Google And Facebook To The Moon… Or Peak Advertising?

By Chris at http://ift.tt/12YmHT5

In the late 90’s and early 2000’s, I spent a lot of time travelling through a host of the world’s airports.

This naturally meant spending an inordinate amount of time staring at random people, wandering about aimlessly (no business class lounges when you’re an impoverished backpacker living on noodles), and traipsing through duty free stores, puzzling on how it is woman can spend so much on perfume and men so much on big ugly watches.

Today, smart phones have come to rescue us but these things were far from ubiquitous back then. Instead, we had trusty newsstands. Remember them? Magazines and newspapers duelled it out for shelf space. Vanity fair, PC Magazine, New Yorker, the FT, you name it.

What kept the newsprint industry alive was advertising revenues.

When it came to newspapers, people bought them to read about the local politician caught fornicating with a ladyboy while on holiday in Bangkok… or to read about some girl named Mildred who had become a movie star after 70,000 auditions and how proud her parents were.

Nobody read them for the silly pictures of Marlboro man on a horse or for the pictures of some freshly-shaven suit flashing a Rolex while sipping champagne on a private jet. But we still had tons of ads because without them there’d have been no stories of Mildred or ladyboy antics. It’s what kept the industry alive.

At its peak, ad rates were astronomical, but the only way to tell people about a new computer was to buy a page in Computer Shopper. And the only way the suits at Goldman Sachs could let you know they were there to screw guide you through the complexities of the market was to buy a full page in the FT.

Then it all imploded.

The internet has been at once the greatest and the most destructive commercial invention in media history. They said it couldn’t happen. Then it did. Playboy? Dead. Rolling Stone? Buried. Citadel? Whoosh!

Two decades ago, if you were an editor at a large rag, you were king of the world. Expense accounts, lavish office space, wielding Schwarzenegger-like power with every institution grappling for your attention. Today, if you’re still alive, you’re bandaging your business together… and you’ve already taken everything online. But guess which god you’re now praying to?

The same guys who now control ad spend.

You see, advertising revenue never went away. It just changed hands.

This chart is a couple years old but shows the overall makeup of the ad market.

And here’s the stellar growth of ad revenue for Google.

Google revenue growth

It’s been a helluva run for both:

For their part, investors clearly aren’t paying for revenues. A forward price to cash flow of 19.71x? Ouch!



And the big boy, Alphabet:



Based on the numbers…investors are buying “Growth”.



Benjamin Graham wouldn’t be turning over in his grave. He’d be backflipping.

Where to Now?

So are we to sail into the sunset with Google and Facebook leading the charge in the advertising space? For how long?

Or is there a coming pressure on ad revenue, meaning millennials will find themselves carrying catheters around and playing bingo to a different world… one not ruled by these two? Or could it all happen even sooner than that?

Ad growth can take place by acquiring new markets as well as maintaining existing revenues. If you’re adding new customers while existing ones are dropping off faster or even at the same pace as additions, you’re a hamster on a wheel, and that “growth” that investors are currently paying such a premium for risks being repriced.

Here at Capitalist Exploits HQ there isn’t a week that goes by without Natasha, or Henry, or Alec (this week’s one) hitting me up with the promise that I can grow my business much faster with SEO/UX/CRM and ad spending with Google, Facebook, and a bunch of other “social media” juggernauts”.

I don’t begrudge these folks. They’re just trying to make a crumb. But unfortunately that usually means promising me they know just the tricks of the trade, and I can pay them to place ads for me and “manage” my online presence. The ROI will come, I just need to be patient. Maybe they’re right, but I doubt it. Know why?

I’ve spoken with many others running online businesses, and you’d have more luck finding the yeti than anyone who’s had the ability to say with certainty that any of their ad spend is driving meaningful numbers over and above dollar spend. Site hits? Sure. But no conversions.

It’s a world of obfuscation with the promise of gold always lurking over the horizon… but never in reach.

A while ago a company run by some friends spent a godawful amount with what is the equivalent of Google’s SAS.

The promise from the Google boys was it’d pay off in a big way — just be patient — and it required a substantial downpayment.

That was nearly a year ago, and the patience has long since worn off. For an excellent breakdown on the murky world of ad trading, I’d strongly suggest Raoul Pal’s GMI report on the topic, which you can find by signing up to Real Vision TV.

I agree with Raoul when he says:

I think that as this story develops, Google and Facebook will begin to come under pressure. They are making super – normal profits based on total sham. They aren’t the villains but they own the eco-system and they clearly can’t be left in charge of it.

I’ve had similar experiences.

In the past, I hired an advertising agency who were considered “best in biz” to build a landing page for me and run a campaign complete with targeting traffic (which I paid for separately) for an event I was hosting.

The results where absolutely hopeless, and after three months and about US$15,000 down it was clear to me there was only one group making money on this gig… and it wasn’t the guy I saw in the mirror.

I fired them, took down the landing page, sat down, and wrote a short message to my existing list. No special copywriting skills, or emotional wording. Nothing. Just what I was up to. Bam! Success. Weird, heh?

Now, I realise that my data sample is admittedly tiny in the grand scheme of things, but the thing is I’ve enjoyed substantial organic growth (thanks to you readers for sharing my content with friends). But the targeting ad side, while only done a couple of times, has been spectacularly useless 100% of the time.

I remembered all of this when last week I came across this article about Procter & Gamble’s dialling back on ad spend.

The world’s largest advertiser slashed spending on ‘crappy’ digital ads by over $100 million — and still saw sales increase

We will vote with our dollars and will not waste our money on a crappy media supply chain—so we can invest in what really matters—better advertising and innovation to drive growth.

You may be thinking that US$100m is a drop in the bucket for the duopoly of Google and Facebook, and you’d be right. What isn’t a drop in the bucket, however, is Procter & Gamble entire annual marketing budget. A whopping US$2.4 billion!

P&G’s Marc Pritchard was pretty frank in a speech given at the Interactive Advertising Bureau’s annual leadership meeting in Hollywood earlier this year.

Frankly, there’s, we believe, at least 20 to 30 percent of waste in the media supply chain because of lack of viewability, nontransparent contracts, nontransparent measurement of inputs, fraud and now even your ads showing up in unsafe places,

He has given the duopoly a one year ultimatum to clean up their act or risk losing P&G’s 2018 budget.

P&G are not the only ones as they’re joined by Unilever and Bank of America to name a few.

Digging deeper I found this from a few months back:

French advertising giant pulls out of Google and YouTube

Havas becomes first major global marketing company to pull entire ad spend after talks with tech company break down.

The problem that humans have is that we need data to understand and make rational decisions.

The entire digital advertising industry has been so new and so fast-moving that businesses haven’t had the time to accumulate meaningful data on which to make calculated rational decisions.

Additionally, the dynamic has been changing so quickly that what may have worked for a few months suddenly no longer works. It’s been like trying to fit a hubcap on a moving car. You just get chewed up.

The rush to get, gain, and retain “online presence” has led to a FOMO and subsequent massive boom in ad agencies and, of course, social media companies themselves.

Attempting to value the ad spend companies have opted to just spraying money at ad agencies in the hope that they know what the hell they’re doing. Investors, finding it impossible to value companies such as Google and Facebook, have chosen instead to just spray money at them buying the “growth”.

Speed Bumps

There are a couple that spring to mind:

1. More government regulation

It’s coming and here’s why.

Whether or not you believe that the Russians are hacking US elections or not is missing the point. Believing that foreign governments don’t or aren’t trying to influence elections is naive at best and deluded at worst. And this goes for all governments.

That manipulation no longer takes place via newsprint journalism. Today it’s Twitter, Facebook, and Google where the battleground lies. Right now, it’s the Wild West.

That’s unlikely to remain unregulated.

China has already banned and regulated both. Facebook isn’t allowed and Google is hamstrung. In Europe, Zuckerberg is increasingly regulated. The US remains relatively untouched, but I think the trend will assert itself. Importantly, as an investor, it’s clear to me that right now none of this is priced into these stocks all the while they’re sporting valuations that cause blood to shoot from the eyes of value investors.

2. Hard data spoiling the party

As mentioned above, the industry chorus is growing louder and louder.

Every business model matures, and Google and Facebook’s is no different. Businesses have had over a decade now to analyse ad spend and ROI. When entire industries find they can no longer square spending with ROI, we’re likely to see them seeking alternatives. It’s tough to envision this being good for either of these two.

Question

11 Oct Poll

Cast your vote here and also see what others think will happen

– Chris

“Customers will realise that the elusive holy grail of digital advertising nirvana is a total sham where everyone is being scalped, returns are virtually non-existent, the system is totally rigged against them and everyone else is getting rich off the back of it.” — Raoul Pal

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Liked this article? Then you’ll probably like my other missives on

this topic as well. Go here to access them (free, of course).

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Illinois Debt Crisis Deepens As Comptroller Admits No Idea What True Balance Of Outstanding Bills Is

Back in July, the state of Illinois narrowly avoided a junk bond rating with a last minute budget deal that included a 32% in hike in income taxes.  Republican Governor Bruce Rauner vetoed the budget and called it a “disaster,” but both houses of the state legislature voted to override his veto.  Meanwhile, S&P and Moody’s were apparently both convinced that the budget deal was sufficient for the state to remain an investment grade credit and all lived happily ever after, if just for a few months.

But, with the state’s past due payables hovering around a record $16 billion

…which is a 3-fold increase over the past two years…

…one has to wonder, as we have on many occasions, just how solid Illinois’ credit rating really is.

But as staggering as Illinois’ $16 billion in unpaid contractor bills is, per a report from the Associated Press today, it may not even fully reflect the true extent to which the state has stiffed its vendors.

Illinois is chasing a moving target as it tries to dig out of the nation’s worst budget crisis, and a review obtained by The Associated Press shows $7.5 billion worth of unpaid bills — as much as half the total — hadn’t been sent to the official who writes the checks by the end of June.

 

Although many of those IOUs have since been paid, a similar amount in unprocessed bills has replaced them in the last three months, Comptroller Susana Mendoza’s office said Monday. That’s in addition to $9 billion worth of checks that are at the office but being delayed because the state lacks the money to pay them.

 

The mound of past-due bills tripled over the two years Republican Gov. Bruce Rauner and Democrats who control the General Assembly were locked in a budget stalemate, which ended in July when lawmakers hiked income taxes over Rauner’s vetoes.

Of course, in the end, it’s Illinois taxpayers who end up getting hurt the most as the state is racking up penalties of 1% per month on unpaid bills that are outstanding for more than 90 days.  As the AP points out, there is roughly $5.5 billion worth of trade claims that are past 90 days overdue meaning that taxpayers are paying just over $650 million a year to cover interest payments on unpaid contractor bills.

In some cases, agencies were waiting to send their receipts to Mendoza because lawmakers haven’t approved the spending. For example, the Department of Corrections had $471 million in unpaid bills on hand as of June 30 largely for that reason.

 

“Ascertaining the precise nature of the state’s past-due obligations and liabilities is an essential component of responsible cash and debt management,” the Democratic comptroller wrote in a letter to Republican Rep. David McSweeney, a budget hawk from Barrington Hills who requested the review.

 

Mendoza and McSweeney plan to use the findings to urge lawmakers to override Rauner’s veto of legislation that would require monthly reporting of bills not yet submitted for processing. The measure, authored by Mendoza’s office, would include a breakdown of how old each bill is and which ones have received legislative approval to be paid.

 

The age of bills is important because many that are 90 days or older face a 1 percent-per-month late-payment fee; about $5.5 billion of the current $15.9 billion backlog is subject to the penalty. Mendoza estimates the state will ultimately pay $900 million in late-payment fees on the existing pile of debt.

 

The Department of Central Management Services, which handles personnel, procurement and employee health care, has most of the June 30 bundle, with $5.8 billion. That’s mostly doctor’s bills owed to employee medical providers under the state group health insurance plan.

Add that to the state’s $130 billion pension underfunding

IL Pension

…and you start to understand why Illinois bonds are trading well over par and near all-time highs…makes perfect sense really.

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Steve Bannon Believes Trump Has 30% Chance Of Finishing His Term

Gabriel Sherman, the former New York Magazine journalist whose reporting helped topple former Fox News chief Roger Ailes, has published a wide-ranging piece in Vanity Fair where he says private grumblings of senior administration officials are spilling out into the open as Trump's behavior has grown more erractic, and that many of the administration's key players are close to a breaking point.

Sherman begins his piece by claiming that Tennessee Sen. Bob Corker’s infamous interview with the New York Times, where he reportedly fretted that Trump would start “World War III” and compared the White House to “adult daycare” represents an inflection point in the Trump presidency. The interview, Sherman claims, “brought into the open what several people close to the president have recently told me in private: that Trump is “unstable,” “losing a step,” and “unraveling.”

Kelly is reportedly miserable, but is refusing to quit out of a sense of duty to try and keep Trump from making a disastrous decision like ordering a preemptive nuclear strike on North Korea. According to Sherman's sources, Kelly and Secretary of Defense James Mattis have discussed what they would do if Trump ordered a nuclear strike…

According to two sources familiar with the conversation, Trump vented to his longtime security chief, Keith Schiller, “I hate everyone in the White House! There are a few exceptions, but I hate them!” (A White House official denies this.) Two senior Republican officials said Chief of Staff John Kelly is miserable in his job and is remaining out of a sense of duty to keep Trump from making some sort of disastrous decision. Today, speculation about Kelly’s future increased after Politico reported that Kelly’s deputy Kirstjen Nielsen is likely to be named Homeland Security Secretary—the theory among some Republicans is that Kelly wanted to give her a soft landing before his departure.

 

One former official even speculated that Kelly and Secretary of Defense James Mattis have discussed what they would do in the event Trump ordered a nuclear first strike. “Would they tackle him?” the person said. Even Trump’s most loyal backers are sowing public doubts. This morning, The Washington Post quoted longtime Trump friend Tom Barrack saying he has been “shocked” and “stunned” by Trump’s behavior.

But perhaps the most alarming claim in Sherman’s report is that Steve Bannon believes Trump only has a 30% chance of finishing out his first term. And furthermore, the biggest threat to Trump’s presidency isn’t impeachment, but a provision of the twenty-fifth amendment that would allow his cabinet members to exercise emergency measures to remove him from office.

Even before Corker’s remarks, some West Wing advisers were worried that Trump’s behavior could cause the Cabinet to take extraordinary Constitutional measures to remove him from office. Several months ago, according to two sources with knowledge of the conversation, former chief strategist Steve Bannon told Trump that the risk to his presidency wasn’t impeachment, but the 25th Amendment—the provision by which a majority of the Cabinet can vote to remove the president. When Bannon mentioned the 25th Amendment, Trump said, “What’s that?” According to a source, Bannon has told people he thinks Trump has only a 30 percent chance of making it the full term.

For what it’s worth, odds that Trump will be impeached before the end of his first term have been more or less steady around 35% for the past three months. Though PredictIt doesn’t have odds for whether the twenty fifth amendment will be invoked before the end of Trump’s first term.

If Breitbart's coverage is any indication, a rift between Trump and Bannon that erupted when the former supported the doomed candidacy of Republican Senator Luther Strange in a runoff primary vote against former Alabama Chief Justice Roy Moore, who won the primary and will likely go on to replace Strange as the senator holding AG Jeff Session's old seat.

But that doesn’t make Bannon’s remarks – if the report is accurate – any less disconcerting.

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Hackers ‘Screw’ Millions Of PornHub Users In Large-Scale Malvertising Scheme

Via StockBoardAsset.com,

Proofpoint, a next-generation American cybersecurity firm, has uncovered a large-scale malvertising  campaign in adverts appearing alongside videos on PornHub (Alexa US Rank 20 and world rank 37 as of this writing).

Researchers at Proofpoint have pinpointed KovCoreG group, the hacker organization behind the “sophisticated social engineering scheme that convinced users to infect themselves” through browser updates. The report states millions of potential victims are in US, Canada, the UK, and Australia. The malvertising scheme was active for more than a year but has since been shut down after PornHub and its ad network were notified of the activity.

According to WIRED, malvertising is the latest sweet spot for cybercriminals’.

Malvertising – seeding malicious code in online advertisements to infect unsuspecting users – might be the most jarring and difficult for many Web surfers to fathom. No one expects to get infected with malware when they visit trusted sites like YouTube or Reuters – hardly the seedy sides of the Web.

 

Yet attackers are preying on users’ implicit trust of these sites to infect them via the third-party ad content quietly displaying on these pages and sometimes burrowing into viewers’ browsers and PCs, before they even click on anything.

As Proofpoint notes, only a handful of hacking groups have penetrated online advertising networks, nevertheless those running on major websites. Several of these groups include:  SadClowns, GooNky, VirtualDonna, and AdGholas.

In KovCoreG case,  PornHub users were redirected to a website which claimed to be offering a software update for Chrome, Firefox, and or the Adobe Flash plugin.

A user would then be tricked into downloading Kovter, a variant of malware that allows the group to track Pornhub users and personal information.

“The combination of large malvertising campaigns on very high-ranking websites with sophisticated social engineering schemes that convince users to infect themselves means that potential exposure to malware is quite high, reaching millions of web surfers”, Proofpoint researchers noted.

 

“While the payload in this case is ad fraud malware, it could just as easily have been ransomware, an information stealer, or any other malware.”

Earlier this year, ADWEEK reports that Google blocked nearly 1.7 billion ‘bad ads’ that violated advertising policies.

The volume of ads that violate Google’s advertising policies has grown substantially.

 

In fact, last year Google’s systems identified and took down 1.7 billion ads across the internet—double what it did in 2015. The way Google puts it, removing that many ads manually would take a human 50 years at a rate of 1 ad per second.

So, if you visited PornHub in the last year, you might want to check out Amazon’s list of ‘virus protection’ software.

*  *  *

Bonus: America and the developed world have a porn addiction beating out The Weather Channel in Alexa website rankings…

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Sears Canada Liquidates: 12,000 Canadians To Lose Their Jobs

12,000 jobs may not sound like much but that’s roughly how many jobs Canada adds to its economy each month. Only in this case, that’s how many workers are about to find themselves without a job because overnight Sears Canada announced plans to liquidate its remaining 150 stores instead of restructuring, the latest admission of brick and mortar defeat in the war with Amazon, with the result some 12,000 job losses in the coming weeks.

In a statement filed on Tuesday, the Toronto-based chain, which filed for creditor protection in June, listing liabilities of C$1.1 billion, said it would seek court approval for the filing on Friday and begin liquidation sales at its remaining stores on Oct. 19 at the earliest. The terminal decision follows a last-ditch attempt by executive chairman Brandon Stranzl, backed by Blackstone Group LP, to put together an offer to save the retailer. However, as Bloomberg reports, Sears Canada failed in this Hail Mary approach and the company said it didn’t receive a viable bid to keep the stores operating as a going concern. This means that whereas Sears had been gradually closing its 225 stores, it will now accelerated the move, potentially closing all remaining stores in the coming days.

The liquidation will hardly come as a major surprise:

Sears Canada has struggled to provide a consistent, appealing brand to its customers across all of its channels, including its website, social media and physical stores, he said. The company has reported nine years of sales declines and years of losses, according to data compiled by Bloomberg.

The Canadian version of Sears is the latest victim of department-store decline that’s swept North America as shoppers gravitate online. While the retailer has dabbled in pop-up stores and e-commerce, its distribution centers aren’t as automated as Amazon.com Inc. or even Canadian peer Hudson’s Bay Co., which last year opened its own robotic facility to accelerate online orders.

“When you have the likes of Amazon that is investing in research and development continuously, it’s just too much for them to react quickly enough,” Jean Rickli, an adviser at retail consultants J.C. Williams Group, told Bloomberg. “It follows the trend of what we noticed in the U.S., with department stores and their decline.”

Sears’ loss is Amazon’s gain: According to Rickli, only 15 to 20% of Canadians are Amazon Prime members, compared with about 50% of Americans, giving the U.S. company lots of room to grow north of the border. The biggest loser, however, is billionaire Eddie Lampert, the company’s biggest shareholder, who partially spun off the company from Sears Holdings Corp. in 2012.

The windup raises questions about whether Sears Holdings may also falter. Sears, once the world’s largest retail chain, has racked up more than $10 billion in losses over the past six years. Lampert, a hedge fund manager and also Sears Holdings’ chief executive officer, has been willing to use his own money to keep the business afloat and recently gave the company a $100 million loan.

“Ostensibly, Eddie could have cut a check to make it through it, but clearly the evaluation he made was that there wasn’t enough there,” Noel Hebert, a Bloomberg Intelligence analyst said. “He sees value left in the U.S. operations but didn’t see a ton of worth left in the enterprise to write a $200 million check to keep it rolling.”

Which begs the question: how long until Eddie decides that throwing good money after bad in Sears USA is also the more prudent decision.

As for the Canadian’s company thousands of workers and retirees, it remains to be seen what will happen to their pensions: Sears Canada has 18,000 retirees and beneficiaries whose monthly pensions its has to address. A motion was filed in August for a windup of the plan, which would require the company to pay the full C$266.8 million deficit, according to the filing. That motion has been postponed until at least Nov. 30.

There is also the question of what happens to all the local malls that suddenly find themselves without 150 anchor tennants. The Sears bankruptcy comes two years after Target’s liquidation left a hole in many of the country’s malls, which made it tougher for Sears Canada to find buyers for its real estate and leases.

According to Trepp, while the Sears stores in Canada which back CMBS loans are not plentiful, but there are a few to footnote. The largest of those is the $21.4 million Festival Marketplace  loan, which makes up 7.23% of the remaining collateral behind IMSCI 2013-4. The collateral is a 224,836 square-foot retail property in Stratford, Ontario. Sears is the top tenant there with 37% of the space. For the year of 2016, DSCR (NCF) was 1.45x. The property was built in 1990 and valued at $34.3 million in late 2012. Also worth footnoting is the $10.8 million Sorel loan, which makes up 2.62% of the collateral behind REALT 2016-2. The property contains almost 360,000 square feet, of which Sears occupies 17.5%. This Sears was slated for closure in July and it will close for good this week. Walmart is the top tenant with 18.9% of the space.

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WTI/RBOB Slide After Surprise Crude Build

WTI/RBOB had bounced back modestly today (on OPEC jawboning) ahead of the API data with bulls hoping the trend of gasoline builds stalls. With the effects of Harvey beginning to fade (and exports at record highs), we are getting a cleaner picture of the state of the energy complex and it's no so pretty for the record-long-specs. Crude inventories saw a surprise 3.1mm build (expectations for a 2.4mm draw), Cushing saw the 7th straight week of restocking and while gasoline inventories dropped, distillates saw a big build.

 

API

  • Crude +3.1mm (-2.4mm exp)
  • Cushing +1.216mm – 8th weekly build in a row
  • Gasoline -1.575mm (+200k exp)
  • Distillates +2.029mm – biggest in 5 months

Cushing continues to be restocked but the crude build is the biggest surprise and while gasoline saw a draw, the distillates build offsets that excitement…

 

 

WTI/RBOB had rallied on the day into the API print…But the initial reaction was selling after th eprint

 

“A lot below $50 and producers do produce a lot less, but conversely, much over $55, there is going to be a lot of extra production. We’re range-bound, but it’s $50-$55 and not $45-$50,” Jay Hatfield, a portfolio manager at the InfraCap MLP exchange-traded fund, says. “The inventory report will be critical”

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Your Pension Is A Lie: There’s $210 Trillion Of Liabilities Our Government Can’t Fulfill

Authored by John Mauldin via MauldinEconomics.com,

In the US, we have two national programs to care for the elderly.

Social Security provides a small pension, and Medicare covers medical expenses.

All workers pay taxes that supposedly fund the benefits we may someday receive.

The problem is that's not actually true. Neither of these programs is comprehensive.

The End of Government Entitlements

Living on Social Security benefits alone is a pretty meager existence.

Medicare has deductibles and copayments that can add up quickly. Both programs assume people have their own savings and other resources (I wrote about this in detail in my previous issues of Thoughts from the Frontline). Despite this, the programs are crucial to millions of retirees, many of whom work well past 65 just to make ends meet.

This chart from my friend John Burns shows the growing trend among generations to work past age 65:

Having turned 68 a few days ago, I guess I’m contributing a bit to the trend

Limited though Social Security and Medicare are, we attribute one huge benefit to them: They’re guaranteed. Uncle Sam will always pay them – he promised. And to his credit, Uncle Sam is trying hard to keep his end of the deal.

Uncle Sam’s Debt Nightmare

In fact, Uncle Sam is running up debt to do so. Actually, a massive amount of debt:

Federal debt as a percentage of GDP has almost doubled since the turn of the century. The big jump occurred during the 2007–2009 recession, but the debt has kept growing since then. That’s a consequence of both higher spending and lower GDP growth.

In theory, Social Security and Medicare don’t count here. Their funding goes into separate trust funds. But in reality, the Treasury borrows from the trust funds, so they simply hold more government debt.

Today it looks like this:

  • Debt held by the public: $14.4 trillion
  • Intragovernmental holdings (the trust funds): $5.4 trillion
  • Total public debt: $19.8 trillion

Total GDP is roughly $19.3 trillion, so the federal debt is about equal to one full year of the entire nation’s collective economic output. That total does not also count the $3 trillion-plus of state and local debt, which in almost every other country of the world is included in their national debt numbers.

Including state and local debt in US figures would take our debt-to-GDP above 115%… and rising.

Just wait. We’re only getting started.

$210 Trillion Worth of Unfunded Liabilities

An old statute requires the Treasury to issue an annual financial statement, similar to a corporation’s annual report. The FY 2016 edition is 274 enlightening pages that the government hopes none of us will read.

Among the many tidbits, it contains a table on page 63 that reveals the net present value of the US government’s 75-year future liability for Social Security and Medicare.

That amount exceeds the net present value of the tax revenue designated to pay those benefits by $46.7 trillion. Yes, trillions.

Where will this $46.7 trillion come from? We don’t know.

Future Congresses will have to find it somewhere. This is the fabled “unfunded liability” you hear about from deficit hawks. Similar promises exist to military and civil service retirees and assorted smaller groups, too.

Trying to add them up quickly becomes an exercise in absurdity. They are so huge that it’s hard to believe the government will pay them, promises or not.

Now, I know this is going to come as a shock, but that $46.7 trillion of unfunded liabilities is pretty much a lie. My friend Professor Larry Kotlikoff estimates the unfunded liabilities to be closer to $210 trillion.

Pensions Are a Lie

Many Americans think of “their” Social Security like a contract, similar to insurance benefits or personal property. The money that comes out of our paychecks is labeled FICA, which stands for Federal Insurance Contributions Act. We paid in all those years, so it’s just our own money coming back to us.

That’s a perfectly understandable viewpoint. It’s also wrong.

A 1960 Supreme Court case, Flemming vs. Nestor, ruled that Social Security is not insurance or any other kind of property. The law obligates you to make FICA “contributions.”

It does not obligate the government to give you anything back. FICA is simply a tax, like income tax or any other. The amount you pay in does figure into your benefit amount, but Congress can change that benefit any time it wishes.

Again, to make this clear: Your Social Security benefits are guaranteed under current law, but Congress reserves the right to change the law. They can give you more, or less, or nothing at all, and your only recourse is the ballot box.

Medicare didn’t yet exist in 1960, but I think Flemming vs. Nestor would apply to it, too. None of us have a “right” to healthcare benefits just because we have paid Medicare taxes all our lives. We are at Washington’s mercy.

I’m not suggesting Congress is about to change anything. My point is about promises. As a moral or political matter, it’s true that Washington promised us all these things. As a legal matter, however, no such promise exists. You can’t sue the government to get what you’re owed because it doesn’t “owe” you anything.

This distinction doesn’t matter right now, but I bet it will someday. If we Baby Boomers figure out ways to stay alive longer, and younger generations don’t accelerate the production of new taxpayers, something will have to give.

If you are dependent on Social Security to fund your retirement, recognize that your future is an unfunded liability a promise that’s not really a promise because it can change at any time. 

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Trump To Nominate Kirstjen Nielsen To Lead Department Of Homeland Security

Two and a half months after President Donald Trump picked John Kelly to replace Reince Priebus as White House Chief of Staff, Trump has reportedly settled on Kelly’s replacement at DHS. And unsurprisingly, it's the candidate that Kelly has been pulling for, Kirstjen Nielsen, who served as his deputy when he ran the department.

A handful of media outlets reported Wednesday afternoon that Trump would soon announce that he’s selected Nielsen, who will then need to be confirmed by the Senate.

Politico reports that Nielsen served as White House chief of staff John Kelly’s top aide during his time as DHS secretary, and moved with him to the West Wing as his principal deputy chief of staff when he decamped for the White House in July.

Nielsen, 45, is a cybersecurity expert and an attorney with an extensive background in homeland security, including stints at the Transportation Security Administration and on the White House Homeland Security Council under President George W. Bush. Elaine Duke has been serving as acting secretary since Kelly stepped down.

As Axios explains, Nielsen was picked because nobody in the White House is closer to Kelly.

Michael Allen, a respected GOP national security figure who worked with Nielsen on the White House Homeland Security Council under George W. Bush highlighted the case for Nielsen in an email to Axios:

"No learning curve. No one else has same policy expertise in cyber, aviation security, FEMA. She takes it to the hoop. Moved to DC from Texas after 9/11 to help stand up TSA. Takes tough jobs, co-authored Katrina Lessons Learned Report which made FEMA better."

Politico also noted her “deep familiarity” with the department.

“She would be the first person to run the department who has actually worked there,” said a person close to the administration. “She has a deep familiarity.”
Nielsen, who was reportedly a dark horse candidate before Kelly started pulling for her, developed a close working relationship with Kelly during the transition, in which she served as his “sherpa,” guiding him through the Senate confirmation process.

According to Politico, Nielsen has been instrumental in Kelly’s efforts to push Trump and his senior aides to adhere to a more traditional policy making process, which hasn’t exactly made her the most popular person in the West Wing.

To be sure, as people familiar with the search reportedly told Politico, nothing in the White House is final until it's publicly announced.
 

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Stocks Up, Bonds Up, Gold Up, & Dollar Down But Tax-Hope Tumbles

Think you had a bad day…

 

Overnight saw market watchers celebrate the exuberant run in Japan's Nikkei 225 to its highest levels since 1996 (up 200% from its 2008/9 lows)…

So – some context – it has taken 21 years of "buy and hold" to breakeven… and the index still needs to rally 88% further to get back to even from its record highs in 1989.

 

Stocks (and gold) ramped higher in the last hour (on regurgitated headlines about Mnuchin preferring Powell for Fed head – which hit 2 weeks ago) but of course, something had to be done to ensure stocks looked good post-FOMC Minutes…

 

After the initial dip following FOMC Minutes, stocks turned around on the day…(Small Caps ended the day red – Here are the closes for Russell 2000 for the last 8 days – 1509, 1511, 1508, 1512, 1510, 1504, 1508, 1507)

 

But this was the headline of the day… The Fed's Williams warns that they "don't want there to be excesses in financial markets… " as VIX is slammed to ramp stocks for another new all-time-high…

 

USDJPY and Stocks were once again inseparable…

 

And, while hope remains in the mainstream, the market is rapidly pricing out tax reform…

 

The Retailer Rout continues…

 

While the yield curve collapses further, banks are bid ahead of the big earnings reports of the next 2 days…

 

Treasury yields fell once again…with a notable flattening…

 

The Dollar Index continued its post-Golden Week demise, extending losses on a dovish Fed statement (re: inflation) and on Mnuchin-Powell headlines…

 

Gold continues its post-Golden Week recovery, surging after Fed Minutes…

 

WTI bounced back above $50 today (and RBOB rallied) after OPEC jawboning and ahead of tonight's API data…

 

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Rationality Versus The Market

Rationality Versus The Market

Posted with permission and written by John Rubino, Dollar Collapse

 

Rationality Versus The Market - John Rubino

The late stages of financial bubbles are always tough for rational analysts. Focused as they are on the numbers, such analysts are relatively immune to the emotion that drives the action at market extremes, so they find themselves making predictions that turn out to be “wrong” for months and sometimes years.

 

Then the cycle turns and the rational analyst is vindicated – though often far too late for his bruised ego and diminished client base to easily recover.

 

[Recall the scene in The Big Short where hedge fund manager Michael Burry, after suffering months of abuse from his clients for shorting the 2006 housing bubble a bit early, is lambasted by a client who can’t believe Burry has, after the crash, gone long equities — because they’re clearly going to zero. In both cases Burry was right and his clients wrong, but he nevertheless closed up shop and quit the business.]

 

Anyhow, we’re there again, with governments manipulating all major markets to valuation levels at which previous crashes have occurred. This is leading analysts who focus on historical norms to issue warnings, which turn out to be wrong (stocks are setting new records as this is written), which draw derision from people who see no reason why the party ever has to end.

 

A good example is John Hussman, whose eponymous family of funds has been on the wrong side of this market for an uncomfortably long time. Yet he persists, because the numbers don’t lie. From his most recent report to clients:


So the mindset, I think, goes something like this. Yes, market valuations are elevated, but, you know, low interest rates justify higher valuations. Besides, there’s really no alternative to stocks because you’ll get what, 1% annually in cash? Look at how the market has done in recent years. There’s no comparison.

Value investors who thought stocks were overpriced in recent years have been wrong, wrong, and wrong again, and even if they’re eventually right, being early is just the same as being wrong. The best bet is just to invest in a passive index fund for the long-term, and ignore the swings. There’s really no alternative.

What’s notable about this mindset is its excruciating reliance on three ideas. The first is that low interest rates “justify” rich valuations. The second is that market returns simply emerge as a kind of providence from a higher power, perhaps magical gnomes, or the Federal Reserve if you like, and that those returns have no particular relationship to valuations even in the long-term. The third is that market returns during the recent advancing half-cycle are an accurate guide to future outcomes.

In effect, stocks are viewed as good investments because they have been going up, and the evidence that stock prices will go up is that stock prices have gone up. Every additional market advance makes stocks look even better, based on past returns. Indeed, the more extreme valuations become, the more convinced investors become that extreme valuations don’t matter.

And that’s why we’re all gonna die.

A few insights may help to deconstruct this mindset. First, if one is going to invest one’s financial future in the stock market here, it’s worth making at least a cursory study of 5, 10 or even 20-year growth rates in population, labor force, productivity, S&P 500 revenues, earnings, real GDP, nominal GDP, and virtually every other measure of fundamentals. That exercise will quickly inform investors not only that the growth rate of fundamentals has persistently slowed from post-war norms in recent decades, but also that the underlying drivers of growth (primarily labor force demographics and productivity growth) are now running at rates that are likely to produce real GDP growth on the order of just 1% annually over the coming decade, while even a sizeable jump in productivity would likely result in sustained real GDP growth below 2% annually.

Unfortunately, this has implications for how one responds to interest rates, because the argument that “low interest rates justify higher valuations” relies on the assumption that the growth rate of underlying cash flows is held constant. Any basic discounted cash flow analysis will demonstrate that if interest rates are low because growth is also low, then no market valuation premium is “justified” by the low interest rates at all. Indeed, if both growth rates and interest rates are x% lower than their historical norms, then even a historically normal level of market valuation would be associated with subsequent market returns that are x% below historical norms. No valuation premium is required to produce this result.

The most reliable valuation measures we identify (those most strongly correlated with actual subsequent market returns) are about 2.5 to 2.7 times their historical norms here. Paying a valuation premium in this case simply causes prospective future market returns to collapse.

In order to provide the longest perspective possible, and also to offer a measure that can be easily calculated and validated should one choose to do so, the chart below shows my variant of Robert Shiller’s cyclically-adjusted P/E (CAPE), which has a correlation near 90% or higher with actual subsequent 10-12 year S&P 500 total returns in market cycles across history.

What investors presently take as a comfortable environment of pleasant market returns and mild volatility is actually, quietly, the single most overvalued point in the history of the U.S. stock market.

Hussman’s conclusion is, obviously, that a horrendous crash is coming. The problem is that this – and most other valuation measures – started flashing red in 2013, so warnings based on them now have a hollow ring.

 

Will they end up being be right? Without a doubt. And the longer the current exuberance goes on the bigger will be the subsequent crash. Somewhere out there is the perfect moment to short the hell out of this and pretty much every other country’s stock market. But only a tiny handful will nail it.

 

 

Questions or comments about this article? Leave your thoughts HERE.

 

 

 

Rationality Versus The Market

Posted with permission and written by John Rubino, Dollar Collapse

 

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