Tag Archives: market crash

Recent Economic Data: More Fiction Than Fact

The advance estimate of Q3 GDP was released on Thursday, October 29th. The headline number was 33.1% (annualized rate) vs 31% expected and negative 31.4% for Q2. This was John Williams’ (Shadowstats.com) comment on the headline number: “ShadowStats contends that the headline BEA estimates understated the 2q2020 quarterly plunge and have overstated the 3q2020 rebound.” On a quarterly basis, the reported GDP growth from Q2 was roughly 10%. To get back to the GDP level reported in Q1 prior to the virus shutdown, Q4 GDP will need to increase roughly 15% annualized. This is highly improbable.

I don’t want to dissect the GDP report for areas in which the estimates differ from actual real world numbers reported by companies. But keep in mind the jump in GDP in Q3 was largely generated by the momentum of businesses reopening, furloughed employees rehired and the stimulus provided by the $1.8 trillion CARES Act, which was signed just before the end of Q2.

As I’ve been detailing on a weekly basis, it appears that most of the sugar high from the Fed’s money printing and the CARES Act has worn off. While weekly jobless claims have dropped to an average of 787,000 over the last four weeks, down from a peak of 7 million at the end of April, the weekly number of new claims is still 3.7x higher than the weekly claims right before the lockdown period began.

Including the supplemental jobless benefits that were rolled out as part of the stimulus bill, over 23 million people are still filing weekly claims. Moreover, several large companies have announced 10’s of thousands of more layoffs, including Disney, Boeing and Exxon. If the Government does not soon pass another stimulus bill that includes bailing out States and local governments, there will be a large-scale layoffs of teachers, firemen and police.

ADP employment report vs Government employment report – The employment report released by the BLS on Friday purports that the economy added 638k new jobs in October. Wall St. expected 600k. The manipulative “button” pushed by the BLS this time was the Birth/Death model. The BLS estimates the number of new businesses started less businesses shut down during the month and derives a guesstimate of the net new number of jobs from this. It’s entirely based on flawed modeling theory. For October the BLS added 344k jobs based on its B/D model. Of course, this chart completely discredits the BLS B/D model(chart sourced from @soberlook):

The small business jobs index suggests that business “deaths” currently exceed “births” by a considerable margin. Data on business closures since March reinforce this.

It’s just amazing how the BLS seems to find jobs in the private sector that ADP, the payroll processing business, is unable to detect. ADP’s jobs report, released two days ahead of the Government report, showed 365k new employees were added to payrolls in October (note, this reflects hirings only, not cuts). Also note that the announced layoffs by big companies during Oct also escaped BLS detection. Finally, as John Williams points out on his Shadowstats.com website, “the BLS acknowledged continuing misclassification of some ‘unemployed’ persons as ’employed.'”

In all likelihood, the economy is much weaker that it would appear from stimulus-juiced economic reports that emerged over the summer. Auto and new home sales are already starting to roll over precipitously. With the stock market historically overvalued.  The upward movement since May was largely driven by hedge fund and newly minted retail “expert” momentum-chasing.  These two factors have set-up the potential for breath-taking market sell-off sometime in the next 3-6 months.

 

Did The Tech Bubble Pop On September 2nd?

For me it doesn’t not matter who wins the election. The person in the Oval Office is not in control of the monetary policies that form the fundamental basis for owning physical gold and silver. Regardless of which party sits in the Oval Office and Congress, the budget deficit and debt load will accelerate and thereby money printing will accelerate. The dollar will start to decline at a more rapid pace than it has declined since mid-March. Gold and Silver will climb over $2,000 and continue moving higher. At some point the stock markets will buckle under the pressure of a falling dollar and rising interest rates.

The chart above (from Crescat Capital) shows an analog that compares the Dow between 1919-1932 and 2009 to the present. The key underlying factors that drove the the stock market in both time periods to an insanely overvalued top and subsequent descent are worse now than back in the 1920’s/early 1930’s: currently stocks have higher multiples, the global economy is more leveraged and Central Banks have created a far bigger systemic imbalance now vs. then.

Also, derivatives were not yet invented and thus not a factor in creating a far bigger “leverage factor” that is impossible to quantify but that will ultimately be lethal to the financial system. This chart illustrates this point using  the volume for exchange-traded options – the OTC derivatives market is far larger in nominal value than the stock market (data from Bloomberg, Artemis Capital):

The light blue line shows total stock market volume plotted against the yellow line which shows total options volume. The proverbial tail is wagging the dog and the Fed and the Government regulators are to blame. The unwind will be ugly for stock market bulls.

That said, I expect the Fed will juice the money supply after a Presidential winner is declared. This may or may not push the stock market higher. I think we can expect a brief move higher in stocks after the election. But soon thereafter the fundamental realities will sink in and have a negative effect on the stock market.

Did the tech bubble pop on September 2nd? –  “Bubbles tend to topple under their own weight. Everybody is in. The last short has covered. The last buyer has bought (or bought massive amounts of weekly calls). The decline starts and the psychology shifts from greed to complacency to worry to panic. Our working hypothesis, which might be disproven, is that September 2, 2020 was the top and the bubble has already popped.” – David Einhorn, Greenlight Capital

 

We won’t know the answer to that question for at least a few months.  In the chart above I sketched in loosely the uptrend line followed by the Nasdaq to an all-time high since the March bottom. The Nasdaq broke below the 50 dma in September (yellow line), then rallied to retest the uptrend line. It bounced off the uptrend line and headed lower almost immediately to form a lower high, after which it fell back below the 50 dma.

At some point I expect the Fed to step in with more money-printing but not until some point after an election winner has been declared. That money will directed at injecting more liquidity into the TBTF banks and funding another big wave of Treasury issuance after the election. But for now the path of least resistance in the stock market is down punctuated with bouts of high two-way volatility.

The commentary above is an excerpt from the Short Seller’s Journal, a weekly newsletter that dissects the latest economic reports and presents ideas for short seller’s. You can learn about it here:  Short Seller’s Journal information.

The Market Is More Dangerous Now Than Early 2000

This market reminds me of the late 1999/early 2000 tech bubble. But back then it was primarily the Nasdaq that bubbled up. This time around the absurd dislocation between value and reality is more comprehensive. It’s not just tech stocks but also non-tech related stocks like HTZ, AAL, BA etc.

Back in late 1999/early 2000, like now, newly minted retail day-trading geniuses who couldn’t explain what a p/e ratio is were piling into tech stocks with risky OTM call options and heavy use of margin.   Most were wiped out when the Nasdaq crashed just like most will be wiped out when this market has the rug pulled out from under it. The February-mid March decline was just an appetizer for patient short sellers.

Silver Liberties invited me back onto its podcast to discuss the insanity of the current stock market and, of course, to talk about gold, silver and mining stocks:

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You can learn more about  Investment Research Dynamics newsletters by following these links (note: a minimum subscription period beyond the 1st month is not required):  Short Seller’s Journal subscription information   –   Mining Stock Journal subscription information

Note:  I do not receive any promotion or sponsor payments in any form from the mining stock companies I present in my newsletter. Furthermore, I invest in many of the ideas personally or in my fund.

“Risk Parity” Was More Risk And No Parity

The “60/40 risk parity” hedge fund strategy has been decimated in the market sell-off.  The strategy was supposed to generate consistent returns while minimizing risk.  So why not apply hedge fund leverage to the trade and enjoy multiples of “consistent returns” and “minimized risk?”   The risk parity funds were among the most leveraged going into the market plunge, which began in earnest on February 19th, though the Dow started tipping over a week earlier.

We’ve seen this “excess returns/alpha” with “minimized risk” fail badly twice in the era of modern finance – i.e. the post Bretton Woods era of unfettered expansion of fiat money supply, highly questionable use of leverage and untested “quant” strategies.

Most of you reading this will not remember or even know about Fisher Black’s “portfolio insurance” quant strategy, which promised to remove downside risk from all-equity portfolios (if you trade options and don’t know who Fisher Black is, then you shouldn’t be trading options).  But the “quantitative” magic embedded in the strategy failed miserably in the 1987 stock market crash.

In the 1990’s Long Term Capital Management branded a similar though more complex “all upside / no risk” strategy by assembling a “dream team” of quants which included Robert Merton and Myron Scholes, two Nobel laureates in economics.  LTCM was using unheard of amounts of leverage because its mad scientists of quant finance had achieved the goal of removing risk from LTCM’s portfolio.  Again, the strategies failed catastrophically when the high risk/return assets upon which LTCM was highly leveraged began to plummet, liquidity disappeared and the risk removal strategies proved worthless.

Amusingly, the purported “expert” in cross-asset strategies, Nomura’s Charles McElligot, apologizes for the failure of risk parity by explaining that “we now see the 18-day period of returns for [Nomura’s] model ‘World 60/40’ fund was 15.5% greater than an 8-sigma move and truly unprecedented dating back to the model’s start 1999 start date.”  Interesting that this “model” does not include data going to back to the 1987 crash or the LTCM collapse. Everyone is the perfect armchair quarterback the day after. But it’s impossible to model the future. Nomura’s model  didn’t even include the two most important multi-sigma downside events in the era of modern finance.

Funny thing about McElligot.  He was in grade school  during the 1987 crash and in college when LTCM blew up.  These quantitative gimmicks are no different than the methodologies applied by boiler-room stock brokers pitching risky stock ideas doomed to eventual failure. They all work wonderfully and make everyone money – especially the purveyors of these fantasy ideas – when markets are rising and even better when the bulls are all-out stampeding into the market.

But all of these strategies have one thing in common. They fail to incorporate the ability to measure and manage the sudden vacuum of liquidity when markets go from functioning continuously with bids just as “deep” on the downside as were the “offers” on the upside.  “Liquidity” is a risk variable that’s impossible to model or manage when everyone is running for the exits and bids disappear.

Just like Fisher Black’s “portfolio insurance” and LTCM’s Nobel Prize backed downside-risk removal models, the risk parity strategy turned out to provide all risk and no parity when the market had the rug pulled out from under it.  And when this happens the biggest charlatans of modern money management start crying for the Fed and the Government to bail them out.

Stocks, Bonds, Paper Gold – What The Hell Is Happening?

Make no mistake, the financial system is collapsing under one giant margin call being issued to banks and hedge funds. How big?  No one knows. The Fed obviously was preparing for something when it commenced its money printing in September. But it had no idea of the scale of the underlying systemic problems.  Coronavirus is not the cause of what’s unfolding in the markets – it merely served as the pin that pricked the biggest financial asset bubble in history.

The $1.5 trillion “repo” QE announced by the Fed today did a complete belly flop, as the Dow closed 400 points lower than where it was trading when the QE was announced.  This will take the Fed’s balance sheet well above its peak level during QE1-3.

Craig “Turd Ferguson” Hemke and I had a short discussion about the devastation in the stock and credit markets, including trying to make sense of the action in the precious metals sector – Use this link to access the podcast and TF Metals or click on the image below:

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You can learn more about  Investment Research Dynamics newsletters by following these links (note: a minimum subscription period beyond the 1st month is not required):  Short Seller’s Journal subscription information   –   Mining Stock Journal subscription information

Coronavirus Is Not The Cause Of Stock Market Turmoil

“The coronavirus could be the proverbial Black Swan event. No one saw that coming. We’ve seen everything else [up to this point] that’s coming. The Fed saw something coming in September and it wasn’t coronavirus.”

All it took was a 10% sell-off in the S&P 500. On Tuesday the Federal Reserve cut its benchmark interest rate by 50 basis points to a target range between 1% and 1.25% over fears the coronavirus will have a negative impact on the U.S. economy. I am confident that the rate cut was targeting the stock market because that’s all the Fed, the White House and Wall Street have as “evidence” the economy is fine. The bond market is suggesting otherwise, the yield curve has compressed to record low yields.

David Stockman perfectly describes the scenario facing the country: “The coronavirus is now exposing a far more deadly disease: Namely, the poisonous brew of easy money, cheap debt, sweeping financialization and unbridled speculation that has been injected into the American economy by the Fed and Washington politicians.” (LINK)

Chris Marcus of Arcadia Economics and I discuss the market forces causing the stock and bond market chaos of the last few weeks:

The Real Stock Market Is Declining

The major stock indices – the Dow, SPX and Nasdaq –  have wafted up to all-time highs on a cloud of Central Bank printed money.  Interestingly, most of the stocks in all three indices are below to well below their all-time highs.  Breadth of the move is shockingly thin.  Very few stocks are responsible for pushing the indices higher. The Dow’s move last Friday, for instance, was primarily attributable to AAPL (by far the biggest contributor), MSFT, HD, UTX and JPM. Of those, only AAPL, UTX and JPM hit their all-time high on Friday.  MSFT and HD were close.

Many of the Dow stocks are down significantly this year. If you find this hard to believe, run the 1yr charts of the 30 Dow stocks. I’m certain the same is true for the SPX and Naz.

Despite the appearance of the stock market moving higher, most of the stocks that make up the 2800 stocks on the NYSE are well below their all-time and/or YTD highs. There’s plenty of money to be made shorting stocks despite the headline, mainstream media and White House’s euphoria over the stock market’s performance. Moreover, short interest in the SPY ETF has plunged to a level that has, in the past, led to sharp sell-offs in the stock market.

And then there’s this, which is the best measure of the real rate of return stocks:

Over the past 52 weeks through November 6th, the S&P 500 has declined 10.5% when measured in terms of gold – i.e. real money.  Money printing at a rate in excess of real wealth output diminishes the marginal value of the currency.  Because the price of gold moves inversely with the inherent value of the dollar, the chart above reflects the effect of dollar devaluation on financial assets.

Thus,  the real upward movement of the stock market highly deceptive in terms of both the number of stocks in the NYSE participating in move higher and in terms of using real money to measure the price of stocks.

Stocks Bubble Up From More Money Printing

The stock market spiked up last week as Trump started in with his trade war optimism tweets, which excited the algos and momentum chasers. As Monday rolled around, however,  it was determined that a “Phase 1” trade agreement amounted to nothing more than a commitment from China to buy some farm products. On Tuesday China made the purchases contingent on Trump removing tariffs. So there is no “Phase 1” trade deal.

But the hedge fund computers don’t care.  Now the market is bubbling higher on the reimplementation of Federal Reserve money printing. Call it whatever your want – QE, balance sheet growth, term repos, whatever. But the bottom line is that Fed is printing money and injecting it into the banking system, which thereby acts as a transmission mechanism channeling some portion of this liquidity into the stock market.

The semiconductor sector is traveling higher at the fastest rate as hedge fund computers and daytraders are chasing the highest beta stocks up the most. The SOXX index is pressing its all-time today.   This is in complete disregard to underlying fundamentals in the sector which are melting down precipitously.

For the 1st ten days of October, exports from South Korea fell 8.5% YoY with chip exports down a staggering 27.2%. Remember back in January when the CEO of Lam Research forecast an upturn in 2H of 2019? Does that look like an industry upturn? Two of the world’s five largest chip manufacturers are based in S Korea:  Samsung is the world’s largest and Hynix is ranked fourth.

Today the Fed’s daily money printing repo program surged to $87.7 billion, which is the highest since “QE Renewed”  began in mid-September.  Recall back then the popular Orwellian narrative explained that the “temporary” funding was necessary  to address quarter-end cash needs by corporations and banks.  Well, certainly the banks need the money…

But on Friday the Fed announced that it was going to extend the overnight and term repo operations at least until January. In addition, the Fed added a  $60 billion per month T-bill purchasing program. The Fed explained that it was implementing the  operation to supplement the liability side of its balance sheet.  Besides currency and coin issued by the Fed, deposits from “depository institutions” –  aka demand deposits from banks – represent the largest liability on the Fed’s balance sheet.

This means that this liability account needs more funding because either bank customers are holding less cash at banks OR banks need to increase reserves to maintain regulatory reserve ratios. The latter issue would imply that bank assets – aka loans – are deteriorating more quickly than the banks can raise the funds needed to meet reserve requirements. Given the recent data on MZM, it would appear that customer cash deposits at banks have increased recently. This implies that banks are experiencing stress in the performance of the loans and derivatives on their balance sheet, thereby requiring more reserve capital.

Money printing apologists want to point at DB or JPM as the target of the Fed’s money printing.  And I’m certain they are among the largest contributors to the problem.   But GS, MS, BAC, HSBC, C should be included in there as well.  They’re all connected via derivatives and I’m guessing subprime asset exposure at all the big banks is blowing up,  causing cash flow shortfalls and counterparty derivatives defaults on credit default and interest rate swaps.  Just look at the dent  WeWork is putting into the exposure to the failed unicorn at JPM and GS.  Then there’s the melt-down going in energy/shale sector debt…

Eventually the Fed will have to announce that it is permanently implementing temporary liquidity relief programs – or “organic” balance sheet growth operations.  Jerome Powell will take painstaking measures to assure the market this is not Quantitative Easing.   And he’ll be right. That’s because it is outright money printing.

I expect the stock markets to get a temporary “meth” fix that pushes the SPX back up to the 3,000 area of resistance.  I also expect that it will fail there again, triggering a sharp sell-off into the end of the year, similar to last year. The risk the Fed is running here by using more money printing to juice the stock market is that eventually – like all heroin or meth addicts – stocks will become immune to increasing doses of the happy drug.   At what point will the Fed be forced administer a dosage level that kills the market?

Fed Balance Sheet Expansion, Unicorns, Unintended Consequences and Gold

The Bank for International Settlements (BIS) – the Central Bank of Central Banks – released two reports on “unconventional policy tools” – e.g. QE/money printing and interest rate suppression. It concluded that the extreme Central Bank interference since 2008 has had a negative impact on the way in which financial markets function.

While Jerome Powell and his “Gang That Couldn’t Shoot Straight” at the Fed prefer to use the term “balance sheet growth” in reference to money printing, the big-thinkers at the BIS call it UMPT (Unconventional Monetary Policy Tools).”

“Last month’s spike in short-term US borrowing costs was just the latest in a series of market shocks that have fueled investors’ suspicions that this radical monetary policy is having an impact on how financial markets function.” (Financial Times)

“Moral Hazard” is defined as the “lack of incentive to guard against risk where one is protected from its consequences.” In economics (real economics, not the Keynesian psycho-babble of the current era) this would refer to the egregious misallocation of investment capital caused by the unfettered creation of fiat currency injected into the global financial system.

Additionally, unprecedented permissiveness by the regulators, who are charged with enforcing laws originally established to prevent or at least contain the escalating financial fraud that accompanies asset bubbles, further enables and accelerates the formation and inflation of investment bubbles.

The BIS report of course neglected to discuss the extreme moral hazard engendered by the trillions in money printing. The “unicorn” IPOs are the direct evidence of this. The extreme  overvaluation of the equity in the ones that have sold stock into the public markets reflects the complete disregard of historically accepted tools and guidelines used for business model appraisal and financial valuation analysis. “But it’s different this time.”

The losses racked up by these companies, the ones with public equity plus the ones yet to be IPO’d, will aggregate well into the $100’s billions, possibly trillions before this era dies. A journalist from The Atlantic, in an article titled “WeWork and The Great Unicorn Delusion,” correctly asserted that “most [of these companies] have never announced, and may never achieve, a profit.” But he lost me when he asserts that these companies are “extraordinary businesses with billions of dollars in annual revenue and hundreds of thousands, even tens of millions, of satisfied global customers.”

Quite frankly, the business model of almost every Silicon Valley unicorn is predicated on building revenues and gaining market share by selling products and services for a significant discount to the all-in cost of production and fulfillment.

Every single unicorn IPO’d over the last several years that I have evaluated is not only highly unprofitable, but also burns legendary amounts of cash. Of course there are “millions of satisfied customers” globally – the unicorn business model functions in a way that is the equivalent of selling $1 bills for 75 cents.

The more relevant proposition is that, in all probability, many of these companies would have never  spawned if the Central Banks had not inflated the global money supply well in excess of real economic growth generated by the global economy.

I find it difficult, if not impossible, to refer to these appallingly unsustainable businesses models as “extraordinary” when in fact most if not all of them are nothing more than the product of the extreme moral hazard created by the Central Banks’ printing presses running overtime.

The economic losses incurred by the Silicon Valley unicorns are funded by the “private equity” funds which have managed to harness a significant share of the cash flowing from Central Bank money-spigots and transmitted through the primary dealer banks into the financial system. Little noticed is the fact that since 2014, roughly $1.3 trillion has drained out of the banks’ excess reserve account at the Fed and disappeared into the financial system’s “black hole.”

The 2008 Great Financial Crisis – which was a de facto financial system collapse until money printing bailed out banks and reckless investors – was fueled by the easy monetary and credit policies of Alan Greenspan and Ben Bernanke. Those policies stimulated huge mortgage, housing and general stock market bubbles. The unintended consequences bankrupted a large swathe of households and banks.

But that decade’s reckless Central Bank policies pale in comparison to the current era of unfettered money printing cranked up by Ben Bernanke (recall that he was affectionately called “Helicopter Ben”). The ensuing widespread asset bubbles have fomented into a financial Frankenstein that has broken free from its chains as evidenced by the sudden implementation of the Fed’s repo program, which has yet to be accompanied by a credible explanation.

Jerome Powell yesterday (October 8th) asserted in a speech that “balance sheet expansion is not Quantitative Easing.”  But make no mistake, the repo operations function as emergency room triage until the Fed and the Treasury Department formalize another round of money printing, or QE or whatever you want to call it. At this point it is nothing more than a game of Orwellian semantics.

If you’re curious as why the price of gold has risen 37% since the end of May, look to the events unfolding at the Fed and in the banking system. Just like in late October 2008, the price-action in gold is sending a loud alarm that is no longer containable with manipulative efforts in the paper derivative gold market. Eventually the Government’s Working Group on Financial Markets will be helpless in coaxing the hedge fund trading robots to help hold up the stock market.

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The commentary above is an excerpt from the next issue of the Short Seller’s Journal (Sunday). I’ll be reviewing several unicorn short ideas over the next several issues. To learn more about this short-sell focused newsletter, click here:  Short Seller’s Journal info

An Unavoidable Global Debt Implosion

“[Whatever] the repo failure involved, it is likely to prove a watershed moment, causing US bankers to more widely consider their exposure to counterparty risk and risky loans, particularly leveraged loans and their collateralised form in CLOs. a new banking crisis is not only in the making, for which the repo problem serves as an early warning, but it could escalate quite rapidly.” Alasdair Macleod, “The Ghost of Failed Bank Returns”

The delinquency and default rate on consumer and corporate debt is rising. This creates funding gaps and cash flow shortfalls at banks. In a fractional banking system, banks only have to put up $1 of reserve for every $9 of money loaned. When the value of the loans declines because of non-performance, it requires capital – cash liquidity – to make up the shortfall in debt service payments received by the banks. In simple terms, the banks are staring at a systemic “margin call.”

To be sure, the current repo funding shortfall may subside. But it will not fix the underlying causes (Deutsche Bank, CLO Trusts, subprime debt, consumer debt, derivatives), which are likely leading up to another round of what happened in 2008 – only worse this time.

Chris Marcus of  Arcadia Economics  invited me to discuss my thoughts on the meaning behind the sudden need for the Fed to inject $10’s of billions into the overnight bank lending system:

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You can learn more about  Investment Research Dynamics newsletters by following these links (note: a miniumum subscription period beyond the 1st month is not required):  Short Seller’s Journal subscription information   –   Mining Stock Journal subscription information