Tuesday/Thursday Market Commentary

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The Two Presidential Candidates Don't Have The Answers
8/05/16 2:00 PM

This comment discusses the assumptions we have been using in our commentaries over the past 20 years or more.  We have been consistently reminding our viewers that the debt built up over the years has a major bearing on the economic health of the U.S. economy, as well as the economic health of other developed countries, who have also built up significant  debt positions.  It should be clear to investors that are as concerned about the debt how these same countries’ GDP slowed down, just like the U.S. We will also discuss why the plans of the two candidates running for the Presidency of the U.S. will not begin to solve the debt problems that are overwhelming us.

It is clear to us that the increase in debt in the U.S. is responsible for the slowdown in the economy that we discussed for many years.  It was made even clearer when the GDP revisions were reduced sharply downwards this past week.  In fact, the GDP results have been significantly lower in all of the developed countries than virtually all the U.S. economists have been predicting for the past eight years (ever since the “Great Recession”). 

We are glad to have recently seen another individual who is also of the same opinion on the worldwide debt as we are.   His name is Atif Mian and he was interviewed by one of the financial networks recently about this situation.  He is a Princeton University professor and he wrote a book, entitled “Household Debt & Business Cycles Worldwide”.  He showed that whenever Household Debt (H/H Debt) rose sharply, it would be followed by a consumption boom.  But debt financed booms of any kind are not permanent as at some point the debt has to be paid back. This boom would be followed by a reversal in the trade deficit, as imports collapse.  Countries with an H/H Debt cycle more correlated with the global debt buildup would be followed for years with a sharper decline in GDP growth. 

Over the past 11 years we have consistently pointed out that the level of H/H Debt caused the “Great Recession” in the U.S.  We believe the same consequences were also prevalent in virtually every advanced economy that built up their H/H Debt before the “Great Depression”.  It is the result of the fluctuations of aggregate demand as monies are borrowed and spent. But, once that spending dries up, something else is needed to substitute for the missing aggregate demand.  When borrowers can’t or won’t borrow any more the economy slows.  

This is a key cause of the economies’ sub-standard growth since the “Great Recession” of 2008 and 2009.  Since then, the Fed tried to increase demand through monetary policy (with QE 1, 2, and 3 as well as building up their balance sheet from $500 bn to over $4.5 tn.).  The US ZIRP and the European and Japanese NIRP, that were intended to solve everything by stimulating financial assets directly and then have a spillover effect to spending and growth, have only successfully stimulated the former.  People are saving what they can, but growth remains anemic.  While debt remains at near record levels, bond yields are near all-time low levels and stock prices are near all-time highs.  Valuations are also not far from all-time highs.  In the meantime corporations are buying back stock, hand over fist, and in many cases borrowing the money to do it at the expense of long term capital investment.  This is not the formula for a vibrant economy and financial markets.

Countries that have been able to weaken their currencies have been able to handle these shocks more effectively than those that haven’t weakened their respective currencies.  But as we have stated many times in referring to the “Cycle of Deflation” (see attachment), devaluations and competitive devaluations (as countries attempt to export their deflation to other countries) are followed by protectionism and tariffs.  It appears to us that is exactly the mantra of candidates Trump and Clinton.  The Fed and financial press have many times used the term “escape velocity”, referring to an acceleration of growth that would allow the Fed to normalize rates.  So far, unfortunately, “escape velocity” is nowhere to be found.  We believe it will be very difficult to extricate our country from this unprecedented situation.

From our point of view, neither Trump nor Clinton have articulated policies that will solve our debt problems.  Though Trump has payed lip service to the size of the $19 tn public debt the protectionist policies he espouses, we believe, will only slow the economy further and thus decrease tax revenue while at the same time adding to the debt and deficit.  For her part, Clinton has not made any mention of the debt as that would be critical of the third Obama term for which she appears to be running. When viewed from the standpoint of Total Credit Market Debt and GDP growth (see attachment courtesy of Ned Davis Research) it is crystal clear to us that as debt has grown at higher rates than GDP, the economy continues to slow further.  Please note that the Total Credit Market Debt to GDP Ratio, while off its all- time high, is still in the stratosphere.  We believe Trump’s stated tax and trade policies should drive debt up by a staggering number.  Clinton’s giveaways to the middle class (such as free college tuition) and the continuation of the Obama regulatory morass should also make our debt problem even worse.  And keep in mind we have not even addressed unfunded liabilities (Social Security, Medicare, etc.) which are estimated to be between $80 - $200 tn.

In summary, we once again state that we are in the “Central Bank Bubble”.  The Fed got things rolling with ZIRP and the Europeans and Japanese upped the ante with NIRP.  The Chinese, it should be mentioned, do have “normal” interest rates.  That’s the only thing that’s normal for their economy and stock market that are not remotely free.  They too are ultra-extended and sitting on a Mount Everest of debt.  The politicians do not appear to have the answers currently, so in closing we say, “Buyer Beware”!

The Central Bank Bubble Is Worse Than The Dot.Com & Housing Bubbles
"Unintended Consequences"
7/07/16 5:05 PM

We warned our viewers, over and over again, how the Dot.Com Bubble and Housing Bubble would play out.  We are now warning our viewers that the unwinding of the “Central Bank Bubble” will be worse than either of the other two bubbles.  It seems like most investors continue to show apathy even with the warnings by us and quite a few others of the “unintended consequences” of the central banks doing things that have never been done before.  Those investors are in good company because it appears to us that the leaders of the major central banks of the world do not have any idea of the “unintended consequences” either.

Think for a moment about exactly what changes the Federal Reserve took in continuing to keep the Federal Funds rate at zero or close to zero for approximately the past 8 years.  This is called ZIRP (Zero Interest Rate Policy) and the Fed, or any of the central banks that followed the Fed’s lead, had any idea of the “unintended consequences” of this policy.  However, if you think they took a chance with ZIRP, just think about the chances our Fed took while building their balance sheet up from $800 bn. in 2008 to over $4.5 tn presently.  They did this by using three Quantitative Easing (QE) programs and one “operation twist” program.  These programs were designed to increase the Fed’s balance sheet by buying U.S. mortgage bonds and U.S. Treasury notes and bonds. The other major central banks followed the Fed’s lead and grew their balance sheets in similar fashion to the Fed.

Our central bank (The Federal Reserve) is now attempting to unwind these extremely risky policies, while the rest of the world is attempting to copy the same risky policies that wound up painting the Fed into a corner.  We believe the unwinding will be extremely negative for the U.S. stock market. 

The “unintended consequences” of which we speak have recently taken place for the Bank of Japan (BOJ) and the European Central Bank. They each discovered this when they implemented negative interest rate policy (NIRP).  It is hard to believe that these powerful central banks experimented with things never tried before and will probably wind up burying the economies and countries that they are supposed to be helping.  Now we have long spoke of currency wars as part of the “Cycle of Deflation”.  The countries that have gone to negative interest rates, in an attempt to weaken their currencies and stimulate their economies have seen their currencies strengthen, their economies hardly budge and stock markets fall…exactly the opposite of the intended effect! 

We believe the Fed’s unwinding (as they continue to try to do things that have never been tried before) will again lead to the “unintended consequences” of a significant bear market and global recession.  They already found out what happens when they stopped each of the QE’s and “operation twist” as the stock market declined sharply.  This time they believe they can stop QE 3 and at the same time raise the Fed Funds rate.  Again, this has never been tried before and will probably lead to a major bear market once interest rates are normalized.  As we have stated time and time again, the only things that U.S. QE’s have stimulated have been financial assets, real estate and certain collectibles.  Stock prices have been driven to near all time highs on both and absolute and relative valuation basis while U.S. debt has yields that have been driven to all time lows.

The S&P 500 made its peak level in May of 2015 at 2134 and has subsequently had major declines while the peak has not been penetrated in 10 unsuccessful attempts to exceed it.  This has brought us to having to drive through all of the technical resistance brought about from these 10 attempts to break through the 2134 peak.  On the downside, we think the “unintended consequences” of this combination of stopping QE and raising rates will drive the S&P 500 substantially lower than the 1810 trough that took place earlier this year.  In fact, we wouldn’t be surprised to see the market drop at least to the 50% level of the Dot.Com decline in 2000 which would take it to 1067, or the Housing Bubble breaking down by 58% in 2008-2009, which would take the market down to 896.  We hope we are wrong, but we believe this is where the market could reach as the result of the aforementioned central bank policies.

The central bankers just can’t seem to understand that the problems of the global economy and stock markets came about from the central bank (especially the Fed’s) mistakes and interference while they just guess at solutions.  The main reason for the increased debt burden started with the Federal Reserve reducing the Fed Funds Rate to 1% in June of 2003 and keeping it there for a year causing the Housing Bubble.  They continued to shut their eyes to the obvious sub-prime housing loans that were being sold as if they were valuable.  Back then the sub-prime market was only $1.3 tn while now we have negative interest rate sovereign debt of close to $12 tn and all time low yield U.S. debt to the tune of $19 tn.  The global debt has increased by about $60 tn since 2007 and there is no way to have a smooth and quick recovery after the debt has grown so quickly (see attachment). 

In summary, remember that the root cause of the many worldwide economic problems, especially the slow growth everywhere, is the overwhelming debt incurred by almost every country.  As long as the major central banks continue to ignore the persistent debt build-up (even encourage it) we certainly do not see how we can avoid a recession and bear market.  The major central banks of the world are now implementing never tried before experimental policies that have distorted financial markets to a point that is nearly unrecognizable.

Operating Versus GAAP Earnings
This Time is Not Different
6/02/16 8:15 AM

As we write this month’s comment the S&P 500 stands at 2,099, 1.33% away from its all-time high of 2,134. So we thought this would be a good time to discuss whether stocks are cheap or expensive relative to historical norms. When investors consider this question they most frequently analyze stock prices relative to past and future earnings. We have the privilege of having written articles on this subject that were published by Barron’s magazine. The articles are titled “What’s the Real P/E Ratio” and “A Simple Calculation” (see attachments).  In the articles we describe the various and often confusing ways that Price/Earnings (P/E) ratios are calculated, and which are used primarily by bulls, and which are used primarily by bears. If you are not familiar with this topic or need a refresher we urge you to open the attachments and read these articles. We continue to subscribe to all that we stated which can be summarized most succinctly as our belief that it is most correct to use GAAP (Generally Accepted Accounting Principles) earnings on a trailing twelve month (TTM) basis when calculating the P/E.


We explain in the attached article that “operating earnings” exclude write offs, while “GAAP reported earnings” include write offs.  That is the main difference, but the difference that is getting much more important as more and more companies resort to using “operating earnings” in order to increase their earnings while bringing down the P/E ratio.  As recently as the early 1990’s GAAP earnings were used exclusively when we started the entrance into the greatest financial mania of all time.  There were so many write offs by companies making unwise investments and then reversing them, that “operating earnings”, grew much faster than the companies using GAAP earnings.  The write offs that had been unusual (using write offs as temporary) became common for more and more companies.


So here is some information based on data from S&P’s website that we believe to be particularly pertinent. With about 97% of the S&P 500 companies having reported first quarter earnings it appears to us that the GAAP number will be $22.43, give or take a little. When added to the previous three quarters we get $87.15 a share in earnings. We should add that Operating Earnings (Non GAAP) look to us to be $99.48, about 14% higher. That differential is slightly higher than when the market peaked in Q3 2007 and also higher than when the market peaked in Q1 2000. Recall that the main difference between Operating and GAAP earnings are that inclusion of extra-ordinary, non-recurring items in GAAP Earnings. Thus to the extent that extra-ordinary items exist, Operating Earnings will always be higher than GAAP Earnings. We also suspect that a good part of this differential (Operating vs. GAAP) is due to the large volume of stock buybacks (many financed by debt and at excessive valuations) that we believe have been a major support for the market. When restricted stock and options that were granted to corporate executives become vested, the “in the money” amount comes directly out of shareholders equity.   GAAP Earnings capture this while Operating Earnings do not.


So given the above numbers of $87.15 in TTM GAAP Earnings versus a 2,099 close the S&P 500 is selling at a 24 multiple. To put that in perspective, if you had a business that you worked hard to build that made $100,000 after taxes and someone walked in off the street and offered you $2.4 million for it you might be inclined to respond “sold to you”! That decision, of course, might be more complicated and largely be a function of expected growth rate, but as we see the numbers, 24 is a historically very high multiple for the stock market in general.


So again from numbers we obtained from S&P here are a few data points that we believe are enlightening. At the end of 1988 the index was 278, the P/E was 11.69. The index “took off” from 306 at Q3 1990 and the P/E was 14.08. Those type of P/E’s might be the kind one would therefore view as on the cheap side, where the market has large potential. On the other side of the coin, for the several quarters preceding the bursting of the “Dot Com Bubble” in 2000 the P/E was in the high 20’s to middle 30’s, the highest that we can document at a top. When the “Housing Bubble” burst, the market dropped from 1527 at end of Q3 2007 and the P/E was 22.19. It had dropped all the way to 1166 (-24%) at end of Q3 2008 and the P/E was 25.38… and THEN the bottom fell out. The point here is that we are in the ballpark of all time rich valuations and while it’s impossible to predict the day a bear market begins, history tells us it is more likely that there is much more downside risk than upside potential. In our opinion, when this period in stock market history is in the record books it will prove to have been a major selling opportunity.


History has many examples of “this time is different“ and we suppose that a big part of the “different” this time is that the economy is finally ready to take off after a “great job” by the Fed in navigating the economy out of a crisis (that began almost 8 years ago!) In other words we finally are about to grow our way out of the low growth/high valuation mess that we’re in. We fully understand what the bulls are saying or more accurately, hoping. We and others call this “The Central Bank Bubble”.  The Fed did its part by stepping on the gas to get us out of the recession caused by the bursting of “The Housing Bubble” (which they and the government were complicit in causing in the first place.)  By keeping its foot on the gas for almost 8 years all it did was inflate financial assets and increase wealth disparity.   We continue to believe that “this time is NOT different” and that in due course “The Central Bank Bubble” will burst.

The Ending of QE
4/28/16 9:05 PM

The ending of QE-3 formed a stock market top formation that presents a very strong technical resistance that will be DIFFICULT to overcome!!

The stock market swings (based on the S&P 500) have been extremely volatile since the end of QE-3 in December of 2014.  In fact, ever since QE-1 ended in 2010, QE 2 ended in 2011, Operation Twist ended in 2012, the market rose slightly and then fell sharply soon afterwards.  Now that the Fed ended QE-3 and have started raising rates the stock market has been very volatile and we suspect that the swings will wind up breaking down through the lows of 1812 and 1810 that took place early this year. (First Attachment—Ending QE and the Markets Reaction). 

(Second Attachment—S&P 500 – Ten Market Peaks) These are the same type of stock market swings that remind us of all the other endings of QE phases.  This time the S&P 500 rose into 2015 to make a record high in May of 2015 at 2135 (rounding out for simplicity).  The market has not exceeded that level since then, even though it has come close numerous times over the past year. In fact, in 2015 the market rose to 2120 in February, 2115 in March, 2126 in April, 2135 in May, 2130 in June, 2133 in July, 2117 in October, 2115 in November, and 2002 in December. Also there has been a 2020 peak this April--that's 10 peaks over the past 15 months.  That's a lot of peaks to break through, especially when the Fed is trying to tighten and you can see from the first attachment that the market breaks down whenever they just stop loose monetary policy. 

The lows made last year were 1867 in August and 1872 in September.  The second low in September was interrupted by a strong move back to 2021 also in September.  The lows that were made this year (2016) were 1812 in January and 1810 in February.  These two lows were also interrupted by a sharp move up to 1947 also in February and the low of 1810 was called the Jamie Dimon low on February 11th.  That was because of Dimon’s purchase of his company stock, JP Morgan, that same day.  The move up since the Feb 11th low has been quite impressive by rising to 2120 in April and is still pretty close to that peak now (2076 ). 

The bulls have been watching the stock market rise to new highs without many corrections over the past seven years.  In fact, the market has not had a significant decline since this bull market started in March of 2009.  Clearly, this seven year bull market in the U.S. was due to the Fed pumping in enormous amounts of money into the financial system.  Such monetary policy in the U.S. (and also worldwide) distorted the way money is typically distributed and inflated the price of stocks, bonds and anything else that trades, including commercial real estate. 

This ludicrous monetary stimulation policy was not confined to the U.S.  The rest of the world copied the U.S. as well as Japan, who has been doing a similar monetary policy for the past 27 years without much success.  The Japanese stock market hasn’t come close to the 39,000 reached by the Nikkei in late 1989.  It is now trading around 16,700.  The Bank of Japan (BOJ) has been even more outrageous than our Fed since they have been buying everything imaginable to keep their economy afloat.  Their present ownership of common stock ETF’s is mind boggling!  Their Japanese government and the (BOJ) own over 10% of over 200 stocks of their most widely traded index, the Nikkei 225. The BOJ has just recently decided to use negative interest rates to stimulate their economy and weaken the Yen.  The “unintentional consequences” hit them as the stock market fell and the Yen rose.  Negative interest rates are also being used by the ECB in order to grow the European economy.  As is the case with Japan, we believe their efforts will fail miserably.  In China, though rates are not negative, the Public Bank of China (PBOC) has “doubled down” and added huge amounts of renminbi debt over the past seven years.  In fact the government debt has grown to 243% of GDP over the last 7 years.

We have been extremely critical of all the Central Banks that have been guessing on the policies they use while hoping everything will work out without even considering the “unintended consequences” that may occur.  Just by studying the first attachment chart you can see what a difficult time the Fed will have in reversing their extremely loose monetary policy.  Every time they have tried to reverse it, the stock market drops, and now they are scared to death of trying to raise rates again after the decline the market took in January, not long after the first rate hike in December. 

In the U.S. alone the Fed’s balance sheet grew from just over $500 bn in 2009 to $4.5 tn presently.  This drove interest rates much lower and essentially forced investors (who wanted to get an adequate return on their money) into risky stock investments, risky bond investments and even commercial real estate.  The Fed claimed they were saving the U.S. from going through another “Great Depression”.  They could be correct in that assessment since this crisis is still called the “Great Recession”.  What the Fed didn’t tell anyone about is the fact that they all have been complicit in this crisis. 

Comstock was one of the first institutions that came out being very, very critical of the Fed since it was so clear to us that what took place to provoke the "Great  Recession" was caused by Alan Greenspan.  He got it right at first during the dot com era when he stated in 1996 that the worldwide markets reflected "irrational exuberance" but then changed his mind when the stock market continued up and he thought maybe this time it would be different!!  When the market finally broke in 2000 he should have realized  that the U.S. market was the most overvalued market in its entire history.  He didn't and instead in 2003 he lowered interest rates to 1% and kept them there for a year.  This started the worst financial crisis and depression since the "Great Depression".  As our readers are aware we have comment after comment on our website, Comstockfunds.com , about the Fed and central banks. In fact, we have a “special report” titled “THE CENTRAL BANK BUBBLE”.

We firmly believe that if the Fed decides to raise rates at this time, while most other central banks continue their stimulus plans, the results could be disastrous.  If the Fed does move this year (which is a high probability), it will drive interest rates higher, the U.S. dollar higher, and the stock market lower.  If the Fed makes more than one rate hike this year, it will just drive the rates and U.S. dollar even higher and the stock market much lower.  However, if we are correct and the stock market drops sharply after the first hike, we suspect they will make the first hike the last hike for the year and maybe forever.  In fact, if they really fear the market as much as we think they do, they could even go back to QE-4.  But, in our opinion, if they do the investors will not continue to be the Fed’s flunkies any longer and the market will still fall sharply knowing there is no way out of this mess except to tighten.

In our opinion, once the Fed makes the next rate hike the market will not have a chance of breaking through the 10 peaks outlined in the second attachment.  Those are all peak prices that should hold with such a weak economic recovery (0.5% GDP for the first quarter), earnings and revenue recessions, and a stock market with very high valuations (22 times earnings if GAAP earnings are used).

Corporate Buybacks Aren't What They Used To Be
3/31/16 3:30 PM

“Financial Engineering” as it applies to a corporate structure usually is defined as the aggressive use of various techniques to enhance shareholder value by affecting the balance sheet.  Probably none has received more attention over the last several years as stock buybacks.  It seems that not a day goes by that CNBC and the financial media are reporting that companies have initiated or increased share buyback authorizations, and there has been a great deal of attention given over the last many months to whether share repurchases represent a judicious use of a corporation’s capital. 

In this report we will attempt to shed some light on this topic and also examine what message the market may be saying about large companies that are doing buybacks.  This is possibly one of the most important questions facing market participants today since the U.S. has been in a zero or near zero interest rate environment for 87 months (an unprecedented amount of time.)  During that time corporations have raised record amounts of long term debt at historically attractive levels, while at the same time remaining voracious buyers of their own shares.   The major buyback companies as a whole have outperformed over the last 7 years, since the bottom on 3/9/09.  However, this recently has not been the case as we will illustrate.

Now in this era where it seems there is an index for any financial asset class that can be measured there are indexes of companies that are buying back their own shares.  The performance metrics of the two most popular are reasonably similar so we will focus on just one, the S&P 500 Buyback Total Return Index (SPBUYUT).  This index is calculated by S&P back to 1994 (numbers sourced from Bloomberg), though it appears a more recent creation since trading volumes and ranges don’t appear until 2013.  This index is equal dollar weighted and rebalanced quarterly.  It is a subset of the S&P 500 consisting of the 100 companies that for the 4 previous quarters have repurchased the largest percentage of their market capitalizations.  We will compare this to the S&P 500 Total Return Index (SPXT).  This index is capitalization weighted and like SPBUYUT reinvests dividends.  It is thus a reasonable “apples to apples’ comparison.

While we would argue that returns on financial assets have been inflated by an experimental and dangerous environment the Fed has created through QE and ZIRP the numbers tell us that since the market low on 3/9/09, SPXT has returned 252% while SPBUYUT has returned 374%.  A shorter and more recent time frame, however, tells a somewhat different story.  Since the 3/9/09 market low there are 29 rolling 4 quarter periods we examined.  Of the 29 periods, there have been five where SPBUYUT underperformed.  There were 2 in 2012 and the most recent 3 (through this writing on 3/29/16).  The largest of the 5 is the last 4 quarter roll and the underperformance number is 7.02%.  So we believe that the market is starting to punish companies that are the most voracious buyers of their own stock.

There are several arguments made by buyback opponents that go as follows:

  1. Buybacks steal from the future by expending resources that should be used to fund/ensure future growth in exchange for the short term gratification of a higher stock price that is the result of the buyback.  Worse yet, if financed with debt, the debt has to be serviced and paid back eventually.

  2. Buybacks do not return money to all shareholders (as dividends do) but rather only to selling shareholders; (that are now no longer shareholders)

  3. Corporate managements have an inherent conflict of interest when, as is typically the case, their compensation is determined by EPS metrics that are influenced by the buybacks they authorize.

These arguments make sense to many, including us.  It is likely true, however, that when the markets are near the high end of their all time ranges, most investors either don’t care or overlook these facts.  When the extended bear market that we see coming arrives in earnest, we believe the finger pointing and recriminations will arrive with it.

In summary, our regular readers know that we believe the U.S. is in a long term deflationary cycle that is the result of excessive debt (see attached “Cycle of Deflation”).  The debt situation has been exacerbated for the last 87 months by the “experiment” of QE and ZIRP by the Fed.  Other Central Banks have followed with their own QE and ZIRP/NIRP.  During this time frame corporations have been large buyers of their own stock with much of it financed by debt.  This most certainly has been a prop under the market.  But as stated above corporations are doing so to the detriment of long term investment in the business.  While in the past, indexes of companies doing buybacks have outperformed their market benchmarks, that has started to change recently.  Buybacks done at elevated levels of valuation will prove to be ill conceived and ill timed (think Devon Energy and Amerada Hess which recently needed to sell equity at levels far below stock repurchase levels of the past several years).  Companies doing excessive buybacks will negatively affect future growth by underinvesting in capital assets; all the worse if financed with debt.   Because of the aforementioned facts and circumstances, yesterday’s stock buyback winners could prove to be tomorrow’s losers.   We believe that will be the case.


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