Category: zerohedge

As stocks have pushed to new record highs in recent weeks, and VIX has dropped accordingly, the cost of protecting desperate asset managers from a far bigger collapse in prices has been soaring. We first noted the record high price of SKEW – a measure of market fear of a big drop in prices – a month ago, but for the first time in history, prices have remained elevated for a considerable period. As Bloomberg reports, the SKEW “is flashing a big warning signal for equity markets right now,” Kevin Cook, a senior stock strategist at
Zacks Investment Research Inc. in Chicago, wrote, adding that, “big players are quietly and eagerly buying up put protection while they hang onto their stocks.” This institutional nervousness is occurring as retail dives and AAII Bulls surge back above 60% of investors.

 

This is a record high and record long period for SKEW to be elevated…

 

In the past four weeks, the SKEW has exceeded 140 three times: on June 20, July 2 and July 3. Only four other earlier readings, in June 1990, October 1998, March 2006 and December 2013, surpassed this threshold since calculations started in 1990. The chart shows all but the earliest occurrence, which happened four weeks before the S&P 500 peaked for the year.

 

Which seems to have been triggered at the FOMC meeting (when Fed confirmed QE will end in Oct)

 

Source: Bloomberg

via Zero Hedge http://ift.tt/1skO4IN Tyler Durden

Submitted by Andy Tully via OilPrice.com,

Beaver dams have so far prevented about 1 million gallons of fracking wastewater discovered spilled July 8 from a rural North Dakota pipeline from spreading too far. But area residents, environmentalists and even a Republican state legislator all want more reliable measures.

The spill of the toxic saltwater, a byproduct of hydraulic fracturing, came from gas extraction operations at the Fort Berthold Indian Reservation and occurred days before it was discovered.

The federal Environmental Protection Agency said the underground pipeline spilled about 24,000 barrels, or 1 million gallon, in North Dakota’s thriving oil and gas region. The water, which can be 10 times saltier than seawater and contains salt and fossil fuel condensates, was being piped away from fuel extraction sites for safe disposal.

The spill has been threatening Bear Den Bay on nearby Lake Sakakawea, which provides water for the reservation occupied by the Arikara, Hidasta and Mandan tribes, though the EPA said there is no evidence that the lake has been contaminated.

In fact, it said, most of the saltwater had pooled near where it had spilled and that beaver dams in the area had kept it from spreading. As a result, the EPA said, the local soil has simply been absorbing the spill.

That’s a bit too fortuitous for Wayde Schafer, a spokesman for the Sierra Club in North Dakota. He said there have been four other spills in the region recently, including three caused by lightning strikes and a fourth attributed to a cow that rubbed against a tank valve.

With its current oil and gas boom, North Dakota has become the second most productive energy state behind Texas. By relying greatly on fracking, though, it also produces millions of barrels of wastewater daily that, like nuclear waste, must be buried underground forever.

In 2013 alone, there were 74 pipeline leaks that spilled 22,000 barrels of saltwater. Yet that same year, the North Dakota Legislature voted 86 to 4 against a bill that would have mandated flow meters and cutoff switches on wastewater-disposal pipelines. Energy companies protested the cost of such measures, and even state regulators argued they wouldn’t detect small leaks.

State Rep. Dick Anderson, a Republican farmer from Willow City, about 140 miles northeast of Lake Sakakawea, wants the legislature to reconsider the bill. He said a revised bill should require energy companies to conduct more frequent examination of the wastewater pipelines, including dogs trained to sniff for spills and even aerial drones that can spot pipeline breaks.

Arrow Pipeline LLC, which owns the pipeline whose spill has been threatening Lake Sakakawea, said the accident wasn’t discovered until employees were reviewing reports on production losses.

Crestwood Midstream Partners LP of Houston, which owns Arrow Pipeline, said the cleanup is likely to last for weeks.

via Zero Hedge http://ift.tt/1wrBmph Tyler Durden

As we suggested last night, the anti-dollar alliance among the BRICS has successfully created a so-called “mini-IMF” since the BRICS are clearly furious with the IMF as it stands currently: this is what the world’s developing nations just said on this topic “We remain disappointed and seriously concerned with the current non-implementation of the 2010 International Monetary Fund (IMF) reforms, which negatively impacts on the IMF’s legitimacy, credibility and effectiveness.”

As Putin explains, this is part of “a system of measures that would help prevent the harassment of countries that do not agree with some foreign policy decisions made by the United States and their allies.” Initial capital for the BRICS Bank will be $50 Billion – paid in equal share among the 5 members (with a contingent reserve up to $100 Billion) and will see India as the first President. The BRICS Bank will be based in Shanghai and chaired by Russia. Simply put, as Sovereign Man’s Simon Black warns, “when you see this happen, you’ll know it’s game over for the dollar…. I give it 2-3 years.”

• BRICS MINISTERS SIGN DEVELOPMENT BANK AGREEMENT
• INITIAL SUBSCRIBED CAPITAL OF BRICS BANK IS $50 BLN: STATEMENT

A quick take on existing monetary policy.

• MONETARY POLICY MUST BE CAREFULLY CALIBRATED: BRICS STATEMENT

The punchline, however, is that using bilateral swaps, the BRICS are effectively disintermediating themselves from a Fed and other “developed world” central-bank dominated world and will provide their own funding.

We are pleased to announce the signing of the Treaty for the establishment of the BRICS Contingent Reserve Arrangement (CRA) with an initial size of US$ 100 billion. This arrangement will have a positive precautionary effect, help countries forestall short-term liquidity pressures, promote further BRICS cooperation, strengthen the global financial safety net and complement existing international arrangements. We appreciate the work undertaken by our Finance Ministers and Central Bank Governors. The Agreement is a framework for the provision of liquidity through currency swaps in response to actual or potential short-term balance of payments pressures. 

Incidentally, the role of the dollars in such a world is, well, nil.

Key excerpts from the Full statement:

We remain disappointed and seriously concerned with the current non-implementation of the 2010 International Monetary Fund (IMF) reforms, which negatively impacts on the IMF’s legitimacy, credibility and effectiveness. The IMF reform process is based on high-level commitments, which already strengthened the Fund’s resources and must also lead to the modernization of its governance structure so as to better reflect the increasing weight of EMDCs in the world economy. The Fund must remain a quota-based institution. We call on the membership of the IMF to find ways to implement the 14th General Review of Quotas without further delay. We reiterate our call on the IMF to develop options to move ahead with its reform process, with a view to ensuring increased voice and representation of EMDCs, in case the 2010 reforms are not entered into force by the end of the year. We also call on the membership of the IMF to reach a final agreement on a new quota formula together with the 15th General Review of Quotas so as not to further jeopardize the postponed deadline of January 2015.

 

BRICS, as well as other EMDCs, continue to face significant financing constraints to address infrastructure gaps and sustainable development needs. With this in mind, we are pleased to announce the signing of the Agreement establishing the New Development Bank (NDB), with the purpose of mobilizing resources for infrastructure and sustainable development projects in BRICS and other emerging and developing economies. We appreciate the work undertaken by our Finance Ministers. Based on sound banking principles, the NDB will strengthen the cooperation among our countries and will supplement the efforts of multilateral and regional financial institutions for global development, thus contributing to our collective commitments for achieving the goal of strong, sustainable and balanced growth.

 

The Bank shall have an initial authorized capital of US$ 100 billion. The initial subscribed capital shall be of US$ 50 billion, equally shared among founding members. The first chair of the Board of Governors shall be from Russia. The first chair of the Board of Directors shall be from Brazil. The first President of the Bank shall be from India. The headquarters of the Bank shall be located in Shanghai. The New Development Bank Africa Regional Center shall be established in South Africa concurrently with the headquarters. We direct our Finance Ministers to work out the modalities for its operationalization.

 

We are pleased to announce the signing of the Treaty for the establishment of the BRICS Contingent Reserve Arrangement (CRA) with an initial size of US$ 100 billion. This arrangement will have a positive precautionary effect, help countries forestall short-term liquidity pressures, promote further BRICS cooperation, strengthen the global financial safety net and complement existing international arrangements. We appreciate the work undertaken by our Finance Ministers and Central Bank Governors. The Agreement is a framework for the provision of liquidity through currency swaps in response to actual or potential short-term balance of payments pressures.

Goodbye visions of an ADR-world currency.

via Zero Hedge http://ift.tt/1ktj5T9 Tyler Durden

A few days ago it was that other great egaliatarian president, Barack Obama, who urged Americans to tear free from the shackles of cynicism and to unleash some more of that hopium that got Obama elected in the first place. Now it is the turn of that other just as impressive socialist, France’s own Francois Hollande, who just like Obama has seen his popularity rating crumble to unprecedented levels, come up with his own prescription for how to fix the troubles that ail France. In short: “less lamenting and disparaging, more confidence.”

From Reuters:

In the television interview to mark Bastille Day, when a crowd stormed a Paris prison on July 14, 1789, at the outset of the French Revolution, Hollande said his compatriots were more inclined than some others to put their country down.

 

“We are very proud but, at the same time, I would say there is a sort of sickness, which is not serious but which can be contagious, whereby we are always lamenting and disparaging,” he said.

 

“Speak well of your country because, when I’m abroad, people do speak well of France, of what it’s doing in the international arena, in the diplomatic sphere, on defense, the operations we have carried out for peace, but also innovation, companies.”

 

The president also cited entrepreneurs, major companies with significant exports, the tourist industry and agriculture.

 

“We have to fight but, most importantly, we have to have confidence in ourselves,” he said.

Bottom line: watch your president and government lie every day while pandering and preaching, working solely on behalf of the rich, while you rot away in your part-time jobs or worse, unemployed, surviving day to day on the measly pittance the government hands you to make you a docile little handout addicted serf, and at the end of the day, whatever you do, don’t become a jaded, cynical lamenter and disparager, but have “hope and confidence.” Truly the road to socialist utopia is paved with best intentions.

via Zero Hedge http://ift.tt/1tNvSt4 Tyler Durden

“My 10-year-old knew it was a scam. It was a complete joke,” rages Tom Laresca – a market-maker at Buckman Buckman & Reid – who sold “pure madness” stock CYNK Technology short at $6 last week. Laresca assumed (reasonably so) that the SEC would suspend trading, sending the price towards zero. Despite Zero Hedge’s initial exposure of this farce to the world (and the rest of the mainstream media’s attention following), the SEC was slow and CYNK soared to $16, squeezing Laresca and forcing his firm to cut off his ability to hold positions – he plans to resign today. “I wish people would just not trade the stupid things.”

 

As Bloomberg reports, a Wall Street trader said Cynk Technology Corp.’s (CYNK) 36,000 percent stock surge cost him his job, and he blames a short squeeze and regulators who didn’t halt the shares before the company’s value shot past $6 billion.

“The stock looked worthless, if there’s even a company behind it,” Laresca said. “My 10-year-old knew it was a scam. It was a complete joke.”

 

He sold it short last week around $6 — which means selling stock you don’t own with a plan to buy it cheaper soon, pocketing the difference. Laresca figured the Securities and Exchange Commission would suspend trading, sending the price toward zero.

Instead of falling, the share price more than doubled the next day, July 9, starting the squeeze. Market-makers who had sold the stock short got nervous and scrambled to buy stock to close their positions, driving it even higher, Laresca said.

“If you’re short, you have to buy it within five days,” Laresca said of market-making rules. “That’s what was driving the stock higher.”

The SEC stopped trading two days later, citing concerns about the accuracy of information in the marketplace and “potentially manipulative transactions.”

 

That was too late, Laresca said, and slammed the SEC…

“When it goes from 6 cents to $16 and you haven’t done anything about it, I’m sorry but you fell asleep at the wheel,” he said. “Everybody knew it. How come they didn’t know it?”

 

While Cynk’s $6 billion paper valuation was unusual, spikes and crashes are common in the over-the-counter markets where it traded. Regulators bust alleged pump-and-dump scams there regularly. Many involve defunct companies, or shells, with shares that still trade. The SEC has suspended trading in at least 255 shells this year.

 

“You lure other people into the marketplace, whether they believe it’s legit or they’re just along for the pump and believe they can get out before the dump,” Sporkin said. “It’s like a big game.”

The end result of this farce… more unemployment…

Laresca said that his firm cut off his ability to hold positions after the Cynk fiasco and that he plans to resign today. He declined to say what the trades cost.

OTC Markets Group Inc., which runs the trading venue once known as the pink sheets, marks questionable stocks on its website to warn investors. It branded Cynk with a skull and crossbones. Cromwell Coulson, the trading venue’s chief executive officer, who predicted the SEC suspension, said the agency will eventually figure out what happened with Cynk.

“I wish people would just not trade the stupid things,” he said.

It’s not just Laresca who has a major problem, as we noted previously – cost of carry on the short is adding up all the time CYNK is halted…

Case in point, this sad individual who on that bulletin board of epic retail investor comedy, Yahoo Finance, has explained their problem: it appears some brokers actually did allow shorting of CYNK, at a cost. A rather high and recurring cost it would appear.

 

 

Oops.

*  *  *
But all the other momo stocks trading at triple-digit P/Es are not stupid…? Or are they – according to Yellen?

via Zero Hedge http://ift.tt/1mewzC7 Tyler Durden

Submitted by Joe Calhoun of Alhambra Investment Partners,

I think sometimes, with the stock market doing its best imitation of the Energizer bunny, we forget just how extraordinary are the times in which we live. We’ve been lulled to sleep by the relentless and mesmerizing march higher of stocks and all manner of risky assets. Maybe it’s just that having lived through two booms and busts already that people have come to believe that another boom in risky behavior is not just the new normal but the old one as well.  And having survived the last two busts, none the wiser apparently, everyone figures we’ll survive the next one too. Maybe. Or maybe people just don’t realize how truly weird things are right now.

I’m guilty of this type of thinking too but it seems like every week I get some kind of reminder that snaps me back to reality. Last week it was an article on MarketWatch about a convicted murderer passing out investment advice while serving a 54 years to life sentence. The article detailed some of his stock picks which included a healthy dose of social media stocks and other tidbits such as his affinity for penny stocks. When the stock market mania has reached all the way to San Quentin, one can’t help but think maybe things have gotten a bit frothy. Stocks are not, as I’ve said more than a few times recently, cheap by any measure but as the market has demonstrated repeatedly in this bull phase, that is no reason prices can’t continue to go higher. The supply of greater fools however is not unlimited and at some point reality and rationality will return, likely with a vengeance.

It isn’t just stock markets that are acting extraordinarily. If anything, debt investors have gone even more bonkers than stock buyers. Leveraged loans, junk bonds and the sovereign debt of governments just about everywhere are trading at prices that incorporate no margin of safety. Banks are lending to companies to buy back stock, an action that increases the risk to existing bondholders (a lot of the bank debt is secured) who seem oblivious to the leverage being taken on to keep the junior part of the capital structure happy. Private equity deals are being struck at unprecedented prices with bonds issued at unprecedented low yields. Merger Monday is back with companies announcing takeover deals struck over the weekend, trying to buy the growth they can’t generate on their own. Having wrung all the excess out of their own operations the only path left for higher earnings and bonuses is to combine with another company, eliminate the duplications and reduce taxes through international tax arbitrage. That is not good news no matter how much it excites existing shareholders and the talking heads of CNBC.

The extraordinary extends to the economy and economic policy as well. The Fed has kept interest rates at zero for 6 years now and their expectations setting forward guidance says 7 is in the bag. For all those who worried that the US might turn into Japan, well worry no more, that ship has sailed. Over a half decade of zero interest rates says we already have become Japan, with the same demographic, productivity and structural problems so well documented. High taxes, a shrinking workforce, offshored production, protection of large incumbent firms, political gridlock, a falling savings rate,  a growing xenophobia and an affinity for sushi all point to America as the economic kissing cousin of the land of the setting sun. Turns out the Vapors were not just one hit wonders but keen eyed economic forecasters as well.

The US economy isn’t acting normally, now in the 6th year of an anemic expansion the likes of which we haven’t seen since, well, never. The temptation is to compare this period with the Great Depression but even the recovery from the early part of that self inflicted economic wound was better in some respects. The unemployment rate has fallen but the path of improvement has been a road less traveled in economic history. No matter the reason, full time employment has become an unreachable dream for too many Americans. Multiple part time jobs and underemployment have made debt a way of life, starting with the ubiquitous student loan and throughout life as a way to achieve the perception, the illusion, of success, if not the real thing.

Companies aren’t investing for the future, preferring to spend on the present through stock buybacks and dividends that in many cases exceed their current cash flow, the difference being plugged with debt. Balance sheets are seen as sound by investors who see cash on the asset side of the ledger, forgetting apparently that there is a liability side as well. Where we have seen investment, the returns have left much to be desired. The capital sunk into extracting high cost oil and gas is staggering, approaching $1 trillion per year and $5.5 trillion globally since 2008. What we got for that staggering sum is not a single field that can produce profitably at less than $80/barrel and $4.5 per foot of gas. In some cases, the search for oil has gone to such extremes the breakeven prices are well over $100/barrel. You don’t have to be an Austrian to see that as malinvestment.

I think this acceptance of the extraordinary as usual is just the normal human desire, after the shocks of the last 15 years – economic, social and geopolitical – for, as Warren Harding put it, a return to normalcy. We want to believe that the Fed’s policies will eventually work their magic and bring back the good old days. Recently, the metric upon which everyone has seized as evidence that normal is right around the corner is the renewed uptrend in borrowing, particularly via credit cards. The optimistic explanation is that it is confidence in their future that allows individuals to go out and spend money they don’t have to fulfill desires they didn’t know they had. There are alternate explanations of course – people borrow on credit cards because they don’t have the income to maintain their lifestyles –  but we latch onto the one that allows us to continue enjoying the mass delusion of debt fueled prosperity.

A return to normalcy would mean a rejection of the idea that debt is the sine qua non of economic growth. A return to normalcy would mean a recognition that the Fed’s monetary gnomes are the ones who got us in this mess and are therefore wholly unsuited in their role as the economy’s knight in shining armor. A return to normalcy would mean rewarding and recognizing savers as the unsung heroes of economic growth. A return to normalcy would mean a shared prosperity for all rather than just the privileged few with access to the Fed or the ear of their congressional representative.

Achieving the goals of the Fed’s extraordinary policies – full employment and low inflation – would require an extraordinary set of conditions to develop. The economy would have to achieve a rate of growth that has escaped it for years while the Fed would have to extricate itself from a policy regime they barely – and that is generous – understand. I see no reason other than wishful thinking to believe those conditions can be met.

via Zero Hedge http://ift.tt/1mHsmM7 Tyler Durden

Who best to summarize what Yellen just said (aside from Bernanke of course, however he will demand at least $250,000/hour for his profound insight), than the bank which actually runs the NY Fed: Goldman Sachs. So without further ado, here is Goldman’s Jan Hatzius on what Yellen really said.

BOTTOM LINE: The Q&A of Yellen’s semi-annual monetary policy testimony contained a few bits of interesting information, including a slightly hawkish shift in her description of when FOMC participants think the first rate hike may occur.

MAIN POINTS:

1. Asked about the timing of the first rate hike, Yellen noted that “almost all” participants expected the first rate hike at some time in 2015, and that the median projection for the fed funds rate at the end of 2015 was “around 1%.” Although simply describing the content of the Summary of Economic Projections (SEP), this language was slightly more hawkish than her response to a similar question in her May Joint Economic Committee testimony, in which she noted “most members believe that in 2015 or 2016 normalization would begin under their baseline outlook.” (The June SEP dots indeed shifted up slightly relative to the March dots, although the number of participants projecting the first hike in 2015 actually increased from 2 to 3.)

2. Despite acknowledging improvement, Yellen generally continued to focus on the substantial degree of slack in the labor market, and highlighted wage growth failing to significantly outpace inflation.

3. Regarding downside risks, Yellen noted that “housing is a sector where we expected to see better recovery, but it’s not quantitatively important enough to cause use to judge that it would hold back the recovery.”

4. Chair Yellen did not appear supportive of proposed legislation that could require the Federal Reserve to follow a formulaic policy rule. We do not think such legislation has a significant prospect of becoming law.

5. Regarding the exit strategy, Yellen stated that she thinks of the fixed-rate reverse repo (RRP) facility as a “backup tool,” consistent with the description of most participants’ views in the June FOMC minutes. She noted financial stability concerns regarding the facility, but indicated that maintaining a wide spread between the interest rate paid on excess reserves and the RRP rate or maintaining per-counterparty or total usage limits on the facility could mitigate these concerns.

6. Yellen noted that she had a “strong preference” for using macroprudential tools to deal with any potential financial imbalances (as opposed to shifting the core stance of monetary policy), similar to her remarks on this issue in the past.

via Zero Hedge http://ift.tt/1ymU5VP Tyler Durden

A week ago, China made it very clear to the US that while it is happy to preserve cordial relations and smile on photo ops, it had no problems with taking the US to task, and even the battlefield, financial or conventional, should the US – having lost most of its credibility in recent years – dare to interfere. It said it so clearly only an idiot could have misread it: “A conflict between China and United States will definitely be a disaster for the two countries and the world,” Xi said. “As long as we uphold mutual respect, maintain strategic patience and remain unperturbed by individual incidents and comments, we’ll be able to keep relations on a firm footing despite ups and downs that may come our way.”

Sadly, since these days US foreign policy indeed appears to be run by idiots, instead of staying out of China’s way, the US responded by kicking the tiger in the teeth and escalated even further when it was reported that the US was unleashing even more military forces in China’s back yard, and is developing new military tactics to deter China’s slow but steady territorial advances in the South China Sea, including more aggressive use of surveillance aircraft and naval operations near contested areas.

Ok, so the US can’t take a hint. So it is up to China to explain again. Which it did earlier today when it warned the United States, in no uncertain terms, to stay out of disputes over the South China Sea and leave countries in the region to resolve problems themselves, after Washington said it wanted a freeze on stoking tension.

From Reuters:

China’s Foreign Ministry repeated that it had irrefutable sovereignty over the Spratly Islands, where most of the competing claims overlap, and that China continued to demand the immediate withdrawal of personnel and equipment of countries which were “illegally occupying” China’s islands.

 

“What is regretful is that certain countries have in recent years have strengthened their illegal presence through construction and increased arms build up,” the ministry said in a statement.

In case it was not clear how far China is willing to go, here is another explanation for the US state depratment: “China would resolutely protect its sovereignty and maritime rights and had always upheld resolving the issue based on direct talks with the countries involved “on the basis of respecting historical facts and international law”, it added.

And since China is aware it is dealing with John Kerry, it explained one final time: China “hopes that countries outside the region strictly maintain their neutrality, clearly distinguish right from wrong and earnestly respect the joint efforts of countries in the region to maintain regional peace and stability”, it added, in reference to the United States.

Not surprisingly, the US toed the party line: Michael Fuchs, U.S. deputy assistant secretary of state for Strategy and Multilateral Affairs, said no country was solely responsible for escalating tension in the region. But he reiterated the U.S. view that “provocative and unilateral” behavior by China had raised questions about its willingness to abide by international law.

That said, now that China has very clearly warned to stay out of its national interest zone, one wonders just how many US aircraft carriers will find their way into the East and South China sea to make sure China is antagonized some more, and a full blown conflict truly erupts. In the meantime, keep an eye on the BRICS bank we reported about yesterday, because while the US pretends its entire economy isn’t merely riding on the coattails of the biggest asset bubble ever inflated, the part of the world that is actually productive is already planning for what happens once said bubble – as implicitly confirmed by Yellen earlier – bursts.

via Zero Hedge http://ift.tt/1mRO9Qw Tyler Durden

Wall Street analysts are “already throwing in the towel” on 3Q, 4Q revenue growth with forecasts for the 30 Dow Jones Industrial Avg. companies of 2.5%, 1.6% versus predictions of 3% or more just 2 months ago. ConvergEx’s chief market strategist Nicholas Colas explains these lowered forecasts fly “in the face of a general consensus from the economic community, the Federal Reserve included, that the back half of 2014 will be better than the Polar Vortex-damaged first half of the year.” As Colas warns, rather ominously, “we aren’t pricing 1.6% revenue growth for Q4 2014 with price/earnings multiples at 17-18x. If you are buying Dow 17,000 or S&P 1980, you expect better. Now, companies and the macro economy have to deliver.”

Via ConvergEx’s Nick Colas,

Summary:

With U.S. corporate earnings season in full swing, today we look at what analysts expect for revenue growth over this and coming quarters.  It’s a good news/bad news thing.  For Q2 2014 – the quarter we’re seeing reported right now – analysts forecast an average of 1.7% year-over-year sales growth for the 30 companies of the Dow Jones Industrial Average.  That’s a muted golf clap better than the 0.3% actual from Q1 2014. At the same time, consider that just 6 months ago analysts were expecting Q2 2014 to print +3% in sales growth.  The next few quarters show the same trend – Q3 2014’s current 2.5% expected revenue comp used to be 5%, and the 1.6% analysts have in their models for Q4 2014 started life at 3%. Revenue estimates are clearly still coming down, which raises a key question: “When will we get a positive surprise?” Since markets typically discount events 2 quarters ahead, the continued rally in equities points to that low-bar 1.6% Q4 2014 expectation.  Christmas in July?…  Let’s hope so. 

My doctor is fond of an old Yiddish saying: “Man plans and God laughs”.  It’s not what you’d expect to hear from a medical man, but he is also free with the more standard advice. “Eat better, exercise more…” At the same time it is heartening that he understands and embraces the role fate plays in life.  Either that, or he has given up on me.  It might be that.

As a sell side analyst for a decade, as well as investor and strategist for another +10 years, I appreciate the aphorism from another perspective as well.  I have had to do more earnings models in my career than most people reading this note.  While all the inputs and subcategories and marginal calculations may look impressive, financial models are just another version of “Man plans”.  Sometimes it works, and sometimes it doesn’t.  God laughs.

Earnings models are the most misunderstood tool of financial analysis on Wall Street, if you want to know the plain truth. Yes, it is always gratifying to “Get the number right”, but that’s just a piece of the puzzle.  A good model reveals far more about the long term health of a business than just hitting the EPS number lottery might indicate.  Here are some other bits that actually matter just as much, if not more:

Cash generation.  The typical income statement has large non-cash charges like depreciation, amortization and taxes.  It also ignores capital expenditures, acquisitions, and working capital requirements.  Health may be wealth (yep, another one from my doc), but cash also counts.  The value of a business is its cash flows, real or projected.  Earnings are sometimes a reasonable proxy, yes, but you have to tie them to cash flow to make a valid investment case. 

 

Margin analysis.  Spoiler alert: this is where the magic actually happens in a good financial model.  What incremental profit does the “nth” unit of revenue carry?  If it is a fully loaded pickup truck rolling down the line at an auto assembly plant, the answer might be 80% incremental profit to the car company producing it. And if it is a low end flat screen TV moving through a plant in eastern China, then 5% to the maker might be right.  Or zero.  Big difference, and good margin analysis captures that.

 

Revenue growth.  In the end, everything in an income statement flows from the top line, and the critical components here are units, price, and mix.  Those inputs all flow from the success of the company’s strategy, not from cells A5 to J22 on an Excel spreadsheet.  A company with an expanding competitive advantage always has better sales growth than its peers.  As the old football saying goes, “You are what your record says you are”.  You can muck around with accruals to “Make” an earnings number, but revenues are far harder to fake or fudge.

With that all in mind, it should be no surprise that for the last 4+ years we’ve tracked the projected revenues for each of the 30 companies in the Dow Jones Industrial Average.  By looking at the revenue growth that brokerage analysts show the investment world every month, we track the confidence they have in future top line growth.  And since we are talking about dominant multi-national companies, these expectations are reasonable proxies for macroeconomic growth as well as single-stock or sector fundamental strength. 

 

The charts above show the slide; but here is a brief summary of this month’s findings:

Analysts have never been more bearish on Q2 2014 as they are right now.  This is the quarter we’re hearing about this month as companies report, and Wall Street isn’t expecting big things.  The average expected revenue growth for the 30 companies of the Dow is just 1.7%, and 2.0% excluding financial companies.  This is better than the 0.3% actual comparison between Q1 2014 and Q1 2013, so the optimist would say “Accelerating comps!”  The realist would quickly point to the steady decline in expectations for Q2 2014 and wonder if companies can meet even this reduced set of expectations.  After all, at the end of 2013 the analyst community was looking for 3-4% year on year revenue growth.  Now, they hope for half that.  Man plans…

 

Looking towards the back half of 2014, and analysts are already throwing in the towel on revenue growth even reaching 3%.  For Q3 2014, the current estimate is 2.5% year on year sales growth.  For Q4, that number is just 1.6%. Both were higher just 2-3 months ago, at 3% or higher.  That comes in the face of a general consensus from the economic community – the Federal Reserve included – that the back half of 2014 will be better than the Polar Vortex-damaged first half of the year.

 

Frequent readers of this note will know that analysts always, always, always guess high and then slowly bring their numbers lower over the course of the year.  This is because it is easier to explain higher earnings in the context of an expanding economy rather than an ever-more-brutally efficient cost structure.  It also nets a higher valuation multiple, of course.  So what’s really new here?

 

The answer is on your screen every day.  U.S. stocks are trending higher (large caps, anyway… the types of names in the Dow).  How do we square that with relatively high valuations and sparse revenue growth?  There is only one answer that makes sense: markets expect that Q4 2014 will surprise to the upside versus that paltry 1.6% expected revenue growth print.  The U.S. economy will actually grow at a 2-3% pace in the back half of 2014, and corporate revenues and earnings can actually surprise to the upside.

For those investors and commentators waiting on a “Correction”, here is the Achilles heel that will cause markets to stumble.  The current earnings season, and the hundreds of conference calls that it spawns, must give analysts some reason for optimism about revenue growth.  We aren’t pricing 1.6% revenue growth for Q4 2014 with price/earnings multiples at 17-18x.  If you are buying Dow 17,000 or S&P 1980, you expect better.  Now, companies and the macro economy have to deliver.

But remember, “Man plans…”

via Zero Hedge http://ift.tt/1zFCaeN Tyler Durden

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Even if the economy were growing at a faster pace, it wouldn't come close to offsetting the interest payments on our ever-expanding debt.

If you want to know why the Status Quo is unsustainable, just look at interest and debt. These are not difficult to understand: debt is a loan that must be paid back or discharged/written off and the loss absorbed by the lender. Interest is paid on the debt to compensate the owner of the money for the risk of loaning it to a borrower.

It's easy to see what's happening with debt and the real economy (as measured by GDP, gross domestic product): debt is skyrocketing while real growth is stagnant. Put another way–we have to create a ton of debt to get a pound of growth.

There is no other way to interpret this chart.

source: Acting Man

The Status Quo has only survived this crushing expansion of debt by dropping interest rates to historic lows. This is a chart of the yield on the 10-year Treasury bond, which reflects the extraordinary decline in interest rates over the past two decades.

The Federal Reserve has pegged rates at essentially 0% for years. That means the strategy of lowering interest rates to enable more debt has run out of oxygen: rates can't drop any lower, and so they can either stay at current levels or rise.

Near-zero interest rates for banks borrowing from the Fed doesn't mean conventional borrowers get near-zero rates: auto loans are around 4%, credit cards are still typically 16% to 25%, garden-variety student loans are around 8% and conventional mortgages are about 4.25% to 4.5% for 30-year fixed-rate home loans.

This decline in interest rates means households can borrow more money while paying the same amount in interest.

So the interest payment on a $30,000 car today is actually less than the payment on a $15,000 auto loan back in 2000.

source: The Born Again Debtor

The monthly payment on a $400,000 home mortgage is roughly the same as the payment at much higher rates on a $200,000 home loan 15 years ago.

So dropping the interest rates has enabled a broad-based expansion of debt across the entire economy. Notice how debt has exploded higher in every segment of the economy: household, finance, government, business.

source: The Born Again Debtor

The other half of the debt/interest rate equation is household income: if income is stagnant and declining, the household cannot afford to take on more debt and pay more interest. With real (adjusted for inflation) household income declining for all but the top 10%, households cannot take on more debt unless rates drop significantly.

Now that rates are at historic lows, there is no more room to lower rates further to enable more debt. That gambit has run its course.

Many financial pundits claim private debts can simply be transferred to the government and the problem goes away. Unfortunately, they're dead-wrong. As economist Michael Pettis explains, bad debt cannot simply be “socialized”:
 

Remember that the only way debt can be resolved is by assigning the losses, either during the period in which the losses occurred or during the subsequent amortization period. There is no other way to “resolve” bad debt – the loss must be assigned, today or tomorrow, to some sector of the economy. “Socializing” the debt, or transferring the debt from one entity to another, does not change this. 

There are three sectors to whom the cost can be assigned: households, businesses, or the government. 

Earlier losses are still unrecognized and hidden in the country’s various balance sheets. These losses will either be explicitly recognized or they will be implicitly amortized. The only interesting question, as I see it, is which sector will effectively be assigned the losses. This is a political question above all….

In other words, when marginal borrowers–households, students, businesses, local government agencies, etc.–start defaulting, the losses will have to be taken by somebody. This is true of every indebted nation: Japan, the European nations, China and the U.S.

The idea that we can transfer the debt to the government or central bank and the losses magically vanish is simply wrong.

Even if you drop interest rates, if debt keeps soaring the interest soon becomes crushing. Even at historically low rates, the interest on Federal debt will soon double. That means some other spending must be cut or taxes must be increased to pay the higher interest costs. Either action reduces spending and thus growth.

If rates actually normalize, i.e. rise back toward historic norms, interest payments could triple.

source: Federal Spending by the Numbers, 2013: Government Spending Trends in Graphics, Tables, and Key Points

Here's one way to understand how reliance on ever-expanding debt hollows out the economy. Let's say the average interest on the $60 trillion in total debt is 4%. (Recall that charge-offs for defaulted loans must be included as debt-related expenses. The interest paid to lenders is only one expense in the debt system; the other is the losses taken by lenders for defaulted credit card loans, mortgages, etc.)

That comes to $2.4 trillion annually.

Now take the $16 trillion U.S. economy and reckon that real growth in gross domestic product (GDP), even with questionable hedonic adjustments and understated inflation, is about 1.5% annually. That's an increase of $240 billion annually.

That means we're eating over $2 trillion every year of our real wealth, i.e. our seed corn, to support an ever-increasing mountain of debt. That is not sustainable. Even if the economy were growing at a faster pace, it wouldn't come close to offsetting the interest payments on our ever-expanding debt.
This leaves the entire Status Quo increasingly vulnerable to any sort of credit shock; either rising rates or a decline in the rate of debt expansion will cause the system to implode.

 

via Zero Hedge http://ift.tt/1meaWle Tyler Durden