After nearly six years of unprecedented intervention by the world's top central
banks, the world's financial markets are hopelessly broken. What used to be
accepted as market gospel and guided investors' decisions in the marketplace,
before the 2008 financial crisis, - no longer seems to apply in today's marketplace.
Wall Street is no longer the bastion of free and open markets, where the prices
of bonds and stocks are determined by the collective judgment of millions of
investors. Instead, market prices are determined by a handful of political
appointees, called central bankers, who pull the levers and intervene from
behind the scenes, in an effort to influence the direction of the markets.
Playing by the older and more traditional set of rules of investing (prior
to 2008) has caused many astute investors to miss out on some of the biggest
gains in Wall Street's history. The "Least Loved" Bull market is now 63-months
old, and it's the fourth longest money minting rally in history. It's still
running on steroids, with the S&P-500 index having nearly tripled from
its Great Recession nadir, and is now zeroing in on the once unthinkable 2,000-level.
The Dow Jones Industrials are clawing their way higher, and are within spitting
distance of the psychological 17,000-level. The faithful Buy-and-Hold - and
dollar cost averaging investor, is enjoying the ride, having cast aside the
frightful memories of six years ago.
Strangely though, even as the US-stock market indexes soar to new stratospheric
heights, the trading volume in the most actively traded exchange traded fund
- based on the S&P-500 index, (ticker symbol; SPY) has plunged by roughly
-60% compared with a year ago. Investors are more content to let their Bullish
bets ride rather than to add to their exposure to the market. Who is the biggest
buyer in the marketplace today, with an unrelenting bid, that buys on all dips?
The answer is: Corporate America. Amid such thin market conditions, the S&P-500
companies can buoy the market, with a few big blocks of buybacks. And further
dispelling investors' fear of heights, there's the safety net of the secretive "Plunge
Protection Team" (PPT) that rescues the index funds when risky bets go sour.
The aging Bull market on Wall Street is dubbed the "Least Loved" Bull, because
it's been accompanied by the weakest economic recovery from a recession since
the 1930's. Since the recovery officially began in June 2009, the US-economy
has been crawling ahead at an anemic +2% growth rate, or less than half the
vigor of the typical rebound from a recession since 1946. The rapidly expanding
wealth on Wall Street, mostly flowing to the Richest-10% of US-households,
hasn't trickled down to the average household - take home pay of $839 a week
in April '14, was only +$20 higher than in January 2008, when adjusted for
inflation.
What skeptics of the "Least Loved" Bull market have failed to realize over
the past 5-years is that the Federal Reserve has turned the stock market upside
down, making bad economic news a reason to buy stocks, and good economic news
a reason to sell them. The distortion keeps the real value of assets obscure
and stuck in the "Twilight Zone." The answer to this bizarre market behavior
is simple: the stock market is being ruled by the Fed, not by fundamentals.
In simple terms, what matters to the stock market is the easy money from the
Fed, not the performance of the companies whose stocks they are buying and
selling.
Indeed, the Bank of International Settlements (BIS) warned a year ago, on
June 6th, 2013, "the equity markets are under the spell of monetary easing
policies that have enabled market participants to "tune out signs of a global
growth slowdown." Investors are able to shrug off weak economic data and instead,
continue to bid stock prices higher, "amid the prospect of further central
bank stimulus. Abundant liquidity and low volatility fostered an environment
favoring risk-taking and carry trade activity," the BIS observed.
As recently as May 20th, 2014, Philly Fed chief Charles Plosser lamented, "It's
the Fed's fault that the markets are ignoring the fundamentals." "Since the
onset of the financial crisis, central banks have become highly interventionist
in their effor ts to manipulate asset prices and financial markets in general,
as they attempt to fine-tune economic outcomes. This approach has continued
well past the end of the financial crisis. While the motivations may be noble,
we have created an environment in which "it is all about the Fed." Market participants
focus on how the central bank may tweak its policy, and central bankers have
become too desirous of managing prices in the financial world," he said.
"I do not see this as a healthy symbiotic relationship for the long term.
If financial market participants believe that their success depends primarily
on the next decisions of monetary policymakers rather than on economic fundamentals,
our capital markets will not deliver the economic benefits they are capable
of providing (ie; accurate price discovery). And if central banks do not limit
their interventionist strategies and focus on returning to more normal policymaking
aimed at promoting price stability and long-term growth, then they will simply
encourage the financial markets to ignore fundamentals and to focus instead
on the next actions of the central bank," Mr Plosser said.
It's all about the Fed - During the tenure of the Bernanke Fed - the US-central
bank shifted its focus from central banking to central planning, from smoothing
the business cycle to micro-managing the markets and financial engineering.
The trading desk that controls the formerly free capital markets is situated
on the ninth floor of 33 Liberty Street, also known as the home New York Fed.
From a glass-enclosed conference room situated next to a small cluster of trading
desks the uber-secretive "Plunge Protection Team" (PPT) controls the money
flows that determine the daily fate of credit, equity and virtually all other
markets, that have now been hijacked by the central planners at the White House
and the US Treasury. As the number of shares traded each day in stock market
dwindles to a six year low, the PPT has become an even more influential price
setter in the stock market. The PPT concentrates its firepower in the Dow Jones
Industrials futures market, which in turn, can move the S&P-500 index several
points, with trading volumes as pathetically low as they are today.
The biggest winners in the financial markets last year were traders that respected
the old axiom, "Don't Fight the Fed." They rode the QE gravy train, and kept
their bets focused on the increasing size of the Fed's portfolio of bonds.
Under the cloak of "Infinity QE" - the Fed injected $1.5-trillion into the
coffers of its agents on Wall Street, which in turn, was funneled into the
stock market, and inflated the market value of NYSE and Nasdaq listed stocks
by $6.5-trillion to a record $25-trillion today. Since the Fed fist launched
QE in Sept '08, the central bank has increased its portfolio of bonds by $3.45-trillion,
while the value of US-listed shares has increased $15-trillion. In other words,
for every $1 of QE, the Fed increased the wealth of shareholders by $4.35.
The Fed's propaganda artists say the QE injections didn't fuel market bubbles,
because the monies were bottled up at the Fed itself, in special reserves accounts,
which have captured most of the QE monies.
However, the chart above tells a different tale. It shows a +87% degree of
correlation between the growing size of the Fed's bond portfolio and the increasing
value of the S&P-500 index. There has a been few periodic pullbacks in
the S&P-500 index along the way to the 2,000-level, but they were all very
brief, and only served as better buying opportunities for Bullish traders that
kept their focus squarely on the size of the Fed's portfolio. Last year, every
bit of news that did not fit the Bullish narrative was downplayed and soon
forgotten.
Even after racking up a stellar +28% gain for all of 2013, the biggest annual
gain in 16-years, the "Least Loved" Bull market was easily able to shrug-off
news of a -1% contraction in the US-economy in Q'1 of 2014. Proving for the
umpteenth time that a weak economy does NOT translate into a weaker stock market,
when all the smoke had cleared, the S&P-500 index ended the first quarter
with a +1.2% gain, despite the lousy economy. The old adage, "Sell in May and
Go Away," was tossed into the trash heap and the "Least Loved" Bull continued
to show its agility as it climbed to new stratospheric highs.
"Least Loved" Bull market running on 2 Cylinders, - Corporate America, - flush
with $2-trillion of cash stashed away in their US-banking accounts, has decided
there's nothing more attractive than itself. So, the S&P-500 companies
are spending big bucks to buy back their own shares. Last year, they plowed
about 80% of their profits into the hands of shareholders, through buybacks
and dividend payments. Over the past 3 ½ years, the number of shares
of stock available to be bought or sold on the US-stock exchanges has dwindled
by -10%. Shareholders like buybacks because they automatically increase earnings
per share (EPS). And most often, though not always, a higher EPS leads to rising
stock prices. It's also made it more treacherous for short sellers to maintain
bearish bets.
Some notable examples are; Northrup Grumman (ticker NOC), the military contractor
expects to reduce its shares outstanding by -25% by the end of 2015, with buybacks.
Last year, Home Depot (ticker HD), announced a $17-billion buyback program,
that will remove -18% of the shares outstanding at current prices . On June
9th, Home Depot issued $2-billion in five and 30-year bonds, with the intention
to use the monies to buyback shares. The demand for HD's debt exceeded the
supply by a ratio of more than 3-to-1. Shares of FedEx (FDX) the operator of
the world's largest cargo airline, - soared to above $140 /share, after it
authorized a buyback plan equivalent to -10% of its shares outstanding.
The powerful impact of Corporate QE can be seen with the outsized performance
of the Power-Shares Buyback Achievers fund (ticker; PKW) compared with the
benchmark S&P-500 index. PKW buys shares of companies that have already
purchased at least 5% of their shares outstanding over the past 12 months.
The goal is to avoid companies whose buybacks go solely toward offsetting stock
option grants and don't shrink the share count. Since January 1st, 2009, PKW
has increased in market value by +176%, compared to a gain of +113% for the
S&P-500 index fund, ticker: SPY. Analysts estimate that 40% of the increase
in the earnings per share of S&P-500 companies in the past 12-months was
due to the "financial engineering" of corporate treasurers. In other words,
corporate buybacks has scared the daylights out of short sellers - and is conceivably
responsible for about one third of the stellar gains of the "Least Loved" Bull
market.
Financial Engineering at Apple - Everyone knows Apple Inc (AAPL) employs many
of the best high-tech engineers in the world. But who knew some were also on
the financial-engineering side? In a deal that was greeted so eagerly by salivating
investors hungry for a piece of Apple's debt pie, the Cupertino, California
- based iPhone maker issued $12 billion of bonds on April 29th, designed to
reward shareholders with a leveraged buyback of shares. The world's most valuable
technology company has $151-billion in cash, but only $18-billion of that stash
is readily available in the US - meaning Apple needed to issue additional debt
to help fund its $130-billion shareholder capital return plan.
The resurgence of Apple's stock has as much to do with financial engineering
as the company's technological wizardry. For years, AAPL has shifted billions
in profits out of the US and into affiliates based in Ireland, where it negotiated
a tax rate of less than 2%. Its offshore entities have paid little or no tax
in recent years, on $40-billion of earnings generated outside the US. Luca
Maestri, - Apple's chief financial officer, explained on the latest earnings
call, "To repatriate our foreign cash under current US-tax law, we would incur
significant tax consequences and we don't believe this would be in the best
interest of our shareholders."
The sharp rebound in AAPL's share price to near its all-time high has a lot
to do with the wizardry of Carl Icahn who has repeatedly argued that AAPL's
shares were undervalued, and Icahn did provide a blow-by-blow update on Twitter
of every new investment he's made in the company since June '13, when he first
disclosed his buying spree in AAPL.
On October 1st, 2013, Icahn said in a tweet that he had pushed Apple CEO Tim
Cook for a $150 billion share buyback, " Had a cordial dinner with Tim last
night. Pushed hard for a $150-billion buyback. We decided to continue dialogue
in about three weeks," Icahn tweeted. In a CNBC interview, Icahn emphasized
how strongly he felt about an increased buyback. "It's a no-brainer and it
makes no sense for this company with their multiple being so low not to do
a major buyback. And there's another reason that I mention, that I think might
go forgotten, the fact that you can borrow money so cheaply today. I don't
think we are going to see this again," Icahn said on CNBC's "Halftime Report."
"They have a golden opportunity to go borrow money. With Apple trading at
about $482 per share, a repurchase of this kind would mean buying more than
300-million shares. Apple currently only has about 900 million shares outstanding,
so a buyback of this size would be a reduction of more than one-third," Mr
Icahn explained. On April 23rd, 2014, Apple put Icahn's advice into motion,
it issued $12-billion of debt, boosted its dividend +8%, and said it would
spend an additional $30-billion to buy back shares, taking to $130-billion
the total amount it plans to spend on repurchases and dividends by the end
of 2015.
Even before the ramped up buybacks, Apple had already reduced the amount of
its floating shares by -8.5% to 860-million shares, and by shrinking the float,
helped to catapult AAPL's share price to $665 today, (pre-split basis) up from
as low as $390 in April '13.
AAPL's most brilliant maneuver was voting to authorize a 7-for-1 stock split.
Since the split was announced in late April, Apple's stock has climbed +25%,
creating more than $100-billion in shareholder wealth while the benchmark S&P-500
index edged up +4%. The lower price also clears the way for AAPL to be included
among the 30 stocks in the Dow Jones Industrial average. Meanwhile, the mastermind
of AAPL's resurgence, - Carl Icahn, the "King of Wall Street" can celebrate
since his hedge fund (IEP) is holding 7.5-million shares of AAPL.
Even as stock prices continue to spiral higher, the S&P-500 companies
are trying to keep pace by raising their dividend payouts . 421 of the S&P
blue-chips are expected to pay a combined $348-billion of dividends this year
. That equals a dividend yield of 2.3%, or about 30-basis points less than
the yield on the US Treasury's 10-year note.
Dow Blue-Chips Unfazed by Shakeout in Small Caps, Nasdaq high flyers, - There
hasn't been a correction of -10% in the benchmark S&P-500 index for 34-months.
Historically, a correction rocks the market about 18-months apart, on average.
Yet there was a stealth correction within the US-stock market from the beginning
of March through the middle of May that went undetected by the unsuspecting
US-public. For instance, the small-cap Russell-2,000 index recently tumbled
-10% from its all-time highs, skidding to the 1,100-level. Other segments of
the high flying Nasdaq index, such as the social media, bio-tech, and internet
retailers stocks were hit even harder, plunging -20% or more. Even Nasdaq kingpins
such as Amazon, (AMZN) lost more than a quarter of its market value from its
peak levels, and the heavyweight champion Google (GOOGL) stumbled -15% from
its highs. As of May 17th, roughly one-third of all US-listed stocks were trading
-20% or more below their 52-week highs, (a bear market), with the average Russell-2,000
member down -24%!
At its peak levels in early March, the Russell-2,000 index was priced at a
whopping 103-times its 12-month Trailing earnings. Historically, its P/E has
averaged 35-time earnings. If there is a bubble to be found anywhere in the
marketplace, the most obvious place to look is the Russell-2,000 index, which
is home to two thirds of all listed US-companies. It's a homegrown collection
of companies that earn about 85% of their revenue within the US's borders,
and is often seen as a proxy for the US-economy. The sudden -10% correction
through the middle of May shaved the Russell-2,000 index's trailing P/E ratio
to 73-times.
Typically, when small-caps get in trouble, a sell-off in the big names is
next. However, on May 7th, the new Fed chief Janet Yellen sought to prevent
the large cap S&P-500 Oligarchs from suffering the same fate, by assuring
Wall Street traders in testimony before Congress that "valuations for the broad
stock market remain within historical norms. O verall, broad metrics don't
suggest we are in obviously bubble territory," she said. And with those magical
words, Yellen put a floor under the Dow Jones Industrials at the 16,350-level.
As the Dow Industrials and Transports quickly regained their footing and climbed
to new heights, the small-caps breathed a sigh of relief. The Russell-2,000
index built a base of support at the 1,100-level, and recovered most of its
recent losses to close at the 1,165-level today. When the PPT does intervene
in the stock index futures market, it concentrates its firepower in the Dow
Industrials contract, where it can get the biggest bang for its buck.
Fear Gauge at 7-year Low, Euphoria sets in, - Nowadays, the higher the S&P-500
index climbs, the less investors seem to worry. Thanks to the hallucinogenic
effects of the Fed's QE-injections, corporate QE (buybacks), and Mergers & Acquisitions,
risk is no longer priced into anything. Everyone has been brainwashed to interpret
and spin all economic news as Bullish for the stock market. There is no need
to hedge and no need to lighten up on positions carrying huge paper profits.
It's enough to just sit back and enjoy the fireworks. As such, the trading
volume on the US-stock exchanges has shriveled up. For example, in the week
ended June 6th, only 353-million shares traded in S&P-500 index fund (ticker;
SPY) that's -62% less than a year ago . In the previous week, only 279-shares
traded.
When the S&P-500 index hit an all-time high on May 23rd, only 24 of its
500-members reached new 52-week highs. That's the lowest participation in a
year. Since 1990, there have been four other times when the SPX set a 52-week
high with fewer than 10% of its members peaking and the overall volume trailing
the average. In 3-of-4 occasions, the SPX fell at least -5% in the next two
or three months. When volume and breadth are weak, and stock indexes surge,
it's often served as a warning sign that has preceded losses in the past.
However, what used to be true in the past is no longer relevant in the hallucinogenic
world of QE, and the Zero Interest Rate Policy (ZIRP). The Fed has made sure
that markets are a one-way bet, risks are eliminated, and by stimulating investors'
animal spirits - the omnipotent Fed can create a virtuous cycle that will support
economic expansion.
The sharp drop in the number of shares changing hands is not necessarily a
sign of danger, because a certain amount of money will buy fewer shares the
higher the stock price goes. Most companies have chosen no to split their shares,
despite the higher prices. As such, corporate buybacks would lose some of their
potency, since treasurers can buy fewer shares as prices become more expensive,
through their own rigging activities. But for now, most traders are reluctant
to jump off the Fed's QE-gravy train, and the safety net of buybacks.
Serene Sense of Tranquility among Buy-and-Hold Investors, On March 4th, Warren
Buffett told CNBC that investors should not to pay much attention to short-term
moves. "M ost investors are blinded by the markets' gyrations and spend far
too much time trying to form macro opinions or listen to market predictions,
rather than investing simply and prudently for the long-term. Games are won
by players who focus on the playing field, not by those whose eyes are glued
to the scoreboard," Buffet said. And there is no need for investing expertise.
Buffett recommends a low-cost S&P-500 index fund for nonprofessionals. "Forming
macro opinions or listening to the macro or market predictions of others is
a waste of time," he adds. His bottom line fundamental advice: "Ignore the
chatter, keep your costs minimal, and invest in stocks as you would in a farm." (In
other words, just Buy-and-Hold, and relax).
After 5-years of monetary sedation, traders don't see the need to buy ultra-cheap
insurance against the possibility of a nasty market correction. The CBOE Volatility
Index (VIX), also known as fear gauge, can be bought as a hedge against falling
markets . Yet the VIX plunged to its lowest level in 7-years last week, reflecting
the lack of fear of even the slightest pullback. Instead, investors on Wall
Street are mesmerized by the Fed and are comfortable living in a calm and predictable
universe, where there is no fear of turbulence. In the past, contrarians used
to view such complacency as a major warning sign of a bubble top.
Outlook; The "Least Loved" Bull market is still running on steroids, even
at 63-months old. The median lifetime of the Top-12 Bull markets is 55-months.
So it's lasted 8-months beyond its mid-life. A -10% correction hasn't happened
for the past 34-months, far beyond the average of 18-months between corrections.
Yet it looks as though the S&P-500 index has entered the Euphoria stage,
- the fourth and final phase of the Bull market. It wouldn't be surprising
to see the Madness of Crowds, - where frustrated investors jump off the sidelines
to buy equities, alongside the indiscriminate buyers, (ie; corporate treasurers),
in what's called a "Melt-Up." The Euphoria stage could see the S&P-500
index surge another +5% to +10% higher from today's close of 1,950. Even as
the Fed winds down its QE injection scheme by October, its comrades at the
Bank of Japan and the European Central Bank will be running the printing presses
in its absence, and keeping the liquor flowing for the late night partiers.
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