 loans secured by retail property were liquidated, up 11% from the same period a year earlier, according to data from Morningstar Credit Ratings.

“We’re seeing a boatload of these kinds of properties coming to market,” said James Hull, managing principal of Augusta, Ga.-based Hull Property Group, which purchased five malls from foreclosure sales in 2016. “There have been some draconian losses for the enclosed mall business.”

And while we"re frequently reminded of the stunning "Obama recovery" by the mainstream media, retailers seem to represent the one "tiny segment" of the U.S. economy that failed to participate in that recovery as evidenced by the soaring delinquency rates of loans backing retail properties.

Despite a strengthening economy in 2016, the delinquency rate for loans backing retail property rose by 0.6 percentage point last year to 5.76%, according to Trepp LLC, a real-estate data service. Special servicers, which deal with troubled commercial mortgage securities, managed $3.1 billion worth of mall-backed loans last year, up from $2.9 billion in 2015, according to Trepp.

This year is off to a shaky start. Earlier this month, Sears said it would close 150 stores, and Macy’s gave more details of a plan to close 100 stores.

Limited Stores Co. said it plans to close all 250 stores and filed for chapter 11 bankruptcy protection last week.

Meanwhile, as Barclays" U.S. REIT team points out, the key question for mall owners in 2017 isn"t whether rent concessions will be granted to tenants, but rather, just how deep the cuts will have to be in order to maintain occupancy.

A key topic going forward will be the extent of rent concessions provided in order for malls to maintain occupancy.  We think rent concessions could accelerate in 2017 as retailers continue to prune their store bases and at the margin, restaurant openings slow.  Many malls backfilled space in recent years with non-apparel offerings, like restaurants - which increase mall traffic, without cannibalizing sales.

Overall, we expect mall REITs to issue cautious outlooks for 2017, with a wait and see approach to the year.  This will be against the backdrop of many retailers also reporting their holiday results and 2017 guidance, which are likely to be conservative.  We believe both these factors will contribute to negative investor sentiment.

Alas, while mega malls were once the destination of choice for America"s misunderstood youth, we fear that they"re bound to suffer the same fate as the big hair, hoop earrings and creepy mustaches that once frequented their food courts in the 80s.