Checking In on a Critical Market Indicator
The tragedy continues... GE's fall from grace is now complete... Checking in on a critical market indicator... 'Inversion' could be just days away... In the mailbag: A big worry about commodities...
Earlier this year, Porter recounted the tragic collapse of General Electric (GE)...
In short, what was once a bellwether of American Industry was slowly (and secretly) transformed into one of the biggest financial frauds in U.S. history. As he explained in the January 19 Digest...
The problems began under GE's "legendary" CEO, Jack Welch. Rather than wonder how GE could always beat its quarterly earnings estimates by exactly one penny, the financial media turned him into a star. In his books, Welch explained exactly how GE used its various subsidiaries to sell assets to generate "earnings" and make their numbers, quarter after quarter.
That is, of course, exactly what Enron did. But GE had a lot more assets to juggle, and so it was able to keep the game going for a long, long time. It also had a lot more power in Washington, D.C... And it owned NBC, which meant it could largely control how the financial media (CNBC) characterized its strategy. Yours truly has been banned from CNBC for 15 years. It's no wonder why.
Way back in 2002, I began to warn investors about the huge, obvious problems with the balance sheet of General Electric and the ethics of its managers. Despite the collapse at Enron, nobody seemed to notice that GE was doing the exact same things. Rather than earning its "profits" through its large industrial businesses, GE was engaged in a giant financial gamble. It was mortgaging all of its industrial assets and using its AAA credit rating to access immense amounts of capital, eventually leveraging itself more than 30-to-1.
By 2009, the company was careening toward bankruptcy...
Without the government's unprecedented support following the financial crisis, the story likely would've ended there.
However, despite the big rebound in GE shares over the next several years – from less than $6 in 2009 to as high as $33 in 2016 – the company remains a shell of its former self. It's a heavily indebted "zombie" that can barely afford even the interest on its massive debt loads today. As Porter explained in the April 27 Digest a few months later...
[GE is] saddled with more than $60 billion in net long-term debt. (Please note: That's net debt – after subtracting all of GE's cash.) Even with record-low interest rates, GE still faces interest obligations of almost $3 billion per year.
And here's the problem: These interest rates are likely to rise a lot faster than GE's ability to grow earnings. Currently, GE earns only $3.6 billion year, when measured by "EBIT" – that's earnings before interest and taxes. If its interest expenses grow and its earnings don't keep up, GE will have a difficult time paying its debts in its current structure.
And don't forget, GE requires at least $7 billion a year in capital investments (capex) to maintain its facilities and position its businesses for future growth. In other words, while GE can do some things to avoid bankruptcy (like cutting its annual capex spending), it isn't earning enough capital to finance both its debts and future growth.
In other words, GE is once again caught up in a 'death spiral'...
But unlike last time, the market is anything but surprised this time around. More from that Digest...
GE's problems are now well known to investors because last year the company's new CEO came forward and told everyone what had really been going on in the company. (We'd been reporting on GE's weak financial position for years.)
You can see what happened to the company's stock price as these balance sheet issues became clear to the market.
Shares have fallen even further since then...
They're now trading within pennies of a fresh nine-year low below $13 per share. Barring another unexpected rescue – or a radical restructuring or breakup – the company is unlikely to survive the next downturn.
In the meantime, S&P Dow Jones Indices isn't waiting around to find out. The firm announced last night that it was officially "booting" GE from its widely-followed Dow Jones Industrial Average after more than 110 years. As the Wall Street Journal reported...
General Electric will drop out of the Dow Jones Industrial Average next week, a milestone in the decline of a firm that once ranked among the mightiest of blue-chips and was a pillar of the U.S. economy.
It will be replaced by drugstore retailer Walgreens Boots Alliance, the latest sign of the rise of the global consumer economy and the postcrisis boom in debt issuance that has fueled a worldwide deal-making frenzy.
The decision to drop GE, an original member of the Dow that has been a part of the 30-stock index continuously since 1907, marks the latest setback for a company that once was the most valuable U.S. firm but has been hit hard in recent years by the unraveling of its finance business and competitive problems.
We can't say we blame them. After all, GE has been the worst performer in the Dow for the past five years... and it's one of only two Dow stocks with a negative total return over that time.
Of course, the move is largely symbolic at this point...
Because the Dow is weighted by share price rather than market cap like most other indexes, GE accounts for only a minuscule 0.36% of the total index today.
In addition, relatively little money is actually benchmarked to this index anymore. According to S&P Dow Jones, just $30 billion of mutual and exchange-traded funds track the Dow Industrials compared with a massive $9.9 trillion that tracks the S&P 500 Index. And – for now, at least – GE remains in this index.
Still, the move marks a sad – if fitting – end for one of America's most iconic companies.
But hey, at least any remaining shareholders can be confident GE won't be the worst-performing stock in the Dow this year.
Elsewhere in the markets, one of the most reliable 'early warning' indicators for stocks and the economy is getting dangerously close to flashing...
We're referring to the U.S. Treasury yield curve, or more specifically, the "spread" between yields on long-term and short-term debt.
As we've discussed, normally long-term yields are higher than short-term yields, so these spreads are positive.
But occasionally, this relationship "inverts," and short-term yields rise above long-term yields. Spreads turn negative... and history shows these inverted yield curves are often followed by a recession and a major bear market in stocks.
As regular Digest readers know, the most widely followed of these spreads is known as the "2-10" spread. As the name implies, this is simply the difference between the yields of benchmark 10-year Treasury notes and two-year Treasury notes.
The 2-10 spread has been falling steadily since February, and just hit a new post-financial crisis low of 0.35% last week. This is concerning... But again, history suggests real trouble doesn't begin until at least several months after the yield curve first inverts.
In other words, we're getting closer...
But we still aren't there yet. However, a different, lesser-watched spread suggests it may now be just a matter of time. As Bloomberg reported on Tuesday...
The first step in the inversion of the U.S. Treasury curve may be poised to occur as soon as next week. The spread between 7- and 10-year yields slipped below 3.5 basis points Tuesday, after shrinking to 2 basis points last month, the smallest gap since at least 2009.
The difference between the maturities, the narrowest among on-the-run benchmarks, may not be particularly well-watched. But its descent into negative territory has historically been a harbinger of similar moves elsewhere along the curve, often in as little as a few days, according to data compiled by Bloomberg and BMO Capital Markets.
In other words, the "7-10" spread has often been a "canary in the coalmine." When this particular spread inverts, the rest of the yield curve tends to follow.
New 52-week highs (as of 6/19/18): Amazon (AMZN), WisdomTree U.S. SmallCap Dividend Fund (DES), Eagle Bulk Shipping (EGLE), and Sysco (SYY).
Anger and confusion in the mailbag... How have we disappointed you? Let us know at feedback@stansberryresearch.com.
"I keep hearing that were supposed to be in an up cycle for commodities, but precious metals and uranium keep going down, down, down. Please explain thank you." – Paid-up subscriber Clint
Brill comment: Clint, you're not the only one who feels this way. We've heard from many folks with a similar concern. There's just one problem: It isn't actually true.
You see, while it has certainly felt like these commodities have been falling, all three have been quietly moving higher for years. Gold and silver are up 22% and 19%, respectively, since bottoming in late 2015, while uranium is up nearly 18% from its 2016 low.
But they aren't alone... Many other commodities have been slowly trending higher, too. And yet, with the exception of crude oil, sentiment toward most of them remains so bearish that most folks don't even realize it. And that is why the potential upside is so great today.
Again, Steve will be sharing all the details on this opportunity at tomorrow night's live event. Reserve your free spot right here.
"Does the hucksterism never stop? Shame on you. We bought True Wealth China Opportunities due to [Steve's] 'once in a lifetime' recommendation of [Chinese stocks]... all heading steadily down and silence from you. True Wealth China Opportunities subscribers should receive any new info on China without having to buy something else. Tiresome & ridiculous." – Paid-up subscriber JMO
Brill comment: We're not sure what you're referring to, JMO. While Steve has recently become bullish on commodities, he remains as bullish as ever on China. He still believes Chinese stocks will soar hundreds of percent from here. Yet, he has also been clear that this won't happen overnight. This is a longer-term opportunity... and there will be plenty of pullbacks along way.
We'll also note that despite the recent pullback, Steve's True Wealth China Opportunities recommendations have done incredibly well to date. Twenty-two of his 24 recommendations so far are in positive territory, including 18 double-digit gains and two triple-digit winners, as of yesterday's close.
And of course, as a True Wealth China Opportunities subscriber, you will continue to receive all of Steve's new China research and recommendations as promised.
"I received an email from Ten Stock Trader suggesting to sell [the KraneShares Bosera MSCI China A Fund (KBA)], yet I haven't seen that from Steve? Puzzled... I sold half my shares early morning and after the suggestion from Ten Stock Trader, I sold the rest as for days these China Opportunity stocks have been dropping?" – Paid-up subscriber Wille B.
Brill comment: Again, the recent correction has not changed Steve's bullish long-term thesis on China. And he continues to recommend owning shares of KBA in both his True Wealth and True Wealth China Opportunities services.
On the other hand, our Ten Stock Trader service is focused primarily on shorter-term trades. Editor Greg Diamond recommended buying shares of KBA late last month to take advantage of a specific short-term trading setup. Earlier this week, he recommended closing this trade, but this decision had nothing to do with Steve's recommendation.
Regards,
Justin Brill
Baltimore, Maryland
June 20, 2018