This Could Mean the End of the Bull Market
Dr. Doom: Don't believe the Fed... Bad news for the economy... Sjuggerud: This could mean the end of the bull market... Buybacks are plunging... Is 'contagion' here?... P.J. O'Rourke: What Washington insiders really think...
The Federal Reserve is "obsessed" with the stock market...
So says Marc "Dr. Doom" Faber, economist, investor, and editor of the Gloom, Boom & Doom Report.
Like us, Faber believes the Fed is more concerned about whether the market is rising or falling than the economic data it purports to follow closely.
In fact, he thinks last week's coordinated announcements about a potential June rate hike were meant to test the market's response. As he explained in an interview with financial-news network CNBC last week...
[The Fed] said a rate hike is on the table so they can watch the market reaction. If we are, in June, 10% to 20% lower in stocks and bond yields are up, they're not going to move. If, on the other hand, the market is relatively stable and moves up from here... they will probably move. They're very much market dependent in my opinion.
While the official measures like unemployment, economic growth, and inflation are at or near the Fed's stated goals, Faber doesn't think the economy is as healthy as those numbers suggest. More from the interview...
My sense is that the economy is, in some sectors, hardly growing. The retail-sales figures are very suspicious and the employment figures are also suspicious. The difficulty is, can you trust the published data, whether that is in the U.S., in Europe, or in China? Of course I don't.
Like several other notable investors we've heard from recently, "Dr. Doom" is especially bullish on gold stocks. But like us, he also believes proper asset allocation is critical today...
The most attractive asset in my view is gold shares... I think they still have significant upside potential this year... You need to be diversified. To own some real estate makes sense, to own some equities makes sense, to own some cash and bonds probably makes sense, and to own some precious metals makes sense.
Speaking of the economy, new data last week showed one of the job market's early warning signs could be flashing. Staffing firms say hiring of temporary workers – one of the biggest drivers of job growth over the past several years – has suddenly slowed.
Why is this important? Because temps tend to be a strong leading indicator of the health of the broad economy... They're often the first employees companies add when the economy strengthens, and the first that companies let go when it starts to weaken.
The Wall Street Journal reports we saw a similar slowdown in temp hiring before each of the past two recessions. As Donald Grimes, a labor economist at the University of Michigan, told the Journal...
It's the first sector that really begins to lose jobs. If you start seeing those numbers go negative, you've got a real problem.
Meanwhile, our colleagues Steve Sjuggerud and Brett Eversole recently noted another troubling sign for the job market...
Initial jobless claims – a measure of the number of new folks applying for unemployment each week – just broke out to a new one-year high... And their research shows this could be bad news for U.S. stocks. As they explained to subscribers in last week's True Wealth Systems Market Extremes...
Stocks actually lose value when Initial Jobless Claims trend higher. And Initial Jobless Claims recently broke out to a one-year high. Take a look...
According to history this move is enough to push Initial Jobless Claims into an uptrend. And history shows that stocks lose 2.0% a year when the trend is up in Initial Jobless Claims.
Obviously, this is a bad thing for U.S. stocks. If this trend continues, it could mean the end of the bull market.
Steve and Brett said they aren't ready to give up on the bull market just yet. It's still a little early to know if an uptrend has begun, but they'll be watching for confirmation in the weeks to come...
Jobless Claims data are notoriously "messy." So the recent reading could be an anomaly, not the beginning of a new trend. However, we'll be watching U.S. employment closely going forward. A continued employment breakdown could mean a recession is on the way. And stocks suffer their biggest losses during recessions...
The U.S. economy and the trend in stocks will be major factors in how we invest in the next few months. And this breakout in Initial Jobless Claims is an important piece of that puzzle. It says to be cautious of the U.S. market today.
Troubles in the job market aren't the only new worries for stocks...
According to Bloomberg Business, the five-year "binge" in share buybacks could be over. (If you're not familiar, share buybacks are when companies purchase their own shares in the market and "retire" them. This reduces the number of shares outstanding and makes each remaining share more valuable.) From the article...
After snapping up trillions of dollars of their own stock in a five-year shopping binge that dwarfed every other buyer, U.S. companies from Apple to IBM just put on the brakes. Announced repurchases dropped 38% to $244 billion in the last four months, the biggest decline since 2009, data compiled by Birinyi Associates and Bloomberg show.
The number of companies cutting dividends has also soared to the highest levels since the financial crisis.
As we've discussed, share buybacks are a double-edged sword.
Under the right circumstances – particularly when shares are trading at a discount to the value of the underlying business – they can be great for investors.
But most of the time, this isn't the case... Just like most individual investors get bullish when the market rallies and bearish when the market falls, corporate executives often choose to buy back shares after they've rallied and are expensive.
Worse, as real earnings have slowed in recent years, management teams have been incentivized to buy back more and more shares regardless of price. They've even been loading up on debt to keep the party going.
Again, this is because buybacks reduce the number of shares outstanding. By reducing share counts, the same amount of earnings is magically transformed into higher earnings per share, Wall Street's favorite metric of profit growth.
Now it appears the slowdown in earnings may have finally reached a tipping point.
Companies may no longer be willing or able to take on more debt to buy back shares and pay dividends... meaning one of the biggest drivers of the stock market rally could be about to disappear. As Commonwealth Financial Network Chief Investment Officer Brad McMillan told Bloomberg...
If the only meaningful source of demand in the market is companies buying their own shares back, then what happens if that goes away? We should be concerned.
Regular Digest readers may recall Porter predicted exactly this scenario last summer. As he wrote in the September 4 Digest...
It should be obvious to everyone that companies can't spend more buying back shares and paying out dividends than they earn – at least not for long...
The last time the S&P 500 managers collectively spent more than they were earning on shares and dividends was the second quarter of 2007. Just a few months before the market's last peak. The managers' spending reached 156% of their free cash flow in the fourth quarter of 2007. You may recall the last big stock market peak was in November of 2007...
The more important thing to understand is that, when they are spending more collectively than they're earning, their buying power is immense – enough to move the market higher by itself. When they stop buying, it's almost certain the market will fall. And they can't keep spending more than they're earning, not for long.
Regular readers know Porter has also predicted a period of vast credit default, or the "greatest legal transfer of wealth in history," as he calls it.
In particular, he has warned that defaults won't be contained to just the oil and gas sector... Instead, "contagion" could spread to every corner of the corporate-bond market.
After the recent rally in high-yield (or "junk") bonds and other corporate debt, some folks may be thinking those predictions were off the mark.
New research from Deutsche Bank says those folks are wrong...
In a recent note to clients, credit strategists Oleg Melentyev and Daniel Sorid warned that there are already signs of contagion in high-yield debt outside of energy and other commodities. They also said history suggests these problems are likely just beginning. As they wrote...
Default cycles of the past have never been about a single sector, or small group of sectors. Yes, cycles were always driven by concentrated distress, but they always found their way to affect other areas of the market...
A frequent argument is being made here how all problems are going to stay limited to [the] commodity sector. Evidence like this, coupled with emerging credit pressures in retail and capital goods sectors, suggest a contained cycle to be a weak starting assumption.
Finally, a quick note before we turn things over to New York Times bestselling author and Digest contributing editor P.J. O'Rourke...
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New 52-week highs (as of 5/20/16): none.
A slow day in the mailbag... Surely, we've done something to please or upset you. Let us know at feedback@stansberryresearch.com.
Regards,
Justin Brill
Baltimore, Maryland
May 23, 2016
What Do the Washington Insiders Think?
I've been back and forth to Washington, D.C. three times since Donald Trump's victory in the Indiana Republican presidential primary. Now that we have (presumably) learned who the presidential candidates will be, I wanted to find out what Washington Insiders are thinking about the election.
Washington is full of pundits, policy wonks, think-tank thinkers, political gatekeepers, and so-called "down ticket" politicians (the people running for all the other offices on the ballot in November). They comprise the entity that is collectively known as "Inside the Beltway." I've been trying to take its temperature. No jokes, please, about where I'm sticking the thermometer.
"Washington Insider" has been the ultimate insult this election cycle. Trump's platform seems to consist entirely of declaring he's not one. Whatever insiders favor, he's against. (Never mind that he's running to be the biggest insider of all.)
The most powerful argument Bernie Sanders has against Hillary Clinton is that she's a political-establishment insider. (As if former representative and current Senator Sanders, who has barely ever held a job outside politics, isn't.)
In reaction to Bernie, Hillary has moved her rhetoric to the left until she sounds like what she's inside is an "Occupy" movement tent. (Check her campaign finances to see where she really is – inside the pocket of donors from the 1%.)
So why should we care what Washington Insiders think?
Because they know how the government works. Insiders understand the fiendish intricacy and arcane details of lawmaking, judicial rulings, regulatory processes, and bureaucratic operations.
The government may be working badly. The insiders may need to change what they're doing and how they think. But in a hospital operating room, when the hip replacement isn't going well, we don't call in a car mechanic to take over with a wrench and a pair of pliers.
And let's be fair to car mechanics. When a piston rod is thrown, we don't ask an orthopedic surgeon to make the repair.
Washington has complex problems. Solving complex problems involves expertise. When expertise is needed, experts are required.
I talked mostly to conservative experts. That's because I find liberals are mostly experts at creating schemes for "equality" and "fairness." That is, they won't replace your hip, but they'll promise to make everybody else in America limp.
Also, the liberals were busy doing their Happy Dance. They think that the youth vote, the minority vote, and the women's vote add up to make it impossible for Hillary to lose.
I'm not sure about the liberal arithmetic. I think they're like little kids counting on their fingers while wearing mittens.
We're dealing with an equation containing double negatives. According to the latest aggregated poll figures from the Huffington Post, Trump has an unfavorable rating of 57.8% and Hillary's unfavorable rating is 54.5%. It's hard to call a race predictable when public opinion is running 112.3% against both candidates.
I live in New Hampshire, a "deep purple" swing state. The two comments about the election I've heard most from my neighbors are, "I can't vote for him, but I really can't vote for her," and, "I can't vote for her, but I really can't vote for him."
Conservative Washington Insiders are saying the same thing. And often the same person says both things.
The smartest person I know in Washington – I'll call him "Deep Thought" – holds an endowed chair at a large and influential nonpartisan public-policy institute. Deep Thought is only somewhat given to exaggeration for effect. He said, "It's like having to choose sides in the Hitler-Stalin Nonaggression Pact of 1939." Deep Thought pondered his quip and then looked somber. "You'll recall," he said, "in the end, we did have to choose sides."
Choosing sides has caused conservative insiders to fall into three groups:
1. Reluctant supporters of Trump. One of these told me, "He has brought a lot of new people into the Republican Party. And after November, I hope they'll all go back to where they came from."
2. Very reluctant supporters of Hillary. One of these told me, "She's wrong about everything, but she's wrong within the known and tested parameters of wrong."
3. Desperate seekers after a viable third candidate. And I tell myself, "Knock, knock... Who's there? Nobody at all."
I talked to former New York City Mayor Michael Bloomberg at one of those big hotel ballroom dinners that Washington Insiders love to hold. Bloomberg, who certainly understands the economy, would have been a great third-party candidate. I said, "Mr. Mayor, I've got $10 right here in my pocket to start a 'dark money' PAC to get you elected."
He laughed. He's not running. Given Bloomberg's record as a businessman and politician, I'm sure he did the math on a third-party candidate's chances. And he's good at math.
I gathered from our conversation that Bloomberg thinks any third-party candidate would either help Trump or Hillary win.
Deep Thought pointed out that although we have a large number of discontented independent voters this year, their discontents are very different. Some think America has taken a wrong turn, and some think America should take a left turn into oncoming traffic. No third-party candidate could appeal to both.
At another one of those dinners I sat next to a senior military officer whose uniform had enough brass on it to make a tuba. We chatted politely about what a strange election season it had been and I said, "If I had to take a guess, I'd say Hillary is going to be the next president."
And he said, "I hope so."
He could see I was surprised. Senior military officers never make partisan political comments. And especially never to a reporter, no matter how off the record the occasion is supposed to be.
"I may," he said, "have a president I agree with. I may have a president I don't agree with. That's fine. But we can't have surprises."
The Reluctant Trump Supporters are counting on the inertia of Washington Insiders to make sure that Trump doesn't do something too surprising.
Any president we get is going to have to deal with "Inside the Beltway" inertia. And the Reluctant Trumps certainly looked inert. They were subdued and glum about the prospect of their candidate winning.
I asked the editor of a prominent conservative publication how things stood with his staff and contributors.
"They're all over the place," he said. "X hates Hillary. Y detests Trump. Z has asked everybody, including Ike's ghost, to run as a write-in."
I asked him how he was handling it.
He said, "Time for the 'Three Monkeys' editorial policy: 'See no Hillary,' 'Hear no Trump,' 'Speak no Third-Party Candidate.' We're going to run a lot of intellectual stuff."
Which brings us to a question that you, the reader, are doubtless already asking: "This grim, pessimistic column that P.J. just wrote – what the heck message is it supposed to have for investors?"
The message is what my editor friend said: "Run a lot of intellectual stuff." Or as it's called in investing, "due diligence."
We're going to get a bad president. The economy will be the worse for it. So it's up to wise investors to start examining the institutions and individuals inside the beltway. Which of these will help avoid or mitigate the disasters threatened by the next administration (whoever's leading it)? Which institutions and individuals deserve encouragement and support?
It's up to smart investors to begin looking carefully at the platforms and policy positions of the congressmen and senators running to become or remain Washington Insiders.
Washington Insiders are – like what's inside our own "beltways" – the guts of the operation. As with our own guts, we know what Washington Insiders are full of. But we can't do without them.
Regards,
P.J. O'Rourke
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