Month: September 2017

Authored by Scott Galloway op-ed via The Wall Street Journal,

Four tech giants – Amazon, Apple, Facebook and Google – have added $2 trillion to their combined market capitalization since the 2007-09 recession, a sum that approaches the GDP of India. The concentrated wealth and power of these companies has alarmed many observers, who see their growth as a threat not just to consumers and other businesses but to American society itself.

After spending most of the past decade researching these companies, I’ve come to the conclusion that our fears are misplaced in focusing on what I call the Four. We should instead be worrying about the One: one firm that will come to dominate search, hardware and cloud computing, that will control a vast network of far-flung businesses, that can ravage entire sectors of the economy simply by announcing its interest in them.

That firm is Amazon. Jeff Bezos has been disciplined and single-minded in his vision of investing in the most enduring consumer wants—price, convenience and selection. Coupled with deft execution, it has made Amazon the most impressive and feared firm in business.

As for the other three, don’t be misled by their current successes. They are falling behind as the One marches ahead.

Google seems to have a commanding market position when it comes to search functions. As European Union regulators pointed out in their recent antitrust finding, Google has an astonishing 90% share in the category in Europe. Its share in the U.S. is 64%. But it’s a very different story in the narrower, and more lucrative, domain of product search. In 2015, more product searches in the U.S. began on Amazon than on search engines, including Google (44% vs. 34%), according to BloomReach. A year later, Amazon’s share grew to 55%. Amazon could reasonably be described as a search engine with a warehouse attached to it.

For years, Apple has been the undisputed king of hardware innovation. But the prize for the most disruptive recent device goes to the hands-free, voice-controlled Amazon Echo speaker and its buttery voice, Alexa. Research firm Gartner predicts that 30% of computing will be screenless by 2020. So far, Apple looks to have blown an early lead in the great voice race: With 700 million iPhones in use world-wide, Apple’s Siri still has the most share in voice overall. But Amazon’s share of voice on home devices—the next frontier—is 70%.

Today’s fastest-growing sector in tech is cloud computing. There are several big players in the field, including old and new tech: IBM , Microsoft , Google. The dominant player again is Amazon, with a business launched originally to support its internal computing needs. According to Synergy Research Group, Amazon’s cloud offering (called Amazon Web Services) enjoys more than 30% of the market, triple the share of the No. 2, Microsoft’s Azure, and will register $16 billion in revenue in 2017. Financial pundits, looking for something negative to say about Amazon’s recent quarterly earnings, highlighted that growth in the company’s cloud business had slowed to 43%. “Slowed to 43%” is not a phrase you read in any other equity analyst’s write-up of a large company in 2017.

Amazon’s consistent outperformance of the other three tech giants is distinct from its continued dominance of old-economy firms. With the acquisition of Whole Foods, Amazon will likely become the fastest-growing online and bricks-and-mortar retailer. The whole grocery sector—with $612 billion in U.S. sales in 2016—has been disrupted overnight by Amazon. In the months between the announcement and closing of Amazon’s acquisition of Whole Foods this year, the largest pure-play grocer, Kroger , lost nearly a third of its market value.

The late business professor C.K. Prahalad of the University of Michigan famously argued that the most successful firms focus not on one market but on one “core competence.” Amazon has proved otherwise. What Amazon has accomplished across industries is unprecedented, even among the most successful businesses. Nike does not have a cloud business; Starbucks is not developing original TV content; Wal-Mart has not filed patents for warehouses in the sky. Amazon has recently been granted patents for a floating warehouse and small drones that can self-assemble into bigger drones capable of transporting larger packages, reflecting the ability, one day, to operate intricate networks of fulfillment by air. Other firms are punished for straying from their familiar areas of strength; Amazon sucks value from sectors in which it has had no previous involvement just by glancing at them.

At New York University’s business school, where I teach, I have for years kept a close watch on which firms are winning the competition for the most talented students. A decade ago, the top recruiter was American Express , with investment banks vying for second position. Now the clear winner is Amazon: 12 students from my most recent class have opted for a life of rain and overrated coffee in the Pacific Northwest.

Why does Amazon’s ascent matter? Aren’t lower prices and greater efficiencies better for everyone? They are, in all the obvious ways, but that’s not a complete picture. Amazon’s seemingly boundless growth forces us to wrestle with difficult questions about the reasons for its dominance.

For one, Amazon, unlike any other firm its size, has changed the basic compact with financial markets.

It has replaced the expectation for profits with a focus on vision and growth, managing its business to break even while investors bid up its stock price.

This radical approach has provided the company with a staggering advantage in free-flowing capital. Google, Facebook, Wal-Mart and most Fortune 500 companies are saddled with expectations of profits. Many firms would be much more innovative if they were given a license to operate without the nuisance of profitability. Amazon has thus had enormous capital on hand to invest in delivery networks, especially the crucial last link for getting goods to the doorsteps of consumers, without having to worry that they don’t yield immediate profits.

Amazon’s strategy of break-even operations also means that it has virtually no profits to tax. Since 2008, Wal-Mart has paid $64 billion in federal income taxes, while Amazon has paid just $1.4 billion. Yet, while paying low taxes, Amazon has added $220 billion in value to the stock held by its shareholders over the past 24 months—equivalent to the entire market capitalization of Wal-Mart.

Something is deeply amiss when a company can ascend to almost a half trillion dollars in market value—becoming the fifth most valuable firm in the world—without paying any meaningful income tax. Does Amazon really owe so little to support public revenue and public needs? If a giant firm pays less than the average 24% in income taxes that the companies of the S&P 500 pay, it logically means that less-successful firms pay more. In this way, Amazon further adds to the winner-take-all tendencies plaguing our economy.

Because Amazon is more efficient than other retailers, it is able to transact the same amount of business with half the employees. If Amazon continues to grow its business by $20 billion a year, the annual toll of lost jobs for merchants, buyers and cashiers will be in the tens of thousands by my calculations. Disruption in the U.S. labor force is nothing new—we have just never dealt with a company that is so ruthless and single-minded about it.

I recently spoke at a conference the day after Jeff Bezos. During his talk, he made the case for a universal guaranteed income for all Americans. It is tempting to admire his progressive values and concern for the public welfare, but there is a dark implication here too. It appears that the most insightful mind in the business world has given up on the notion that our economy, or his firm, can support that pillar of American identity: a well-paying job.

Amazon has brought us many benefits, but we all must recognize that the rise of the One brings with it much more than free two-day delivery. “Alexa, is this a good thing?”

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As stagnant wages and rising tuition and medical costs squeeze middle class families, Bloomberg reports that US employers cut employee bonuses this year for the first time in seven years, further straining household budgets despite an ostensibly bright economic outlook. Bonuses slipped a tenth of a percentage point to 12.7% of total compensation this year, according to data from Aon Hewitt, which conducts an annual survey of more than 1,000 employers.

Aon said that while the move may not be dramatic, it's confusing considering the relatively healthy state of the economy. What's more worrying is that the cuts come as part of a broader retrenchment.

“It’s not a dramatic change, but it is counterintuitive,” said Ken Abosch, who heads compensation at Aon Hewitt.

 

“What’s even more surprising and alarming is that organizations are pulling back their projected spending in 2018,” he added. Companies expect to spend 12.5% of total compensation on bonuses next year, the survey found.

And in the spirit of “the buck stops here,” employers are blaming President Trump for the cuts, explaining that the uncertainty surrounding policies from tax reform to health care is making long-term planning difficult. Fears of an imminent recession have also inspired some employers to pare back compensation spending, risking losing their most valuable employees in the process.

“Despite the strength of the economy, a tight job market, and strong corporate performance, employers have resisted raising wages out of fear of increasing their fixed costs. Those surveyed said they had given out, on average, 2.9 percent raises this year and expect to give around the same next year. The specter of a recession, or even just a bad year, has kept salary increases at that level for the last five years. “There’s just not any appetite to budge on salary spending,” said Abosch. In that kind of climate, the bonus is a much more alluring way to reward workers: It’s not permanent, so companies can choose to hand out bonuses during boom times or withhold them when budgets tighten. Workers who rely on their regular earnings to pay the bills would be justifiably angered by wage cuts, but they may not expect to get a bonus every year.”

And bonuses will likely continue to shrink this year. Ironically, Bloomberg says employers are claiming that Hurricanes Harvey and Irma are forcing them to be more conservative by increasing the chances that inflation could pick up and erode profits. Even after several investment banks warned that the storms could lead to a slight pickup in GDP by increasing construction costs.  

“This year, however, companies are skittish on bonuses, too. Their budgets aren’t tight, but they fear an economic downturn is on the horizon—and specifically, those surveyed said, that greater government spending on defense, infrastructure, and hurricane relief could boost inflation and hurt corporate profits. “Organizations are expressing concerns about how all of that is going to get paid for,” said Abosch.”

Oh, and they’re blaming Congress, too.

“There’s something else giving employers pause on bonuses, too: “The accomplishments, or lack thereof, in terms of congressional results this year, and just some uncertainty about leadership in general out of Washington,” Abosch said. Congress has passed a $700 billion defense funding bill and a $15 billion in hurricane relief, but the passage of tax reform and health care legislation, two Republican priorities that would have a major impact on employers, is far from assured.”

US wages have been stagnant for years even as household wealth has ballooned to a record $96.2 trillion, according to the Fed’s latest flow of funds report."

Unfortunately, the benefits of this increase have largely accrued to the richest Americans, who own the majority of tradeable, and non-tradeable, assets in the US. According to the survey, virtually all of the rise in household net worth has only benefited a handful of the richest

Americans, with the top 10% of the wealth distribution holding 76% of all family wealth.

Because of this, the bonus cuts will almost certainly impact spending decisions made by middle class families, which could have economic ramifications for GDP, given the consumption-focused state of the US economy.

We wonder: With more cuts expected, whom will employers blame next to justify their “frugality”?

Our money’s on Putin.   
 

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Authored by Daniel Nevins via FFWiley.com,

Pension plan administrators do it. Their actuaries and consultants do it. Professional endowment and foundation investors do it. Financial advisors do it. Private investors may or may not do it, but they probably should.

Do what?

All of these folks already are or should be asking themselves the following question: What’s a reasonable expectation for the long-term return on a broad-market equity investment?

Professionals usually answer the question using complex models, and there’s nothing wrong with that, but we’ll keep it simple here. Simple often beats the snot out of a long white paper, and two recent developments beg for simple.

First, on Thursday the Fed released its flow-of-funds data, which includes an estimate for the household sector’s overall asset allocation. Data show allocations to corporate equities reaching 25.1% of total household (and nonprofit) assets, a level only before seen between Q4 1998 and Q3 2000. Here’s the full history:

Now, you may say 25% is just a number, and we would agree, but only to a point. We don’t think the household sector’s current allocations tell us anything about the market’s near-term direction. In fact, we don’t detect any of the most common precursors to major market turning points, as discussed here.

But we do think household equity allocations offer clues to long-term returns. Consider the next chart, which compares the allocation data to the corresponding S&P 500 returns over subsequent periods of six, eight and ten years:

You’ll decide for yourself, of course, how to interpret the chart, but we’ll entertain three possibilities.

First, you might rely on a few instances in which S&P 500 returns reached almost 4% after the equity allocation was 25% or more. Compared to today’s miniscule bond yields, 4% looks respectable. If stocks do, indeed, return 4% over the next six to ten years, that could be higher than the return on any other major asset class, which probably explains how stocks got so expensive in the first place.

 

Second, you might mentally project the scatter plot’s downward trend out to the current equity allocation. Doing that, returns appear to spread evenly around today’s cash rate of about 1%. So, whereas optimistically you might expect a return of 4% or thereabouts, more realistically a negative return is almost as likely.

 

Third, you might look at the data and say, “So what? We should really use a traditional indicator – one that compares prices to earnings – not an asset allocation measure.”

Which brings us to another recent development that might alter future returns—the S&P 500 busting through 2500. To account for that latest market milestone, the next chart updates one of our favorite S&P 500 indicators, the price–to–peak earnings multiple or P/PE. (Unlike a standard price-to-earnings multiple that places the past year’s earnings in the denominator, P/PE uses the highest four-quarter earnings to date, mitigating distortions that occur when earnings fall in recessions.)

At a price–to–peak earnings multiple of 23.6, we’re currently at about the same valuation as in December 1997. Once again, you might find an optimistic interpretation – that is, the long bull market that finally ended in 2000 suggests there could still be room to bubble up from here. But the implications for long-term returns aren’t nearly as optimistic, as shown in our final chart:

If you stare at the chart long enough, you might see a less bearish picture than in the first scatter plot above. (Stare even longer and you might see the King of France.) But the difference isn’t especially large. On either chart, the downward slope points to a meager long-term return. In fact, if we use only the scatter plots above to make our estimate, while also accounting for the Fed’s predicted interest rate path, the S&P 500 appears to offer a similar return to cash.

Conclusions

To be clear, we’re encouraging long-term bulls to reconsider their assumptions, but we’re not advising them to dismantle carefully diversified portfolios (meaning those that are spread sensibly among multiple asset classes). We would be more likely to recommend a major portfolio shift if the usual bear-market catalysts – sharply rising inflation, high interest rates and poor credit conditions – were present.

More to the point, it seems a good time for investors to check their expectations and risk levels. Investors should develop reasonable expectations informed by data such as those in the scatter plots above. And they shouldn’t take more risk than they’ll be able to tolerate as the next bear market plays out. As always, only a small percentage of investors will accurately time the next market cycle, and we shouldn’t bet too heavily on being among those fortunate few

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In a stark variation from scenes of protest observed during performances of national anthems at today’s football games, the AP reports that no drivers, crew or other team members participated in a protest during the national anthem to start the NASCAR Cup series race Sunday in Loudon, New Hampshire. It adds that several team owners and executives said they wouldn’t condone “anyone in their organizations” protesting during the anthem amid ongoing protests by sports players at football and baseball games in the latest feud involving president Trump, suggesting that this latest form of protest is split along cultural and geographic lines.

Richard Childress, who was Dale Earnhardt’s longtime team owner, said of protesting, “It’ll get you a ride on a Greyhound bus.” Childress said he told his team that “anybody that works for me should respect the country we live in. So many people gave their lives for it. This is America.”

Hall of Fame driver and former NASCAR champion Richard Petty took it one step further, and told the AP that “anybody that don’t stand up for the anthem oughta be out of the country. Period. What got ’em where they’re at? The United States.” When asked if a protester at Richard Petty Motorsports would be fired, he said, “You’re right.”

The sentiment, however, wasn’t uniform and at least one team owner, Chip Ganassi- member of the Motorsports Hall of Fame of America – said he supports Pittsburgh Steelers coach Mike Tomlin’s comments. Tomlin said before the Steelers played on Sunday that players would remain in the locker room and that “we’re not going to let divisive times or divisive individuals affect our agenda.”

The comments from the NASCAR owners come as numerous NFL players and owners took part in protests at games across the country after Trump on Friday slammed players who kneel rather than stand during the U.S. anthem. “Wouldn’t you love to see one of these NFL owners, when somebody disrespects our flag, to say, ‘Get that son of a b—- off the field right now,'” Trump said during a Friday rally. “‘He is fired.'”

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Years ago, we reported on the shockingly effective college-to-Wall Street pipeline established by Sigma Chi Epsilon, a fraternity whose members made it a goal to build a “little fraternity on Wall Street.” By offering insider tips, as well as offers to intervene on candidates’ behalf, members of the fraternity have helped populate banks like J.P. Morgan, BofA and Wells Fargo with fellow alumni – helping them beat odds three times steeper than the Princeton admissions rate.

Now, a new study by researchers at Union College in Schenectady has confirmed what that story appeared to suggest. That despite the constant distraction from academics that fraternity membership represents, students who join reap the benefits of the associated professional network for years to come, MarketWatch reports.

Of course, these benefits come with a tradeoff: The study showed that being a member of a fraternity also makes you dumber.

“Being a member of a fraternity in college lowers a student's GPA by approximately 0.25 points on the traditional four-point scale, but raises future income by around 36%, according to a paper, “Social Animal House: The Economic and Academic Consequences of Fraternity Membership,” published by two economists from Union College in Schenectady, New York. “For this reason, joining a fraternity may be a rational decision that improves the long-term prospects of an individual student despite its damaging effects on a student’s grades,” the paper concluded.”

 

These results suggest that fraternity membership causally produces large gains in social capital, which more than outweigh its negative effects on human capital for potential members,” they concluded. “These findings suggest that college administrators face significant trade-offs when crafting policies related to Greek life on campus.” They surveyed 3,762 alumni from a liberal Northeastern college who work full-time and also adjusted for the statistical impact of age, gender and ethnicity on a person’s income.”

While fraternities have frequently been the subject of unflattering press coverage in recent years – the Penn State hazing-death case being one example – about the culture of rape and dangerous risk-taking that fraternities perpetuate, the study’s results offer a strong argument for universities to keep Greek life programs: namely, that the organizations offer at least some long-term benefits to members.

“Despite the partying and troubling headlines that fraternity life involving hazing and sexual assault in recent years, supporters of fraternities say there’s another side to Greek life. Among them, they provide academic support for students and social connections that can last a lifetime. Studies at the American University in Washington, D.C. and other colleges have found that Greek life results in higher GPAs. Fraternity alumni programs, LinkedIn groups, online communities all help foster strong social ties that are designed to last a lifetime across different generations of members of the same fraternity.”

The study’s authors explained that they controlled specifically for the impact of social connections by correcting the data to factor out other behavioral tendencies of fraternity life – like excessive alcohol consumption.

“Alcohol-related behavior did not explain much of the effects of fraternity membership, the latest study found. Fraternity membership lowers grades by 0.18 to 0.42 points. Controlling for alcohol-related behavior reduces this estimate only slightly – by about 0.03 to 0.05 points.

 

“This suggests that, despite its visibility, alcohol consumption plays a relatively minor role,” the paper concluded. Because the data was collected from workers from ages 25 to 65, it incorporates the effect of Greek membership on lifetime earnings – not just on earnings in the first job after college.

As MarketWatch explains, other studies have also proven that alcohol consumption has myriad negative repercussions for individuals, most notably by lowering the odds of attaining full-time employment after graduation.

“However, heavy drinking just six times a month reduces the probability that a new college graduate will land a job by 10%, according to researchers at Tel Aviv University and Cornell University published in the peer-reviewed academic journal “Journal of Applied Psychology.” Alcohol is a depressant that impacts motor functions and brain activity. The authors suggest that each individual episode of student binge-drinking during a month-long period lowers the odds of attaining full-time employment upon graduation by 1.4%.”

In summary, the study effectively proves the old saying: “It’s not what you know, it’s who you know.” But then again, we imagine readers – particularly, American readers – have long suspected this to be accurate.

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Submitted by Shant Movsesian and Rajan Dhall MSTA at FXDaily.co.uk

After the FOMC meeting last week, it was (yet) again apparent that the Fed are still keen to maintain a normalisation path designed to not only get rates back to neutral levels, but also build up the policy tool kit again as well as staving off excessive leverage which has boosted stock markets to record highs.  In the latter part of that, many of us believe we have already gone way past the point of excess, and therein lies the delicate situation the Fed is faced with.  As such, it is steady as she goes, and as we can see with the plans on balance sheet reduction, the reinvestment caps are barely scratching the surface.  

On these bases, the market is happy to continue 'taking on' any USD recovery, and alongside this, we also have a persistent bid in the EUR, as the pace of economic expansion shows greater acceleration in Europe – what we call gamma in the options market.  Consequently, the prospects of a meaningful pullback in EUR/USD look slim, but over-exhaustion and the constantly communicated concerns from the ECB limit gains to the degree that sellers above 1.2000 are also a little more confident in 'playing the range' for now.  As we noted a few weeks back, 1.1800 will prove to be a strong support point given president Draghi revealed this level as the reference point in the last staff projections, and will be seen to be tacit 'acceptance' of fair value – for now. 

On Friday, we saw the EU wide PMIs pointing to continued expansion in activity, and looking to the 5 days ahead, we expect the German IFO survey on Monday to do the same.  Midweek we get Italian trade and industrial orders which have also been improving at a rapid pace, while in Germany again, we get Sep inflation data, retail sales and unemployment.  At the end of the week however, we also have EU wide inflation, but this will have to dip significantly to derail EUR sentiment.  

So from the US perspective, Thursday's final Q2 GDP number will be the focal point, preceded by the volatile durable goods orders reported the day before.  This is expected to remain at 3.0%, and traders will naturally pounce on this if we miss on expectations.  Any upside surprise will likely have less of an effect given a series of downgrades due to the impact of Hurricanes Harvey, Irma and Maria.  On Friday we then core PCE for Aug as well as the personal income and spending components, so we expect a cautious start to the week for all USD pairs, with limited upside likely unless we get some good news on fiscal policy.  

The Trump administration reverts focus back to efforts on tax overhaul, which has slipped up and down the priority list as the GOP look for some form of progress here as well as in health-care reform and the multitude of trade agreements and disputes including China and NAFTA. Working from a low base – ie, none – one could argue that from this perspective, the USD 'risk' is to the upside, but after so many falls over hurdles, the market confidence is low.  

This may well be one of the more supportive factors for USD/JPY, with the pick up in Treasury yields having run their course.  10yr has tested and held first 'target' at 2.30%, and odds for a Dec Fed move are back up to 70%, so above 112.00 there is and has been little momentum to drive us to the next target area which we see closer to 114.00. That said, we see limited downside from here in the meantime, though this has room to extend into the mid to lower 110.00's.  

Barring any fresh developments emanating from North Korea, the JPY pairs should be relatively stable through the week, but as ever, this carry trade relies on stock market performance.  AUD, CAD and NZD rates are all off better levels, but will be seen to represent a dip buying opportunity for now.  

Lots of Japanese data to look to, chief of which is the inflation number on Friday.  Core CPI is expected to rise from 0.5% to 0.7% in Aug.  Later on in the session, industrial production and construction orders also stand out, less so retail sales, but all expected to show market improvement in Aug.  

Friday is also the focal point of UK data watchers as we get the latest estimates of Q2 GDP and also business investment.  The BoE believe this is strong enough to weather a rate increase in order to tame inflation first and foremost, but I remain firmly in the camp that a 25bp move – now widely priced into November – would be a case of 'one and done'.  Little else to note earlier in the week other than the CBI's distributive trades survey – recall last week – industrial trend orders on Friday saw the index weaken from 13 to 7.  

On Brexit, the hype over Theresa May's speech in Florence was overdone, but this comes as little surprise for a market hungry for event risk – and Brexit is good source of this.  Even so, judging by comments from the EU's Barnier, it was relatively well received in terms of spirit, but including the line that 'no deal is better than a bad deal', there is clearly a line which the UK government will not cross, no matter how conciliatory they have been in recent weeks and months.  

GBP gains from here should be limited – indeed, some will have been surprised that we have extended this far, with the present day market hanging on every word of central banks.  That said, some of the data has been holding up well under the circumstances, but numbers such as the strong retail sales print last week should be taken in context – in this case seasonality.  Cable has hit a wall of selling interest above 1.3600, and with the CofT positioning somewhat lightened, we cannot count on short covering to drive GBP south at this stage, with EUR/GBP losses having taken us back to key levels in and around 0.8800.  

Little of note of Australia again, with the AUD tone softened a little after comments from gov Lowe that even though the next move in rates is likely up, we should not expect any imminent change. 

Over in NZ, the election result means another hung parliament and coalition to be formed, so it will be an interesting start to NZD trade when Asian markets get underway, with the Nationals and Labour vying for the support of New Zealand First to form government.  As if that is not enough, we also have the RBNZ meeting and announcement Wednesday, but in the current climate, no change and or material change in their statement will be anticipated.  Trade data on Monday to note, but likely to be overshadowed.  

AUD/NZD will be as volatile as NZD/USD, with both pairs reacting to the polls last week which saw the Nationals back in the lead – the vote count so far matching the 46% touted, but uncertainty from here set to weigh again.  AUD/USD levels to watch for lie at .7900 and .8100, and are largely dependent on the USD from here.  

This may also be the case for the CAD, though on Friday, we saw core CPI in Canada sticking to 0.9% while the headline rate rose less than expected from 1.2% to 1.4%.  Growth and improving economic activity have pushed the BoC to reverse the rate cuts from 2015, so from here we would not be pursuing the steep rate profile the market is now pricing in, so we see further room for CAD correction. 

BoC gov Poloz is speaking next week and may well take a more cautious tone in light of the strong CAD appreciation, which the central bank are now monitoring along with the impact of higher rates.  Jul GDP on Friday is the only key data point of note, with a rise of 0.1% expected (seems a little low) vs 0.3% in Jun.  

Retail sales data in both Norway and Sweden to look to as well as Norwegian unemployment and Swedish trade.  From a policy point of view, both central banks are on the cautious side, more so the Riksbank, but the Norges bank will not have been encouraged the slippage in inflation – a global phenomenon (UK excluded) which the market seems to forget at times.  NOK/SEK still well contained.  

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Authored by Zainab Calcuttawala via OilPrice.com,

Landfills in Colorado have begun to fill their space with low-level radioactive substances from oil and gas activities, state health officials have said, according to the local news site the Daily Camera.

After a series of meetings with local officials, state authorities have concluded that unknown amounts of radioactive material have been stored at landfills throughout the state.

Local authorities are currently trying to prohibit the practice altogether by strengthening their oversight mechanisms.

"There is some of it that is just going to solid waste landfills…It is probably, mostly, staying in state," the state health agency’s director Gary Baughman said during the Wednesday meeting.

So far, no “imminent” threats to public health have been detected, though landfill operators will continue to monitor water flowing out of the fills for radioactive qualities.

Technologically advanced naturally occurring radioactive materials, or TENORM, have been a concern for health officials for a while now, especially in cases of improperly disposed materials from the fossil fuel industry.

An accumulation of TENORM could cause cancer-causing exposure to the public and the environment.

“It is in the industry's best interest to mitigate long-term risks. And it is in the public's best interest. This radiation lasts for a long time,” Jane Witheridge, a project manager for a special TENORM disposal plant in Pawnee, said.

 

"If we don't treat it differently from municipal solid waste, we would not be serving either the industry or the environment as it should be in Colorado. This is being done in North Dakota. It is being done in Texas.”

The 15 million-ton facility still will not be enough to dispose of all the TENORM produced by Colorado’s booming oil and gas sector.

The Colorado Oil and Gas Association (COGA) denies that the TENORM has been destructive so far, though it continues to monitor the issue, an official statement read.

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Two weeks ago, Goldman’s clients were so worried about an imminent crash, the investment bank’s chief equity strategist, David Kostin enumerated no less than 7 reasons why, as Goldman itself admitted, “the question every client asks: Is an equity correction imminent?” As a reminder, the reasons – summarized – were the following:

1. History. Many investors argue the bull market is “long in the tooth” and will soon come to an end. 
2. Volatility (or lack thereof). Realized 3-month vol is nearly the lowest in 50 years. Implied vol as measured by the VIX stands at 12, a 6th percentile event since 1990.
3. Valuation. Equity valuations are stretched on almost every metric. The typical stock trades at the 98th percentile and the overall index at the 87th percentile relative to the past 40 years
4. Economics. The current US economic expansion just celebrated its 8th birthday making it one of the longest stretches without a recession
5. Fed policy. The FOMC has lifted the funds rate by 100 bp since it started tightening in December 2015. During prior hiking cycles, equity P/E multiples typically fell but multiples have actually expanded during the past two years.
6. Interest rates. Two months ago, Treasury yields equaled 2.4%, ten-year implied inflation was 1.7%, and the S&P 500 stood at 2410.
7. Politics. President Trump’s fluid positions on domestic policy disputes in Washington, D.C. and geopolitical gamesmanship with Pyongyang and Beijing make political forecasting a precarious activity.

Incidentally, like a good shepherd, Goldman quickly comforted said worried clients, giving two reasons why a crash is not imminent:

• First, investors are not complacent. In Sir John Templeton’s timeless observation, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” Investors today are situated between skepticism and optimism. Few are euphoric as 27% of core managers are beating their benchmark. “Tormented bulls” best describes investor mentality.
• Second, US economic growth persists led by consumers that account for 69% of GDP. Monthly job growth has averaged 175K YTD, wages are rising (our leading indicator is a 2.7% rate), confidence is at the highest level since 2001, and household balance sheets are the strongest since 1980.

And, at least so far, Goldman has proven correct, with the S&P rising to new all time highs above 2,500 even as the Fed hiked rates one more time in the interim in an unexpectedly hawkish move which expects at least one more rate hike in December and 3 more in 2018.

So what are Goldman’s clients worried about now? According to the latest note from David Kostin, what Goldman’s clients want to know now that an imminent crash is no longer of concern, is “where to from here?” or as Kostin writes, “what is the likely path forward now that the 8½ year long bull market has lifted the S&P 500 index by 1824 points (270%) since its 667 low on March 9, 2009” and just broke the 2500 threshold for the first time and this week set a new high of 2508.

Or, in other words, “how should investors think about the next 100 point move?” Here is Goldman’s answer:

The tactical near-term path of the market during the next few months will be determined more by a change in valuation (lower P/E multiple) as investors confront a higher prospective interest rate environment than a shift in underlying fundamentals such as a change in the sales, margin, or earnings outlook. This view explains our year-end 2017 target of 2400 (-100 points).

In terms of price targets, Kostin says that the forward path of S&P 500 during the next few years will be determined more by sales growth than a shift in valuation, however the Goldman analyst is hopeful that sustained modest economic growth will support top-line revenue growth. This view is the basis for Goldman’s year-end 2019 target of 2600 (+100 points), while its year-end 2018 forecast of 2500 implies a flat 1-year price return, and Kostin expects that stocks with high expected sales growth will outperform during the next 12-months.

Before Goldman elaborates on what happens next, it first looks at how we got here:

Looking back at the drivers of the bull market reveals that higher profits contributed 1111 points (61%) of the index gain since 2009 as trailing EPS rose to $130 from $67. An improvement in expected earnings growth added 209 points (11%) of the 1824 point index gain as forecast EPS growth rose to 9% compared with -1% at the low in 2009. The higher valuation of the market accounted for 504 points (28%) of the overall index climb as the forward P/E multiple rose to 17.7x today vs. 10.1x at the trough (Exhibit 1).

 

 

 

Earnings growth since 2009 has been powered by a combination of changes in sales and margins. Margin expansion disproportionately explains the growth in profits. The more than 300 bp improvement in margins (to 10% from 7%) accounts for 80% of earnings growth for the S&P 500 index (excluding Financials, Utilities, and Real Estate). Sales growth contributed 20% of the overall earnings growth outside of the sectors above.

 

Summarizing the building blocks of overall EPS growth contribution to the 1824 point gain in the S&P 500 since 2009: roughly 30% stems from margin expansion, 8% from increased sales, and 23% from higher earnings in Financials, Utilities, and Real Estate (for a total EPS growth share of 61%).

With the past out of the way, here is Goldman’s rather gloomy response to the question that keeps its clients up at night: “what will keep the market levitating higher?“

Looking forward, rising labor costs and interest rates are headwinds to further profit margin expansion. We assume margins climb by 20 bp to 9.9% in 2018 but slip to 9.8% in 2019. Our US Economists’ Wage Survey Leading Indicator stands at 2.7%. Their forecast of 5 hikes during the next 15 months compares with 2 hikes implied by the futures market. Our forecast is more hawkish than the path of the median estimate in the Fed’s Summary of Economic Projections (SEP) released this week. We forecast Treasury yields will reach 2.75% at year-end 2017, 3.25% in 2018, and 3.6% by 2019.

 

Similarly, we assign a low probability of further valuation expansion. The aggregate P/E multiple ranks in the 89th percentile vs. the past 40 years and higher interest rates typically correspond with lower valuations. The S&P 500 currently trades at 18.0x our top-down 2018 EPS forecast of $139 and 17.2x bottom-up consensus of $146. By the end of next year, the P/E on our top-down 2019 estimate of $146 will be 17.1x, one point below today.

 

Absent support from improving margins or P/E multiple expansion, equity returns are likely to be dependent on sales growth. Our baseline forecast is revenues grow by 4.7% in 2018 and 4.5% in 2019. Our top-down sales model specifies 5 macro variables that have historically driven revenue growth.

 

None will spark acceleration in sales growth during the next 3 years.

• 1. US GDP growth: Our US economics team forecasts GDP growth of 2.4% in 2018 and 1.7% in 2019. Although above the trend growth rate of 1.75%, the modest pace of expansion is unlikely to accelerate S&P 500 sales growth.
• 2. World GDP growth: We forecast global GDP growth of 3.9% in 2018 and 2019. Although recent data has been encouraging, 71% of S&P 500 sales is domestic, dampening the possible sales tailwind from faster non-US growth.
• 3. Inflation: Inflation as measured by core PCE has remained below the Fed’s 2% objective for more than five years. Our economists forecast core PCE inflation will accelerate to 1.9% in 2018 led by services inflation (+2.6%).
• 4. US Dollar: Our FX strategists expect the trade-weighted USD will rise by 2% through 2019, creating a slight drag on S&P 500 sales growth.
• 5. Crude oil: Our Commodity strategists expect WTI and Brent will average $55 and $58/bbl through 2019 suggesting a shallow trajectory for Energy sales. Passage of tax reform represents an upside risk to our margin and EPS forecasts. The Senate may have reached a deal to include instructions in the budget resolution to cut taxes. Every 1 pp in rate reduction equals $1 in EPS.

Amid such a downbeat environment, one in which margin expansion is unlikely, in which P/E multiples will contract, and where sales growth is unlikely, it is no surprise that Goldman’s conclusion is that “stocks with the best sales growth will outperform.”

Our rebalanced 50-stock sector-neutral High Revenue Growth basket comprises firms with the fastest sales growth in 2018. Median constituent has forecast sales growth of 14% next year vs. 5% for the median S&P 500 stock. Basket has returned 20% YTD vs. 13% for S&P 500. PEG ratio equals 1.3x vs. 1.8x for the S&P 500.

It also explains why Goldman has pretty much given up hoping for any equity upside in the US, expecting a 100 point drop by year end, an unchanged market by the end of 2018, and a measly 100 point increase in just over two years, with the S&P closing 2019 at 2,600.

What is more surprising, is that following last week’s admission by Goldman again that its bear market risk indicator surged to the highest since 2000 and 2007, and now implies a 67% probability of a market crash, that Kostin does not even contemplate the possibility of a much sharped drop in the market over the next two years…

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Via GEFIRA,

Aristotle was the first to point out how a thriving middle class is a condition sine qua non for a functioning democracy: “A constitution based on the middle class is the mean between the extremes of the rule by the rich and the rule by the poor.”

That the middle [constitution] is best is evident, for it is the freest from faction: where the middle class is numerous, there least occur factions and divisions among citizens” (Politics IV.11.1296a7–9)” – For those who possess the goods of fortune in moderation find it “easiest to obey the rule of reason”. ( IV.11.1295b4–6).

When we speak of the middle class we therefore mean the median group of society, the one representing the largest group of people by income.

To clarify with a simple example, in a population of 2000 people, if 500 earn 1000€ a month, 1400 people earn 2000€ a month and 100 earn 10000€ a month, then the 1400 people are the ”middle class”.

A prosperous, educated middle class is the best bulwark against extremes. Ganesh Sitaraman of Vanderbilt University argues:

“From the time of the ancients, statesmen and philosophers were deeply worried about the problem of economic inequality. They worried that either the rich would oppress the poor or the poor would seek to confiscate the wealth of the rich, and the result would be violence, instability, even revolution.”

Sitaraman worked for US Senator (Dem) Elizabeth Warren from 2011 to 2013. If Democrats had bothered listening to him and looking at what is actually happening, maybe Hillary Clinton wouldn’t have needed to write her own book “What Happened”, trying to explain her electoral debacle.

The Western class is necessary for political centrism

After the Second World War, the Western world saw itself reaching new peaks of prosperity. As the Western middle class prospered, political extremes faded. By the 1990s political extremes in the form of fascism from the right and communism from the left had been reduced to insignificance. Center-right “liberals” and center-left “social-democrats” both moved towards the center of politics to appease the large, moderate electorate i.e. the middle class. As the economic issues lost importance in the political debate, the focus shifted to social ones like gay rights or climate. Center leaning political parties were so indistinguishable on core issues that it often made little difference for voters.

In the 1990s however, a game changing process started whose name was globalization in the form of free capital flow, outsourcing and, to a lesser and yet significant extent, free movement of people. This entailed problems: financial crisis from capital mobility, ghettos, crimes and then even terrorism from immigration. What few noticed was also the economic impact of globalization on the Western middle-class: it began to collapse. The winners were the elites and the now growing middle-class of the developing world.

Paying attention to Dr. Milanovic’s studies on inequality over the years could easily help predicting what was going to happen. Opposition in the 2000s started to grow but it was too insignificant little to have an impact on political cycles.

A decade has passed and it is now exploding: Donald Trump won the US elections on an economic nationalist ticket, while on the left Hillary struggled to contain the socialist Sanders. In the UK, Theresa May is trying (and failing) to adopt an approach similar to Trump’s, which clashes with the traditional elitist Tory message, while the socialist Jeremy Corbyn ousted centrist Blairites from the command of Labour. In France, the centrist Emmanuel Macron won, yes, but the share of the extremes (left and right combined) went from 31% in the first turn and 0% in the second turn in 2012, to almost 50% in the first turn and 34% in the second in 2017. Half of the country is fed up and only the difference on what extreme approach to adopt does keep centrism alive so far. Italy and Spain share similar situations, where the center-left and center-right parties, that at their peak could muster 80% of the votes, now have shrunk to barely above half. Germany with its approaching elections seems so far partially immune, but even here the combined share of extremes is likely to have doubled since the last elections.

Over 2000 years later, Aristotle’s theory still holds good: the middle-class voters are the moderate ones; if the middle-class shrinks, slowly but surely it will show in the electoral results. The survival of centrism depends on the prosperity of the middle-class.

“Populism” is here to stay

If our reasoning is correct then there’s only one solution to the “populist upheaval” of the economically displaced former middle-class. It shouldn’t be a surprise to anyone that the message that carries the day is: “Make the Western Middle-Class Great Again.”

Will it happen? After all, the survival of the liberal elite, occupying the center of politics for the past 70-plus years is at stake. If we have to look at the reaction of the liberal elite, flailing angrily against “fake news” and “post-truth politics” and consequently using that as an excuse for repressing dissent with censorship, then the answer is clearly no. Unfortunately for the elite, the collapse of the middle-class is real and not stopping any time soon as long as globalization continues. We’ll see why in a bit. The political repression, if we stick to Aristotle, means that we are moving towards the oligarchical phase, where the rich rule; a dangerous path leading to revolution.

Why can’t the elite fix the middle-class and thus save democracy? They are certainly educated enough to read Aristotle, and IMF’s Lagarde at Davos 2017 (the biggest aggregation of elite individuals) warned about the suffering of the middle-class, so there’s a degree of awareness. She also called for some degree of compensation for the losers of globalization. So why is it not happening? The answer is, once again, globalization.

It is the ideology of the elite and they adhere to it in its totality. As such, they don’t care about the Western middle-class, the world is their ostrich. They have zero loyalty towards their countries, often hold dual-citizenship and marry trans-nationally. You will hear from them answers like: “The West? So what? Global GDP is growing!” or “The global middle-class is growing!” It matters nothing to them that they swear on constitutions or God to serve the “nation”. They resent Trump’s “America First”. The question is when will this disloyalty towards their own countries be termed as treason. It still does not matter to them. While the ground under their feet, their core support is crumbling, the globalist elites’ focus is on rather trivial issues like “diversity” or the “gender gap”.

The “compensation for the losers” of globalization is also not going to happen or never in the size needed to re-invigorate hundreds of millions of individuals of the middle-class. No centrist party makes it a core element of its policies to begin with. Even if they did, it would require a significant increase in the taxation of high income individuals and their wealth but, thanks to globalization and capital mobility that results in offshore tax havens, it’s something that states can’t touch. Does anyone really believe that the Western globalist elites would bring back its offshore wealth and enact a heavy taxation on it?

In conclusion, despite the fact that the survival of the liberal centre depends on the economic well-being of the middle-class, the liberal elites do not care enough to salvage it. Their attitude towards the issue is a mix of sufficiency, contempt and plain unwillingness to change a system that they perceive as beneficial to them.

Sticking once again to Aristotle, revolution seems inevitable. For democracy to survive, the winners of the revolution should do what the current elites refuse to do: rescue the middle-class. Otherwise we will see oligarchy or the tyranny of the poor.

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With VIX at its 2nd lowest level weekly close in history, amid storms, quakes, dismal data, oh yeah and nuclear armageddon looming, it is perhaps no surprise that speculators sold more VIX futures last week… to a new record level of shorts…

As Reuters reports, the long stretch of low volatility for U.S. stocks has made betting on continued calm a popular and lucrative trade, but traders and strategists warn that risks to the trade have mounted, while the potential for profits has shrunk.

Some traders, however, have grown more wary of increased risks to the trade.

“I think a lot of folks have gotten lulled into a false sense of security because the short trade has gone so well for so long,” said Matt Thompson co-head of Volatility Group at Typhon Capital LLC, in Chicago.

 

“We are still shorting volatility but we have an itchier trigger finger.”

Assets under management for the top two short volatility products is at $2.8 billion and their exposure to volatility is at an all-time high, according to Barclays Capital. But the very popularity of the trade has cranked up the risk.

And of course, we all know who ends up wearing it at the end…

Positioning in these products, primarily driven by retail players, may be more skewed to the short side than the broader market where institutional investors hold sway.

 

“I don’t think the risk is necessarily as big on the institutional side as it is on the retail side,” said Omprakash.

In fact, it seems that only FX options traders are seeing through the bullshit…

 

Which is interesting since, while the Dollar Index just completed its best 2-week rally since December…

 

Speculators remain at their most short the Dollar (in aggregate across FX Futures) since early 2013…

 

And finally, as speculators have never been more levered long of the US equity market, so households are loading up on US Stocks.

As Dana Lyons explains, the percentage of financial assets that households currently have invested in stocks has only been exceeded by the 2000 bubble.

From the Federal Reserve’s latest Z.1 Release (formerly, Flow Of Funds), we learn that in the 2nd quarter, household and nonprofit’s stock holdings amounted to 35.7% of their total financial assets. This is the highest percentage since 2000. In fact, the blow-off phase from 1998 to 2000 leading up to the dotcom bubble burst was the only time in the history of the data (since 1945) that saw higher stock investment than now. You might say that everyone is in the pool.

 

We’ve talked about this data series many times. It is certainly not a timing tool. Rather, it is what we call a “background” indicator, representative of the longer-term backdrop — and potential — of the stock market. It also serves as an instructional lens into investor psychology. For these reasons, it is one of our favorite metrics pertaining to the stock market, as we wrote in a September 2014 post:

“This is one of our favorite data series because it reveals a lot about not only investment levels but investor psychology as well. When investors have had positive recent experiences in the stock market, i.e., a bull market, they have been happy to pour money into stocks. It is consistent with all of the evidence of performance-chasing pointed out by many.

 

Note how stock investment peaked with major tops in 1966, 1968, 1972, 2000 and 2007. Of course, investment will rise merely with the appreciation of the market; however, we also observe disproportionate jumps in investment levels near tops as well. Note the spikes at the 1968 and 1972 tops and, most egregiously, at the 2000 top.

 

On the flip side, when investors have bad recent experiences with stocks, it negatively effects investment flows, and in a more profound way than the positive effect. This is consistent with the scientifically proven notion we’ve discussed before that feelings of fear or loss are much stronger than those of greed or gain. Stock investment during he 1966-82 secular bear market provides a good example of this.

 

After stock investment peaked at 31% in 1968 (by the way, after many of the indexes had topped in 1966 — investors were still buying the dip), it embarked on steady decline over the next 14 years. This, despite the fact the stock market drifted sideways during that time. By the beginning of the secular bull market in 1982, the S&P 500 was right where it was in 1968. However, household stock investment was at an all-time low of 10.9%. If the stock averages drifted sideways, why did stock investment drop by two thirds? The repeated declines over that period left investors scorned and distrustful of the stock market. They never really started putting money back into stocks until 1991.

 

What is the significance of the current reading? As we mentioned, it is the highest reading since 2000. Considering the markets are at an all-time high, this should not be surprising. In fact, while most of the indexes surpassed their prior peaks in early 2013, household stock investment did not surpass the 2007 highs until the first quarter of this year. The financial crisis put a dent in many investors’ psyches (along with their portfolios) and they’ve been slow to return again. However, along with market appreciation, investor flows have seen at least streaks of exuberance over the past 18 months, boosting investment levels.

 

Yes, there is still room to go (7.5 percentage points) to reach the bubble highs of 2000. However, one flawed behavioral practice we see time and time again is gauging context and probability based on outlier readings. This is the case in many walks of life from government budgeting to homeowner psychology to analyzing equity valuations. The fact that we are below the highest reading of all-time in stock investment should not lead one’s primary conclusion to be that there is still plenty of room to go to reach those levels.

 

There are no doubt many investors who are still wary of returning to the stock market due to the two cyclical bear markets in the past dozen years. However, while there may be a certain level of investor mistrust, the moniker of “most hated bull market of all-time” does not seem appropriate. It should not be lost on investors that we are at the second highest level of stock investment ever, behind only the most speculative stock blowoff in U.S. history.”

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If you’re interested in the “all-access” version of our charts and research, please check out our new site, The Lyons Share. Considering what we believe will be a very difficult investment climate for awhile, there has never been a better time to reap the benefits of our risk-managed approach. Thanks for reading!

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