Financial Armageddon

Anybody Left to Buy (Technology Stocks)?

While at least some market-watchers will view today's key reversal (on extremely heavy volume) in technology bellwether Apple as a potential turning point for the sector, which has been on an incredible tear in recent weeks, there's no shortage of data suggesting that enthusiasm for the group has reached historically untenable extremes.

For example, based on figures derived from the Commodity Futures Trading Commission's weekly Commitments of Traders report, traders categorized as "speculators" by the CFTC (including hedge funds) now have a record net-long position in futures on the technology-laden NASDAQ-100 index.

The obvious question, of course, is if a large chunk of the speculative crowd has already placed its bets on higher prices, who is left to buy?

The "Smart Money"?!

 

Leading the Way?

It's been said (many times) that correlation is not causation, but I wonder if the recent rout in industrial metals -- copper futures, for example, fell more than five percent today -- is telling us something about share prices?

Just a little food for thought.

On the Same Wavelength

In "Defending Shiller (Again)," Buttonwood's Notebook reveals that, contrary to what your average retail broker (and CNBC pundit) would have you believe, stocks are not cheap (and that's not even considering the possibility -- nay, certainty -- of another economic downturn and its effect on corporate bottom lines).

One measure, the cyclically-adjusted price-earnings ratio, also known as CAPE or Shiller P/E after one of its biggest proponents, Yale Professor and author of Irrational Exuberance Robert Shiller, reveals that when you take longer-term earnings trends into account -- rather than the next 12 months of fantasy-riddled analyst estimates -- valuations remain above historical averages (i.e., share prices are high relative to earnings).

Then there is the Q ratio, calculated by Andrew Smithers and Stephen Wright. This compares shares with the replacement cost of their net assets. The rationale is that if shares are cheap relative to assets, business will get taken over (since buying shares will be a cheap way of buying assets). And if shares are expensive, people will buy assets directly, not through the stockmarket.

"The key point," the Economist-sponsored blog notes, "is that it is calculated on quite a different basis from the Shiller p/e. But look how closely the two measures track each other. The Q ratio like Shiller says US shares are overvalued. [italics mine]

 
Click here to read the rest.

The Dope Gap

According to Merriam Webster, a "dope" is a stupid person, or an illicit, habit-forming, or narcotic drug (e.g., he is spaced out after smoking a lot of dope). As detailed below, I reckon either meaning might apply when it comes to describing Wall Street's big bet on the health of the consumer (especially after today's dismal data from the Conference Board).

Mind the Gap?

Credit markets seem to have a more negative perspective on where things are headed than equity markets:

Hmmm...I wonder which one is closer to the mark?

(Hint: if history is any guide, the answer is obvious).

Days Like This

With the kinds of markets we've seen lately, there's only one thing to do: revisit the Brokers with Hands on Their Faces blog:

Of course, after today's big plunge, I'm betting there were more than a few who looked like this...

...and who were praying, no doubt, for...

...the rally monkey...

...a greater fool (in fact, lots of them)...

(Image: source)

...or that faitfhful old money printer...

...Helicopter Ben!

(Image: source)

Shhhh -- I think I hear the chopper blades whirring already!

But I Thought It Doesn't Matter?

If you ask the "analysts" on Wall Street, they'll tell you that the macro picture doesn't matter -- it's all about earnings.

Well, based on following comments from and about several companies that just reported their quarterly results, it sounds like the economy is a lot more important than those "experts" have given it credit for [italics mine].

Texas Instruments:

"Texas Instruments' Profit Forecast Misses Some Estimates" (Bloomberg)

"Production at some computing and consumer manufacturers appears lukewarm even though we're heading into the back-to- school and holiday seasons," Chief Executive Officer Rich Templeton said in the statement.

...

[Chief Financial Officer Kevin March said] “no one can ignore the glaring headlines. We’ve gotten lackluster outlooks from our customers in the computer and consumer segments.”

HCA Holding:

"HCA’s Declining Surgery Rates May Show Slowdown in U.S. Hospital Industry" (Bloomberg)

HCA Holdings Inc.’s report of a drop in expensive surgeries may signal a broad slowdown for hospitals because of rising unemployment and tepid consumer spending.

Patients at HCA, the biggest U.S. hospital chain, sought less-expensive procedures during the quarter, according to the company. Per-patient income from Medicare, the government plan for the elderly, also fell.

UPS:

"UPS Warns About Curbs on Global Economy" (Financial Times)

Dithering over the debt ceiling in the US, concerns about sovereign debt in the European Union and slowing growth in Asia are restraining the global economy, according to top executives at United Parcel Service, the package delivery company.

...

[Chief executive Scott] Davis singled out the political gridlock over debt issues in Washington and continuing high unemployment as creating a weak US economy that was slowing demand for domestic services and also imports from places such as China.

AK Steel, United States Steel, and Nucor:

"Steel Makers Say Slow Economy Will Hit 3Q Results" (Associated Press)

Three of the nation's steel makers expect weakness in the U.S. and global economy will affect their third-quarter performances.

AK Steel Holding Corp. on Tuesday joined United States Steel Corp. and Nucor Corp. in predicting weaker results in the July-to-September quarter. Individual companies cited factors ranging from softer demand, higher costs and lower steel prices to rising supplies that could pressure prices and margins.

UBS:

"UBS Issues Profit Warning on Weaker Economy" (DealBook)

UBS warned on Tuesday that it would probably miss an earnings target set two years ago, after its profit fell by half in the second quarter and the economy weakened.

...

“Banks’ returns have declined over all in the last 12 months, reflecting deleveraging and the actions being taken in advance of increased capital requirements,” [chief executive Oswald J. Grübel] said in the statement.

“We are responding to this changed environment and the weakening economic outlook by adapting our business and increasing efficiency,” he said.

Illinois Tool Works:

"Illinois Tool Works 2Q Net Income Disappoints" (Associated Press)

GLENVIEW, Ill. — Industrial materials-maker Illinois Tool Works Inc. said its second-quarter net income and sales came in below expectations as demand was weaker than expected.

Illinois Tool Works makes everything from heavy equipment to adhesive and flooring materials. Its sales are closely tied to broader economic growth. CEO David Speer said the company expects "similar moderating demand levels in the second half of 2011."

Which One?

A yawning gap has opened up in recent weeks between the performance of two risky asset classes, high yield bonds and equities.

The question some might ask, of course, is which one appears to be out of line with reality.

I bet you know what I think.

The Perfect Metaphor

I admit I've been very confused by the ever-growing gap between Wall Street and Main Street, but when I looked at this chart, suddenly it all became clear.

(Note: In case you were wondering, this is not a forecast and I don't have any position in the stock. Cisco's trading history just seemed like the perfect metaphor for the kind of market environment we find ourselves in).

Keys to Today's Rally

I scanned the news to try and figure out what got equity traders so excited today and here's what I came up with:

Bull point #1: Rising revenue for financial firms that process food stamps and other government assistance payments; expanding niche market for canned pet food products

"One in Six Seniors Lives in Poverty, New Analysis Finds" (National Council on Aging)

Washington, DC – One in six older Americans lives below the federal poverty line, according to a new government analysis which almost doubles the number of very poor seniors compared to the standard estimate.

At 16%, the proportion of seniors living in poverty is also higher than the proportion of all Americans in poverty. The plight of poor women is particularly striking: 43% of Hispanic women who live alone, and 34% of black women who live alone, live in poverty, according to Supplemental Poverty Measure Research, an alternative calculation from the U.S. Census Bureau. The Supplemental Poverty Measure is a U.S. Census research tool that considers previously overlooked costs like out-of-pocket medical expenses and taxes that can create economic stress for seniors on fixed incomes.

Bull point #2: Heightened demand for refrigeration equipment and cold storage facilities

"Even in Death, Budget Cuts Take a Toll" (Wall Street Journal)

Squeezed Governments Look at Cremation, Other Ways to Trim Cost of Simple Burials for the Indigent and Unidentified.

DETROIT—Government budget cuts have reached the potter's field.

Communities have long provided simple burials for the indigent or unidentified, but cash-strapped jurisdictions from North Dakota to Arizona are trimming subsidies, raising fees or switching to cremation. The deliberations over such changes underscore that in an era of austerity, governments have to face issues that touch on both the economic and the moral.

"Do we continue this benefit for those who are deceased, or do we divert [resources] to those who are living?" said Robert Lamkey, director of public safety for Sedgwick County, Kan., which is paying for such burials out of its general fund after the state ended its support.

...

In Wayne County, Mich., which includes Detroit, state budget cuts have allowed the medical examiner's office to bury only half the number of bodies that need to be buried each year, according to Albert Samuels, chief investigator for the office. Mr. Samuels said he has about 185 bodies in storage.

Once Mr. Samuels uses up his annual budget of $30,000, he has to stop burials. "Bodies are still coming in," he said. "I get into a hole after a while."

Bull point #3: Expanding market for pharmaceuticals and mental health services

"Recession Begets Kids' Depression" (The News-Press)

Mental health pro see more juveniles in need of treatment

Adults aren't the only ones feeling emotionally wounded by the economy.

Last week, the David Lawrence Center in Naples added another outpatient group for youth ages 12 to 17. Called "Tough Times," it's another way the mental health and substance abuse center is trying to meet an increasing need for help among Southwest Florida adolescents.

"The trend now, as it has been in the last several years, is for us to see co-occurring things." said Bonnie Fredeen, the center's chief operating officer. With the economy, we see things such as adjustment disorders, some anger issues, and kids may be dabbling with substances," "We're seeing so many teens with anxiety and depression."

Bull point #4: Growing demand for snack food products and institutional catering services

"New School Data Reveal Worrisome Trends" (Chicago Tribune)

Poverty rises among Illinois public school children as overall enrollment dips for third straight year

As a group, Illinois' public school children are fewer in number, increasingly poor, more diverse and more likely than in recent years to spend the entire school year at the same building, according to new data.

Nearly half of the state's 2.1 million public school children came from families who were considered low-income during the last school year, as the recession nudged more families toward poverty. About 45.4 percent qualified for a free or discounted school meal, the highest rate in decades.

"It's a trend I am worried about," said state schools Superintendent Christopher Koch. "We are seeing additional stress on families ... and we know this impacts students."

Bull point #5: Prospect of additional bank bailouts, quantitative easing, and federal home buying assistance programs

"How ‘Distressed’ Home Sales Are Fuzzing the Numbers" (CNBC)

A new report today from Campbell/Inside Mortgage Finance shows distressed sales, that is bank-owned properties (REO's) and short sales, where the home is sold for less than the value of the mortgage, made up 47 percent of all home sales in December. That's up from 44.5 percent in November.

The National Association of Realtors put out a lower percentage last week (36 percent), but after speaking with the number crunchers at Campbell, I'm thinking the higher share is more accurate. We also just got numbers from DataQuick out West, showing 38 percent of California sales in December were REOs, and that doesn't include short sales, so you see the evidence.

Full House

Actually, it's five of a kind -- the kinds of bullish sentiment extremes that usually mean just one thing: Watch out below!

1. Individual investors

(Hat tip to Pragmatic Capitalism.)

2. Investment newsletter writers

(Hat tip to Pragmatic Capitalism.)

3. Options traders

4. Wall Street strategists

(Source: Bespoke Investment Group.)

5. The mass media

(Hat tip to Slope of Hope.)

Timing Is Everything

One of the (many) excuses that the bulls use to justify buying stocks at the present time is their belief that equities are a great hedge against inflation, particularly a hyperinflationary episode.

Whether or not we've reached the point where the prices of most goods and services are set to rise at a rapid rate (for the record, I don't think we're there -- yet), history suggests that timing is everything as far as this kind of hedge is concerned.

If, as the following chart (courtesy of A World of Possible Futures) reveals, you bought equities at the wrong point during the Weimar inflation of the early 1920s (i.e., September 1921), your portfolio took a gargantuan hit (i.e., roughly 85% in real terms through November 1922) before share prices began to catch up with what was happening on the ground.

 

Hmmm. I wonder how many investors actually held on for the eventual recovery?

(Hat tip to Broad Oak Blog.)

Only One Way to Go?

According to the "experts," the fact that the U.S. economy is softening, companies aren't hiring, sales are sluggish, and margins have nowhere to go but down is not a barrier to higher share prices. Indeed, many of them believe that fundamentals like these merely represent a "wall of worry" that serves as a springboard to continuing gains.

Under the circumstances, the following Wall Street Journal report, "Growth in Profit, But Concerns Over Sales" -- along with the fact that insiders are selling at a record pace, investor sentiment is near bullish extremes, and credit markets are on (government) life support, benefitting from a giant ponzi scheme -- should be enough to jam stocks a lot higher over the coming days, weeks, and months -- right?

Corporate America is on track to post its healthiest profit margins in more than three years in the current third-quarter earnings season. But some companies are warning that skittish consumers and higher raw-materials prices promise a tougher road next year, damping hopes for a resurgence in hiring.

...

So far, more than 60% of the companies in the Standard & Poor's 500-stock index have posted earnings for the quarter. About four-fifths of those have logged higher profit and sales than a year earlier, S&P says. It forecasts margins of the 500 companies will come in at 8.94% overall, the widest in more than three years, and their quarterly sales will rise 8% to $2.17 trillion, the highest in two years.

Weakness underlies those comparisons, however. Sales rose, but from a low base last year, when revenue was just beginning to recover from the recession. If S&P's forecast holds, third-quarter sales will fall more than $170 billion short of where they were in the third quarter of 2008, just before the financial crisis pummeled the economy.

The economy remains sluggish, growing just 2% in the third quarter, up from 1.7% in the second. Economists think that pace is too slow to create enough jobs to roll back unemployment, which was 9.6% in September.

More troubling, the bulk of third-quarter economic growth–1.44 percentage points—came from businesses restocking their inventories, a process many economists think has run its course. Growth in underlying demand slowed from each of the previous two quarters. Business spending on equipment rose, but at a slower pace, and gains in consumer spending were less robust than in previous recoveries.

Against that backdrop, S&P says corporate operating margins will narrow to 8.85% in the fourth quarter from 8.94% in the third. Margins at a number of big companies are already under pressure from more costly raw materials or the need to spend more on promotions or discounts to attract consumers.

Withering on the Vine

The so-called Wall Street experts maintain that there's lots of small investor cash on the sidelines just waiting to come into the stocks. They also claim that the bull market won't end until these greater -- greatest? -- fools have thrown in the towel and joined the rally party. Are they right? Well, based on what Charles Hugh Smith, publisher of the Of Two Minds blog, had to say on the subject in a post entitled "U.S. Financial Markets: The Well Has Been Poisoned (Anger of the Honest Part II)," I suggest they don't hold their breaths waiting for it to happen:

When financial markets have become riddled with fraud, embezzlement and corruption that goes unpunished, then institutional players will avoid that market as crooked: the well has been poisoned.

The full consequences of what I termed The Rot Within: Our Culture of Financial Fraud and the Anger of the Honest (October 15, 2010) are now unfolding: the well has been poisoned. One of my most astute correspondents made a critical observation that I've seen nowhere else: once a market has been poisoned by fraud which goes unpunished, then institutional players will avoid that market as untrustworthy.

Without institutional trust and participation, the market then withers on the vine-- exactly what has happened to the U.S. mortgage securities market. The market for mortgage-backed securities has vanished, except for one player: the Federal Reserve, which has bought a staggering $1.2 trillion in the past 18 months to create the facsimile of an active market.

The well has been poisoned. The only mortgages being traded are those 100% guaranteed by the U.S. government: in effect, the risks intrinsic to a corrupted market have been shifted to the taxpayers, while the criminals who profited from the fraud and embezzlement got away scot-free.

...

The same distrust has poisoned U.S. stock markets. The high keening cry to "get into the market while stocks are cheap" which has been spewed daily for months on end on network TV and other channels of raw propaganda has been ignored by the "retail investor," a.k.a. the top 20% of Americans who have financial wealth to preserve and invest.

For 24 straight weeks, retail investors have been pulling tens of billions of dollars out of U.S. mutual funds and plowing hundreds of billions into low-yield Treasury bonds.

Why? Because they sense the stock market is hopelessly, deeply corrupt and by comparison Treasuries are trustworthy. You won't make a lot of yield in Treasuries, thanks to the Fed's zero-interest rate policy (ZIRP) which is designed to drive money into risky assets, but then you won't lose 40% like you did in 2008-09 or 2000-2002 in the stock market.

We can also see how insiders are responding to the knowledge that the well has been poisoned: they're selling 500 shares for every share they buy. This unprecedented cascade of insider selling has been noted elsewhere many times, as has the declining expectations for the "recovery" of U.S. CEOs.

Those who know the most are selling their shares as fast as they legally can, and are publicly expressing their lack of faith in the tricked-up "recovery."

The U.S. financial markets have been poisoned, with long-term negative consequences. Only crooks, fraudsters and "marks" (those who still believe the propaganda about the "recovery" and "stocks are cheap" poison) will be left in a stock market propped up by the same socialization of risk which keeps the flimsy facade of a mortgage market from crumbling. High-frequency trading machines create the illusion of a market, and State intervention via proxies and other corrupt games provides the liquidity needed to fund the facsimile of a "rising market" and a "recovery" in the U.S. economy. But the public isn't buying the fraud any longer; they finally "get it": The well has been poisoned and only a fool drinks from a poisoned well.

This is why we can safely anticipate a hollowed-out stock market which trades at a steep discount to its present propped-up levels in the years ahead--until the crooked players are indicted and the financial markets thoroughly cleaned. That will take political will which is completely lacking in the Demopublican-Republicrat status quo.