Why Good News for the Economy Could Be Bad News for Stocks

Why good news for the economy could be bad news for stocks... A dark side to the 'buyback boom'... History says Apple could be the first $1 trillion company... New signs of trouble in credit... Fitch sounds the alarm on auto loans...

We could be on the verge of a 'capex' boom...

According to new data, U.S. companies are ramping up spending on their businesses – so-called capital expenditures (or "capex") – at the fastest pace in years. As the Wall Street Journal reported this morning...

Spending on factories, equipment and other capital expenditures by companies in the S&P 500 is expected to have risen 24% in the first quarter to $166 billion, on track for the fastest quarterly pickup since 2011 and a record for the first quarter of a year, according to Credit Suisse data going back to 1995. The jump has been aided by a tax-code overhaul that is putting more cash in companies' pockets.

The biggest spenders run the gamut, from technology behemoths such as Google parent Alphabet to auto maker General Motors and oil firm ExxonMobil.

Investors and economists agree capex is good for long-term corporate profits and the broader economy, which has languished for years without such spending.

As the Journal noted, this is likely to be a positive for both the economy and many of these firms in the long run...

But unlike spending on dividends and share buybacks, rising capital spending may not be a boon for their stock prices in the near term. In fact, history suggests exactly the opposite.

According to Bank of America Merrill Lynch data, companies with large and growing capex tend to underperform the broad market by more than two percentage points a year. This is particularly noteworthy, considering the bulk of this new spending is coming from one sector in particular: market-leading technology stocks. More from the Journal...

Capital spending has been growing rapidly in the tech sector, where companies that have seen some of the biggest share-price growth in recent years are becoming increasingly capital intensive. More than half of the growth in first-quarter capex spending can be attributed to the tech sector, Credit Suisse data show...

"Greater investment and high valuations imply that we probably won't experience a stock market boom in the next couple years," said Christopher Anderson, a University of Kansas professor. His 2006 research found that companies that have the biggest increases in capital spending have subsequently had damped stock returns.

Of course, companies are also ramping up share buybacks as well...

As we noted yesterday, S&P 500 companies are on pace to announce a record $650 billion in buybacks this year.

In theory, this should help offset the costs of rising capex spending. But that may not be the case this time.

You see, while companies have been buying back shares like there's no tomorrow, the total number of shares outstanding in the market has remained relatively stable.

How can this be? In short, companies have been issuing new shares practically as fast as they've been buying them back.

Worse, according to new research from Société Générale analyst Andrew Lapthorne, much of this new issuance has been used to back up options grants to corporate management teams.

In other words, rather than using buybacks to benefit all shareholders, many executives appear to be using them to make themselves wealthier at shareholders' expense.

One company that has been using buybacks transparently is consumer-electronics giant Apple (AAPL)...

The company bought back $23.5 billion worth of its own shares over the first three months of the year. This is the most in any quarter by a U.S. company in history, and brings it total repurchases to an incredible $200 billion over the past five years.

More important, Apple's share count has fallen from a peak of more than 6.5 billion shares in early 2013 to 4.9 billion today, a decline of more than 25%. And analysts expect the company to continue to buy back another $70 billion to $80 billion of stock annually for the next several years, good for another 15% decline by 2020.

But a plummeting share count isn't the only reason to remain bullish on Apple today...

As our colleagues Steve Sjuggerud and Brett Eversole noted to their True Wealth Systems subscribers last week, Apple recently experienced a big one-week rally that suggests even bigger gains are ahead. As they explained in their Review of Market Extremes on Wednesday...

The world's largest company rallied 13% last week...

That was an extreme one-week move. And it was Apple's largest weekly gain in six years. Take a look...

As they explained, the last time Apple saw a similar one-week rally was more than six years ago in October 2011...

Similar extremes have only happened seven other times since 2001. And buying after these rallies led to massive gains over the next year. Take a look at the returns...

Apple is the world's largest company for a reason... It has produced unbelievable 34% annualized gains for nearly two decades, as you can see in the table. Still, buying after extreme one-week jumps has led to even better gains... 21% in three months and 64% over the following year. Those are unbelievable returns.

Of course, Apple is much larger and more mature than it was during many of these other extremes. It doesn't often make moves like this anymore. But as last week showed, the company can still move higher very quickly.

This extreme says the gains will likely continue. And that'll likely push Apple to a trillion-dollar valuation along the way. Even if we don't see 64% gains over the next year, the smart bet is on higher prices from here.

On another note, yesterday we noted that student-loan defaults could be far higher than the official numbers suggest...

Today, we see new signs of trouble in another corner of the consumer-credit markets: auto loans.

According to ratings agency Fitch Ratings, subprime auto loans are now going bad at a higher rate than during the peak of the financial crisis in 2008. As Bloomberg reports...

The delinquency rate for subprime auto loans more than 60 days past due reached the highest since 1996 at 5.8%, according to March data, the most recent available from Fitch. That compares with default rate of around 5% during the financial crisis in 2008.

More important, as we've long predicted, the data suggest credit is now beginning to tighten as a result...

Lenders are responding by pulling back on financing to applicants with shaky credit histories and requiring higher standards for loans that they bundle and sell on to investors...

The number of auto loans and leases extended to subprime borrowers fell by almost 10% from a year earlier in January, which is the latest data available from the credit reporting agency Equifax. Auto-lease origination to those customers decreased by 13.5%.

Expect to hear much more about these problems as the long bull market ends... and the biggest credit-default cycle in our nation's history begins.

It won't happen tomorrow. But make no mistake, it is coming.

New 52-week highs (as of 5/14/18): Eagle Bulk Shipping (EGLE), Eaton Vance Enhanced Equity Income Fund (EOI), Microsoft (MSFT), United States Commodity Index Fund (USCI), and Verisign (VRSN).

A busy day in the mailbag: Kudos from three longtime subscribers... a question about the student loan crisis... and Porter responds to several more comments on Berkshire Hathaway. As always, send your notes to feedback@stansberryresearch.com.

"Just a note to say I appreciate the hand holding during this market. I really like Doc's statement that 'the market is too good'. I see earnings are good right now... market going higher and priced for perfection... Seems to me we are due for another October surprise. Makes sense to be cautious, as you say none of us has any crystal ball telling us the future. Your approach is helpful." – Paid-up subscriber Gary G.

"The recipe I have for anyone who wants piece of mind about their retirement is the Triple Crown: (1) Porter's stocks (2) Steve's macro (3) Richard Smith's position management. That's the package. No guessing. No emotion. Just consistency." – Paid-up subscriber Andrew F.

"I am a Stansberry Flex member for about six years. I have to say that the best return on my money has been the education I have gotten. I am 68 years old and I wish you had been around a lot sooner. Before you guys came along I did not have a clue. Now I feel I have the knowledge to manage my own money. I am very grateful. Thank you." – Paid-up subscriber Tony

"Dear Stansberry Research, so, what are the holders of student loans going to do? How is this going to work in our country? Is there a solution that wasn't discussed in the article? How will this be solved, how can we all benefit/profit from this?

"Can they get rid of the death-grip of simple interest leveraged in student loans? Are they going to forgive them like they did years ago? Will Porter create an investment strategy so good they can use it to pay off their loans? What are the options?" – Paid-up subscriber Paul S.

Brill comment: Porter detailed the likely "solutions" to these problems – and how you can protect yourself from them – in his recent book, The American Jubilee. Stansberry's Investment Advisory subscribers can access it for free right here. If you're not yet a subscriber, you can learn more – and find out how to get a copy for yourself – right here.

"Amen to subscriber BG for his comments in Monday's Digest. Porter's reply totally defended his work on Buffet. Sorry to say Porter, I don't think that was the point of BG's remarks. You don't get it, Dude, how your bombastic comments offend some of your paid-up subscribers, including me." – Paid-up Stansberry Alliance member Tim N.

Porter comment: Tim, I'm very grateful for your business and the faith you've shown in our work.

It's difficult to have opinions that are strong enough to be clear and interesting... and yet never offend anyone. In any case, it's not unusual for my work to be offensive to many people... long before it's viewed as prescient. That was true of my work on GE, GM, Fannie and Freddie, and many others.

A subscriber once sent me a death threat, to my home address, claiming that my warnings that GM was going to go bankrupt were responsible for the loss of his pension benefits. Obviously, sometimes the messenger gets shot.

When you take on sacred cows, you're bound to ruffle some feathers.

If my words have upset you, I sincerely apologize. I'm not trying to win an argument or prove that I'm smart. I've won plenty of big arguments. And I don't think I have to prove anything about my abilities anymore.

All I'm trying to do is serve my subscribers to the very limit of my abilities.

And many, many, many investors view Berkshire as a "free" way to beat the S&P 500. Warning them that that simply isn't going to be the case going forward is, in my view, an important message.

"Often times I wonder how you guys have the ability to remain as professional as you do. By no means should people agree at all times, though, was paid up subscriber B.G. feeling a little insecure the other night or was he being plain old rude?! Clearly, he knows everything and doesn't need Porter to tell him – just ask him. You should hire him as a consultant for your newsletter service, he'd likely make a great addition to your team (sarcasm), after all, he 'was' a stockbroker for 10 years.

"I have a college degree. I was a stock broker for 10 years. I am a voracious reader. I was a successful investor prior to subscribing. If I don't understand something, I am intelligent enough to seek out additional information. I don't automatically assume someone's opinion is fact. I appreciate the knowledge that Porter and others bring but I don't like the completely unnecessary ego-driven comments interjected into the message." – Paid-up subscriber B.G.

"I, I, I... holy sh*t – talk about yourself much? After 22 years in the financial world here's what I know about 'most stockbrokers,' their arrogance is mind numbing, just when you think they couldn't be more arrogant – they are; they know everything and it's always someone else's fault. Their clients don't have names, and are identified merely by AUM (Assets Under Management). Additionally, I can't think of a single 'successful' broker who has left the business after 10 years as there are few professions that pay as well. B.G's idea of being a voracious reader is likely thumbing through wine enthusiast or cigar aficionado while at the country club.

"Yes, Porter may pat himself on the back now and again, though, he has gone through great lengths to speak more highly of his colleagues than himself. He has gone on the record as saying if anyone spoke poorly to women in their office it would not be tolerated – the man has gotten kicked off CNBC for being honest. With ungrateful readers like B.G. taking shots at how Porter should run his tremendously successful newsletter business, he should take a moment every now and again to remind readers that he has said things few have the balls to say. I can't think of any journalists in the main stream media to question the Oracle of Omaha – ever – I'm glad someone has the proverbial 'stones' to do so. I'm guessing B.G did in the ever so popular newsletter that he writes though.

"Thank you, Porter – thank you Stansberry team – your attention to detail is unparalleled in this business." – Paid-up Stansberry Alliance member Mitchel K.

Porter comment: Well... blushing... thank you, Mitchel. Writing and having strong opinions, especially contrarian ones, are acts of ego. I can't deny that I have an ego.

Nor would I argue that it serves me well.

We are all working on something. And that's one of my many faults.

But I fight for you guys. If I sometimes fight too passionately, I hope you'll have some grace for my excesses.

"Dear Porter, agreed, your proposal to split or spin-off a Berkshire Industrial co. makes sense, and I applaud you for publishing it.

"But i think it is not simply ego that is in the way, it is more a question of strategic integrity, culture and promises made long ago by Buffett on Berkshire being a permanent home to acquired business. Porteribelieve that especially you value integrity very highly. Promises combined with mistakes will bite you someday – the downside of integrity – is that the 'ego' you meant?

"Only a new board of berkshire, after the death of current member(s) might consider your split proposal. That is why Buffett responded to the girl with 'you are killing me'. it begs the question: which place has integrity, when a promise was made to someone (group) that you cannot renegotiate with afterwards? and you find out it has negative effects to continue to keep the promise? is it better to break such a promise? would that be responsible?" – Paid-up subscriber Andreas

Porter comment: Andreas, you bring up an interesting point, which I admit I hadn't considered at all.

Personally, I wouldn't view splitting Berkshire in into two pieces as tantamount to selling any of its holdings. It would just be dividing them in a way that benefits shareholders.

As shareholders would have to approve such a division, I can't imagine that would render Buffett's promise invalid or broken. Those companies, as a point of fact, wouldn't have been sold. They would still belong to Berkshire. The assets would just be organized in a new way, allowing shareholders to hold the assets that best serve their needs: Berkshire I (insurance and capital-efficient stocks) and Berkshire II (heavy assets, levered, and dividend-paying).

Regards,

Justin Brill
Baltimore, Maryland
May 15, 2018