Month: August 2020

Authored by Sven Henrich via NorthmanTrader.com,

The panic buying we’re seeing in $TSLA and $APPL today, following the historic runs into the stock splits effective today, firms my view that we are setting up for something sinister in markets.

To be sure we live in strange times, even some bulls are capitulating giving up completely on rationalizing the Fed induced bubble price action. Today Tony Dwyer suspended all efforts to give price targets, in essence acknowledging that traditional valuations metrics no longer apply:

Tony Dwyer at Canaccord, who’s been bullish and has carried a “3300+” S&P 500 target, says this morning he is “withdrawing SPX targets because there is no precedent to how high valuations can go.”

— Michael Santoli (@michaelsantoli) August 31, 2020

Unlimited upside in a risk free market that keeps ignoring everything.
And hence it should come as no surprise that the market cap expansion machine keeps creating value out of nothing:

$TSLA and $AAPL adding another combined $94B in market cap in the first 90 minutes of trading.

— Sven Henrich (@NorthmanTrader) August 31, 2020

Extended buying pure and hence we end up with charts such as this:

On the last day of the month $NDX is trading 987 points or 8.9% above its upper monthly Bollinger band and 1,493 points or 14.1% above its monthly 5 EMA. pic.twitter.com/EWES3KTHL9

— Sven Henrich (@NorthmanTrader) August 31, 2020

This is the circus the Fed has unleashed.

So let’s all acknowledge that sentiment is vastly bullish and people are piling into select stocks with no regard to risk.

I say select stocks because the internal picture keeps showing dreadful weakness underneath, even in the almighty Nasdaq:

All of which brings me to a historic irony.  Let’s recognize that the Fed has produced a liquidity machine that has pushed select indices to all time highs with most gains coming from a few tech stocks. Take those stocks out of the equation and $SPX is still flat on the year and most stocks are down on the year.

Viewed with this lens this multi month rally is not all that different than what we’ve seen in the past.

In fact, the precedence is striking in that the counter rally in the year 2000 peaked on September 1st following a furious rally in August. Sound familiar?

$SPX hit a peak of 1530 on that day as the worst was assumed to be over and optimism had come back roaring following the initial tech crash in March of that year.

But it was after September 1 that the real fun started and $SPX then commenced its long journey down that ended in October 2002 when $SPX bottomed at 798.55:

It is hence notable that $SPX is coming into the end of August and beginning of September approaching historic resistance. Indeed $ES tagged that resistance line in overnight and has sconce rejected as $NDX continues to make new all time highs:

It is the very chart I  discussed in context and detail in The Jaws:

On the last day of the month $NDX is trading 987 points or 8.9% above its upper monthly Bollinger band and 1,493 points or 14.1% above its monthly 5 EMA. pic.twitter.com/EWES3KTHL9

— Sven Henrich (@NorthmanTrader) August 31, 2020

Who knows if history is still any guide in these times. If it is then the panic buying and optimism of these days is laying the groundwork for the tears that are to follow.

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VP Joe Biden is deliveriong remarks on the violence unfurling in America’s Democrat-led cities

Brian Kolfage, a triple-amputee and veteran known as the founder of “We Build The Wall”, the private group that went viral via a GoFundMe campaign to finance a “privately constructed” border wall, has pleaded guilty in a fraud case that has also ensnared former White House Chief Strategist Steve Bannon.

• STEVE BANNON CO-DEFENDANT, BRIAN KOLFAGE, PLEADS NOT GUILTY TO DEFRAUDING BORDER WALL DONORS – COURT HEARING
• BOND OF $500,000 FOR KOLFAGE, $250,000 FOR BADOLATO AND SHEA
• JUDGE IN ‘WE BUILD THE WALL’ CASE SETS MAY 24, 2021, TRIAL DATE
• STEVE BANNON ALREADY PLEADED NOT GUILTY IN THE CASE

Bannon pleaded guilty more than a week ago, and has suggested that the charges against him, as well a Kolfage and one other co-defendant named Timothy Shea, are part of a politically motivated harassment campaign. The criminal complaint alleged that Bannon may have earned as much as $1 million – a pittance compared with his already considerable net worth – via his involvement in the fundraiser. Kolfage is charged with using money from the fundraiser to finance his ‘luxe lifestyle’.

Michael Flynn’s request to force a judge to immediately dismiss his case was shot down by a federal appeals court on Monday.

In an 8-2 ruling, the DC Circuit Court of Appeals struck down Flynn’s petition to force Judge Emmett Sullivan to accept the Justice Department’s motion to drop charges without holding a hearing, according to The Hill.

Flynn’s request that Sullivan be forced to recuse himself was also struck down, after his legal team argued that the judge acted improperly when he appointed a partisan outside attorney to argue against the DOJ’s decision to drop the case, and that it was inappropriate to ask the full circuit court to revisit an earlier decision by a three-member panel of the DC Circuit to drop the case.

Unless Flynn’s lawyers appeal to the Supreme Court, Sullivan will be able to move forward with a hearing about the DOJ’s unusual reversal in the case, before deciding whether to allow the Trump administration to withdraw its charges against the president’s former close aide.

Flynn had pleaded guilty in 2017 to lying to the FBI about his conversations with the Russian ambassador to the U.S. and agreed to cooperate with the special counsel’s investigation into Russian interference in 2016 election. –The Hill

The DOJ filed a motion to drop the case against Flynn in May, after it was revealed that the FBI engaged in a ‘perjury trap’ against the former Trump National Security Adviser.

#Flynn Appeals court denies former National Security adviser @GenFlynn’s effort to force a judge to immediately dismiss charges. 61 page opinion. ORDER attached. @CBSNews pic.twitter.com/RVCQFvaUfp

— Catherine Herridge (@CBS_Herridge) August 31, 2020

Authored by Lance Roberts via RealInvestmentAdvice.com,

The “rationalization” that low rates justify high valuations is but one of several arguments used to justify overpaying for value in a late-stage bull market.

As discussed previously, one of the “bullish spins” for the market has been that “earnings are cheap” based on 2- and even 3-year forward estimates. As noted in “Is It Justifiable Bullishness:”

“In 2020, investors are again chasing “growth at any price” and rationalizing overpaying for growth. Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”

Such is also why there is the most significant disparity between growth and value on record.

This Time Is Different

The belief this time is different from the past has always been the most dangerous of phrases for investors. However, this is where participants exist today. While it is true the excessive monetary liquidity has certainly changed short-term market dynamics; there is no evidence it has mitigated long-term consequences.

Moreover, investors are also relying on the belief that low interest rates justify overpaying for earnings and sales.

“Valuations don’t matter as much as they did in the past because ‘this time is different’ in that interest rates are so low.”

The basic premise of the interest rate/valuation argument has its roots in the “Fed Model” as promoted by Alan Greenspan during his tenure as Federal Reserve Chairman.

The Fed Model states that when the earnings yield on stocks (earnings divided by price) is higher than the Treasury yield, you invest in stocks and vice-versa. In other words, disregard valuations and buy yield.

There is a critical disconnect that needs to be understood.

Earnings Yield

You receive the income from owning a Treasury bond. However, there is NO tangible return from the earnings yield. 

For example, if I own a Treasury bond with a 1% coupon and a stock with a 2% earnings yield, if the price of both assets doesn’t move for one year – my net return on the bond is 1% while the net return on the stock is 0%.

Which one had the better return from 2000-present?

Yet, analysts keep trotting out this broken model to entice investors to chase an asset class with substantially higher volatility risk and lower returns.

Low Rates Don’t Justify High Valuations

An offshoot of the Fed Model to rationalize overpaying for assets is that low interest rates justify high valuations.

However, is the recent decline in interest rates, driven by massive global Central Bank interventions, really providing valuation support? The premise is that cheaper borrowing costs boost bottom-line earnings. The problem is that over the last decade, low rates have led to a deterioration in economic growth and prosperity.

The chart below takes the interest rate argument from a little different angle. I have capped interest rates from their “low point” of each interest rate cycle to the next “high point” and then compared it to the S&P 500 index. (The vertical dashed lines mark the peaks in the S&P 500 Index)

In the majority of cases, the market tends to peak between the low point interest rates for each cycle and the next high point. In other words, a period of steadily rising interest rates is not conducive to higher equity prices. 

Discounting The Discount

The primary argument is that when inflation or interest rates fall, the present value of future cash flows from equities rises, and subsequently, so should their valuation. While true, assuming all else is equal, a falling discount rate does suggest a higher valuation. However, when inflation declines, future nominal cash flow from equities also falls, this can offset the effect of lower discount rates. Lower discount rates are applied to lower expected cash flows.

In other words, without adjusting for inflation and, in no small degree, economic growth, suggesting low rates justify overpaying for cash flows is a very flawed premise.

“Instead of regarding stocks as a fixed-rate bond with known nominal coupons, one must think of stocks as a floating-rate bond whose coupons will float with nominal earnings growth. In this analogy, the stock market’s P/E is like the price of a floating-rate bond. In most cases, despite moves in interest rates, the price of a floating-rate bond changes little, and likewise the rational P/E for the stock market moves little.” – Cliff Asness

Historically, when interest rates or infla­tion are low, the stock market’s E/P is also low, as shown in the chart above.

But when isolating the times when interest rates were meager, that has occurred twice; in the 1940s and currently. In the 1940s, stock valuations were low, along with interest rates. Therefore, the statement that low interest rates cause high valuations is a .500 batting average, which is the equivalent of a coin-flip.

Analysis

• Exceptionally high-interest rates, which have occurred twice, coincided with low stock market valuations. This fact does not prove that high-interest rates “cause” low stock valuations. But at least the historical record is consistent with such a statement.

• Extremely low interest rates, which have occurred twice, have coincided with high stock market valuations only once; today. The historical record (1/2 probability) does not validate the highly-confident mainstream narrative that low interest rates “cause” or extremely high stock market valuations.

• Extremely high stock valuations have occurred three times. Only once (1/3 probability) did high stock valuations coincide with low interest rates; today.

• If extremely low interest rates do not cause extremely high stock market valuations, then a rise in rates should not necessarily cause a decline in stocks. That is, the historical record does not support the near-certain mainstream narrative that an increase in rates will torpedo stock prices.

• To demonstrate the ability of a consensus narrative to overwhelm analysis of historical facts and even current reality, consider that the Fed has hiked short-term interest rates five times since December 2015. Also, long-term rates bottomed in mid-2016 and have moved more than a full percent higher. Yet the S&P 500 index has risen more than 30% since the lows in short-term and long-term rates. 

As noted in “Why This Isn’t 1920,” the highest correlation between stock prices and future returns comes from valuations.

Forward Returns Suffer

There is little support for the statement that low rates support high valuations, as noted by Cliff Asness previously.

So, when pundits say it is a good time for long-term investors to buy stocks because interest rates are low, and then show you something like chart above to prove their point, please watch the tense of what they say, as what they often really mean is that it WAS a good time to buy stocks ten years ago, as investors are now paying a very high P/E for the stock market (perhaps fooled into doing so by low interest rates as I contend), and the story going forward may be painfully different.” – Cliff Asness

The last point is crucially important. The chart below, which compares earnings yield (inverted scale) to forward 5-year real returns. When E/Y has been near current levels, the performance over the next 5-years has been quite dismal.

Conclusion

It is imperative to remember valuations are very predictive of long-term returns from the investment process. However, they are horrible timing indicators. 

Beware the investment advisor, pundit, or superstar investor who is sure that extremely low rates cause incredibly high stock valuations. Or, that a rise in rates from extremely low levels will cause a decline in stock prices. Stocks may fall, and interest rates may rise, but the historical record disagrees that one causes the other.

There is much to debate about the current level of interest rates and future stock market returns. However, what is clear is the 40-year decline in rates did not mitigate two extremely nasty bear markets since 1998, just as falling rates did not mitigate the crash in 1929 and the subsequent depression.

Do low-interest rates justify high valuations?

History suggests they don’t. 

In the latest reminder that valiant police officers are still venturing out into America’s worst, most crime-afflicted neighborhoods to try and apprehend dangerous criminals, a  St. Louis police officer who was a “hero” to his family died Sunday after being shot in the head by a gunman Saturday evening. He succumbed to his wounds on Sunday. 

Officer Tamarris L. Bohannon bore several coincidental commonalities with Jacob Blake, the suspect who was shot repeatedly in Kenosha while officers feared he was reaching for a weapon. Both were 29. Both are men of color.

Officer Tamarris L. Bohannon dedicated over three and a half years of service to the citizens of the City of St. Louis.

We will be deeply missed. https://t.co/pyE6QdQ3Uk pic.twitter.com/qXFn0AiqYg

— St. Louis, MO Police (@SLMPD) August 31, 2020

But while Blake is facing an assault charge and a long – but not impossible – road to recovery, Bohannon will never again be able to spend time with his family, including his loving wife and three children.

“He is a hero to many but most importantly to his loving wife and three incredible children,” said St. Louis Police Chief John Hayden.

Bohannon had been with the department for 3.5 years.

“The loss of this great man is felt deeply within the St Louis community and we ask for your prayers and support in the days ahead,” his family wrote.

In a briefing about the incident, Hayden explained that the gunman had ordered a family out of their home at gunpoint and barricaded himself inside for nearly 12 hours, creating a tense standoff. As officers and SWAT team assembled outside, police threw tear gas grenades into the house and tried to communicate with the suspect via a bullhorn.

The exact details weren’t clear, but officer Bohannon and one of his colleagues were both shot while searching for another shooting victim. While Bohannon’s injuries proved fatal, his partner, who was shot in the leg, is expected to survive.”

The 43-year-old suspect connected to the shootings was finally taken into custody at around 0530 Sunday morning.

St Louis Mayor Lyda Krewson said on Sunday she was “heartbroken” at the cop’s death.

“I’ve had the privilege of spending some time with his family under these extraordinarily challenging circumstances,” she said.

“They’re wonderful people and immensely proud of the way he selflessly served and protected our community with distinction and honor for more than three years.”

“This is a horrific reminder of the dangers our brave men and women willingly face everyday to keep us safe,” Krewson added. “This is a terrible, senseless tragedy.”

Chief Hayden has said the officers were just “trying to do their job, that’s all they’re trying to do and they’re suffering under gunfire.”

The chief added that there has been a “surge in violence” this summer.

“We’re trying to cope through a very trying summer, and it’s very difficult. It’s very difficult,” he said.

Since June 1, eight St Louis police officers have been shot in the line of duty. We wonder: how would the NFL react if a player wanted to display a tribute to Bohannon on their helmets?

While the broader market is finally taking on some water, the two stocks that have come to define the bubble euphoria gripping the market – AAPL and TSLA – continue storming higher. The move is perplexing virtually everyone – except those who are buying probably – because most somewhat serious analysts had expected investors to buy into the stock split frenzy but sell afterward. Instead, the pre-split buying has continued, resulting in such laughable titles from Bloomberg seeking to “goalseek” what is going on.

One person who is laughing (all the way to the bank) is Elon Musk, who thanks to the “bullish” stock split is now the third-richest person in the world.

According to the Bloomberg Billionaire Index, Musk surpassed Facebook’s humanoid co-founder Mark Zuckerberg as shares of Tesla continued their unrelenting rally after undergoing a forward stock split. As of 11:25 a.m., Musk was worth $111.3 billion compared with $110.5 billion for Zuckerberg. The table below shows the absolute net worth of the world’s top 10 billionaires as of Friday’s close. This morning, Musk’s net worth has already rocketed by another $7 billion, putting him in the 3rd spot.

As Bloomberg notes, “Musk has seen a meteoric rise in his wealth, with his net worth growing by $76.1 billion this year as Tesla shares surged more than 475%. Also helpful: an audacious pay package – the largest corporate pay deal ever struck between a chief executive officer and a board of directors – that could yield him more than $50 billion if all goals are met.”

What is remarkable is that it was only a few months ago that Musk joined the Top 10 club, and only last week did the Tesla CEO join Zuckerberg, Bezos and Bill Gates in the ultra exclusive centi-billionaire club as tech stocks surged.

Meanwhile, as the uber-rich get richer, the poor are not only getting poorer, but desperate for some action out of Congress to mitigate their fate as millions have found themselves without a job after the coronavirus shutdowns.

That said, Musk still has a long way to become the world’s richest person: to overtake Bezos, whose worth about $200 billion, TSLA stock would have to double from here, a move which at least some optimistic punters who have been aggressively buying TSLA $800 calls expiring Sept 4 all morning…

… believe may happen as soon as this Friday.