Marty Zweig died this year at 70. Marty was an investor from another era who appeared frequently on Wall Street Week on PBS. I read Marty's book, "Winning on Wall Street", twenty odd years ago. All I remember from it was high praise for Jesse Livermore and "Don't fight the Fed". I don't know if Marty was able to smile through the cancer that got him, but even in this new era, where trades occur faster than the speed of light (and hedge funds and institutions fight it out rather than individual investors) the only battle cry that has mattered is: "Don't fight the Fed."
So, what happened a few weeks ago when the Fed finally appeared ready to reverse its unprecedented course of lowering rates and buying up treasuries and virtually all of the mortgages out there? It blinked that's what. Perhaps the voting members were a bit concerned about possible political ramifications on the CR (Continuing Resolution) and debt limit? Perhaps they wanted a "coast is clear" determination from the Government that would allow them to make monetary decisions knowing what outside influences on interest rates might be? The other Fed item that really concerns me is its intense effort to politically maneuver the QE boat through troubled waters. One month it forgets that it has stated targets of 6.5% unemployment and 2% inflation as taper benchmarks. The talk is "we'll know it when we see it". This meeting they reverted back to the 6.5% and 2% after two months. Shrinks and sociologists say people hate uncertainty more than anything and an uncertain Fed is scary. Moreover, the desire of President Obama to appoint Larry Summers tells us he knows how tough the rest of this is going to be. I am deathly afraid Ms. Yellen, an uber-dove, will be unable to pull the trigger on tightening until it is way too late.
After three years plus of "0" real rates for its member banks and almost 4 trillion dollars of add-ons to its balance sheet, I am going to suggest that at least being a little nervous about this market is justified. Marty was always nervous, rising to his own personal nervous crescendo on October 16, 1987, three days before the market crash that saw the Dow lose close to 30% of its value in one session. I know you might say "the Fed will only be tapering a titch" (when it does decide to start its engines ) and " it will be 2015 before the fed actually raises rates". Nonetheless I believe we have passed the "Don't fight the Fed" period as justification alone to be heavily invested in this market. And, if the Fed is nervous (has the taper "yips" so to speak) shouldn't we be just a bit concerned about what havoc the government will wreak? What does an indecisive Fed mean for rates and the unwinding of its massive balance sheet? They seem uncertain about which way the economy will ultimately turn, as it appears from all the data to be equally capable of going either way.
Another thought that occurs to me is the overwhelming prejudice of the market to go up any given day, any given year. People, as a commodity, are generally pretty positive and the market is an emotional mirror. Even with the individual investor still skeptical about plopping his/her non-qualified cash back into equities after the 2008/09 disaster, nonetheless every month 401 k contributions and other qualified monies provide a vast, ready supply of new capital for equities. Half of the gains in the market over the last 80 years can be attributed to inflation; it's still around and the Fed wants way more of it.
It would take real selling for this market to go down much. Even a record of withdrawals from equity ETFs in August had no impact. The Indexes are all at all-time highs, give or take. How can that be? Margin #'s on the NYSE are as high as they have ever been. Extreme leverage is usually a sign of a stretched market. On Thursday, after ten days of lost revenue, renewed consumer fears and loss of faith in our government leaders, the idea of a return to short-term status quo inspired a 2% rally. The fundamentals heading into a shaky earnings season hadn't changed a bit.
In 2000, the market bubble finally burst because there were companies that were just ideas trading at obscene market caps. Today, I would argue the overvaluation is even worse. Many of the highest flyers keeping the indexes afloat are businesses that should be well-defined, with cashflows, that have been around awhile. They are capable of being modeled and projected. The absurd price/book, price/sales, free cashflow, PEs of Netflix (NASDAQ:NFLX), LinkedIn (NYSE:LNKD), Salesforce (NYSE:CRM), Tesla Motors (NASDAQ:TSLA), Amazon (NASDAQ:AMZN), Netsuite (NYSE:N), Zillow (NASDAQ:Z), and Green Mountain Coffee Roasters (NASDAQ:GMCR) presage an unhappy ending for many investors. The institutions have poured into these whole hog in order to take advantage of window-dressing and momentum. If, at some point, the economy turns south, or fundamentals are thought to matter again, or interest rates leap, they will all have to exit at once. This will create a deadly stampede.
So, how is the economy? Well, the malls are awfully quiet and unemployment is still unresolved. And does that matter these days for stocks or the companies that stocks represent? (and I do mean to separate the two.) It matters for earnings. As long as interest rates are not much competition, and they won't be for a while yet, there are only three reasons stocks will drop: earnings fall off a cliff, people are scared into selling by an external event, or they need the money. Seventeen billion dollars poured into US ETFs a few weeks ago, the largest input ever for one week. I think that is a large contrarian signal.
First off, how has all the QE worked? I think the name QE, like a cruise ship label, is so apt. Ben really has taken us on an ocean voyage and may not know where port is. It has not done as well in three years as the nascent QE effort has in Japan in six months - in terms of GDP juicing. Housing turned around enough - due to historically low rates and the institutional buying of BlackRock and others - to merit a nod. But individual equity hasn't gone to the moon. It isn't anywhere near where it was at its height in 2006. REITs are performing terribly, the homebuilders haven fallen quietly to near yearly lows if not actual lows. The fairly rapid uptick in mortgage rates is one of the quickest, largest reversals in history and has created scary data going forward on new apps.
The jobs data continues to be perplexing, in light of all the QEs. There were 160,000 jobs in August, the same in September (per ADP). There never has been an outlier like a 300,000 month, a one-off that there should be in a genuinely improving marketplace. The 150-200,000 numbers barely cover the monthly first-time job seekers entering the pool. The constant, sizeable revisions which give me real pause in trusting the data at all; we counted up the jobs but we over-counted by 100,000. Huh? The labor force participation rate is the lowest it has been in 30 years. Wage advancement for the average worker is virtually zero over a twenty year period. The real unemployment rate is far closer to the 14% number folk like Robert Reich are talking about (25% if you happen to be a young minority member). Reich's credentials? He happened to be Sec. of Labor - twice. So bad reports are rejoice for the market, because that means that Goldman Sachs (NYSE:GS), J.P. Morgan (NYSE:JPM), Morgan Stanley (NYSE:MS) and Bank of America (NYSE:BAC) will continue to get new, free money. It is unfortunate that they seem not to want to lend it out, but rather prefer to speculate with it.
The media has done its job; it just loves the cute little terms - QE1, QE3, taper - to death, though it never explains the process very much. Because it is like sausage-making I suppose. The Fed has a bond desk with hundreds of traders in New York. They buy debt from Goldman et al by simply doing electronic shuffles of bonds and treasury money from us. The mandated goal is to energize the economy, create companies needing workers, create a buzz of activity, and even raise pricing power through demand and the increased supply of cash.
We all know that the average retiree looking for a fixed rate of return on his/her savings has been crushed by the artificial low rates in the interest of "saving the country"; they might even have bought some of the Verizon B-rated issue a month ago if they could have - if it weren't way oversubscribed by hungry institutions. So, we have been killed twice by this Fed, because we will now repay the real debt at higher rates. I have a question I have never heard framed or answered in all the noise: why would Goldman sell its bonds to the Fed if rates are going down and the value will go up? Why did they buy them, only to see the market go their way - and then sell them to the Fed? Well, it's because the Fed overpays them. It's another bank gift with no strings - kill us three times. They are not obligated to lend the money and can use it however they want. It's a gang shaking down the American dream and it still poses one of the great mysteries of our time going forward, and one that greatly affects all of our futures. Will they able to safely unwind the vast balance sheet they have created or will they be forced to hold until maturity creating higher rates to finance our government and services? It's virgin territory. Who knows!
And, I will bury this lead way down here, but I believe the Fed has actually been more directly influencing the equity markets (as that is it's only hope for salvation) through direct ETF purchases and Futures buying pre-market to paint the tape. If you watch the ETF inflows between 2-3 p.m. New York time, over the last few years it strongly hints of one very big buyer. I believe this will ultimately be revealed as a "we had to, but couldn't tell you". If you read recently about the relationship between the Fed and Pimco, Wellington, Goldman and BlackRock - whereby the said firms bought bonds for the Fed as part of QEs 1 and 2, supposedly separating this from their normal business by secure locks and codes and sworn secrecy - you would not find this belief of mine to be wild. And, of course since the market is not a zero-sum game like your Friday night poker game, the fed and the street have been strongly inviting the average American to take them out of their " investments" at way higher prices - a very long and wide pump and dump. If the Fed had given the dollars to individuals instead they would not be buying stock or bonds with it; they would be buying lumber, cars, meals, houses, notebooks.
What if we are not in a Goldilocks economy (not too hot, not too cold) anymore? Many Investment commentators have suggested that if we only don't go into a recession we are at a perfect balancing point for stocks and we will never fall off of this high wire. PIMCO says we are going to recess in 2015, maybe it could be May of 2014 if they are sandbagging a bit. My dad, who was a career GE executive, used to say that companies can juggle their financials for the better part of a year, but that they had to pay the piper at year end. So with top-line revenue growth at virtual zero, bottom-line growth through accounting tricks, fewer employee hours, tax loopholes (see Google news today) at a few percent at best, how does this market in multiple expansion go higher without entering the bubble-zone (Greenspanian Irrational Exuberance II)? Add in debt-ceiling, continuing resolution, Syria, Egypt, Iran, government shutdown, new Fed head.
The Fed has taken its shot; it didn't focus on jobs or communities or infrastructure. It is done. I really don't believe that they can leverage their balance sheet anymore without being criminally irresponsible. We have weak data and they need to taper. The money was all wasted - unless you are JPM or GS. Believe me, they will only taper because they are terrified of what they have wrought. This is not a Goldilocks environment, but rather more akin to too hot, too cold, nothing right . It is hurricane season for the markets and the economy that is upon us. Doing my best Marty Zweig, I am nervous, very nervous and, because the structural defects of the US economy, rather the world economy, have not been fixed or improved, and Wall Street has been allowed to run with free money by a cowardly, lazy, risky, uncertain Fed, the fall will be substantial. It won't take much, with the consumer stretched and underemployed, and with higher rates taking a toll, to turn a 2% finagled increase in earnings into a 3% decrease and a recession.
Here are a few points to consider amid some old tapes from my 25 year Investment Advisory career.
- The breadth of the market move in the last several months has been borne by fewer and fewer stocks; much of the inner market has actually dropped as the Indexes hit new highs.
- The cult of personality (an old poli sci term) is religious-like and terrifying. With all due respect, Elon Musk and Reed Hastings and Mark Zuckerberg are no Steve Jobs, nor Jack Welch, nor Bill Gates. A huge number of funds own these profitless gambles that have no domination of their industries, yet have obscene market caps. The fact that people actually think these are sane valuations - and use charts and data to prove it - means that getting out will be as hard to do as booking a 7:30 table on Saturday night at the hottest new restaurant in Manhattan. It will be like the old stockbroker joke: "Sell ... to whom?". NFLX could be Enron - its financials are as obtuse and hidden. It could be Blockbuster; it has no ownership of anything but millions of corroding worthless DVD's. Tesla, after 15 minutes of producing one model, a 75,000 dollar car, has a higher market cap than Fiat, and half that of GM (General Motors). With all due respect, it is a hot Christmas toy right now - like a Tickle-Me-Elmo. It could easily be a memory in five years, but this market discounts none of that.
- As my first cubicle-mate in the Investment business, a character named Vic Lawrence said, "It's a lot better to recommend companies losing money because they can't miss earnings and no one expects very much". I call it the Vic L. rule, and as crazy as it seems, in this bubble-bull market it has been driving much of the gains. I am sorry but LNKD at 700x non-GAAP earnings (which means no real earnings) trading at absurd multiples of book value and sales, NFLX at infinite times earnings, CRM and TSLA the same, CMG (Chipotle Mexican Grill) trading at three times the industry norm - all as stocks have done phenomenally well. As companies, however, would you like them to be your family business, where you needed profits to live on.
- Only in this environment, where they have been able to dilute and buy-back, have they even survived. Real companies with successful business models do not take ten years to become profitable. Real companies are never so overlooked by Wall Street that they can be fairly valued at 5-6x what they were earlier in a year without discovering a cure for something. And everything does eventually revert to real value - gold anyone? It is not a real market - to be trusted - when Apple (NASDAQ:AAPL) trades at 10x earnings, with huge cash resources and a history of profitability (whatever you think of its future challenges and the reverse cult of personality represented by the demonizing of Tim Cook) and can't find an uptick while the non-profits soar. Oh yeah, the argument is you have to pay for growth and you get rewarded for growth; but it has to be growth at a reasonable price - like Starbucks (SBUX) grows or Nike (NYSE:NKE) grows with dollars in the bank, not dollars from stock sales.
Marty RIP, your work is done. The Fed is fighting itself. Its work is just beginning. I also believe Stagflation will ride again, that Netflix and Tesla and Netsuite and Linked-in and Zillow (Z) and even Facebook will shortly be reviled by recent investors and the hedgies, and that fund managers will also be infighting - to get out first and least bloodied. To quote Bob Dylan - in regard to these momentum high-flyers - "those not busy being born are busy dying".