But before we drive down that one-way highway we need to look at the “canary in the coal mine”!
Look at the United States’ $80 billion auto bailout. You’ll find record car sales through last December (though they declined in the first half of 2017) but falling earnings for some of the major carmakers.
Currently the subprime title vehicle public traded companies have forsaken the guidelines used to bond and package each contract portfolio that is then bundled as globally securitizations to raise additional (close to zero interest rate) capital. Consequentially, the subprime lenders abusive modified usurious rates that are regulated by the geographical loan or lease origination, will not provide the financial reserves put aside to offset the modeled losses. These loses will not cover the recovered collaterals underlying collateral that secures the contracts of the securitizations. Adding insult to injury, no longer will the future perfected civil judgments be a credit deterrent for a future subprime or prime borrower or lessee. In addition, the fix is in with the credit reporting agencies being strong armed by the financial institutions to make a new crop of credit worthy borrowers and lessees. The "Fake News" as the current swag declares is not the "Consumer Protection Agency". The July 1, 2017 policy of removing any civil judgment, tax lien and most public records due to the redaction of certain data on an individual’s analysis is a last ditch effort to raise the individual to the current bondable guidelines. Why? Each portfolio is bonded and commission/fee priced (normally 3% of deferred contract price)based on credit grades of the individuals, loan to value of the underlying collateral and the age of the collateral. Without the artificial scoring increase the futures of the originators and securitizations would first be: 1) Non qualifiable 2) Second or third bite of the apple as the repossession will not be visible for future underwriting 3) Create a domino effect across the mortgage, credit card and personal lending institutions.
We have been down this crooked road a few times in the last 40 years. From the Resolution Trust Corporations in the 1990’s to the so called Great Recession of the 2000’s and approaching the finish line in the 2017-2018 era. Having been involved personally as the regulator compliance marketer, originator, servicer, collector that helped in the guideline validation and detailed national and international bonding securitization of over 2 billion dollars of collateralized, bonded and serviceable collateral, this unfolding scenario is concerning. Our analysts’ project the next financial crises will be a head on collision with the titled vehicle lending and leasing industries that will cascade into a waterfall of horrendous historical defaults and financial domino corporate collapse. When will this happen? No one knows! It’s probable already started and the drastic lending criteria is the canary in the coal mine. Where is “Big Bad John” when we need him as the song goes, anyways. Based on these assumptions, we are preparing a Special Purpose Company with an LLC classification for Accredited Investors. This LLC will allow for individual portfolios underwritten and bonded by AAA bonding componies. We have stopped short of issuing Bearer Bonds but this concept is still on the options board. “We shall see”, said the blind man at the artificial intelligence underwriting desk that has replaced the three C’s of lending: 1) Character 2) Collateral 3) Capacity. If history is a teacher the reset button might not be to far in the financial future.
In the mean time Bulls are running free but the Bears have been storing nuclear ammunition.
This week, companies with a total of $3 trillion in market value will announce their results. Unless there are some surprises, they will show modest increases in earnings.
But wait; there’s something fishy here. Since 2009, earnings per share for U.S. companies have increased a spectacular 265%. Sales, however, have gone up only 32%.
How is that possible? Another miracle?
When the cost of borrowing is low, companies prefer to get financing from debt. When it is high, they switch to equity – they issue stock.
Debt financing costs are as low as they have ever been; naturally, shrewd CFOs have borrowed heavily, increasing corporate debt by more than $1 trillion – a 50% rise – since the bottom of the last crisis.
What do they do with the money?
You buy back your own shares and cancel them. This removes shares from the market, increasing earnings per share for the remaining shares. (Each remaining share then represents a higher portion of the company’s earnings.)
Since 2009, the open market share count has gone down as earnings have gone up. According to Real Investment Advice, this has added $1.60 per share to the earnings of the average company.
Instead of investing its money to produce more at a lower cost, corporate America has used debt financing to buy back shares at the highest prices in history.
Corporate chiefs get stock option bonuses (because share prices go up). But now the company is deeper in debt and floating on a tide of easy money.
For our own family account, we have money in stocks, gold, cash… and real estate.
Since we think we are nearing a financial catastrophe – this post-1971 credit bubble must pop sometime – we keep nearly half our liquid wealth in cash and gold, more than we would normally want.
As for stocks, we are never “in the market,” merely hoping that it will go up. Instead, we have two main strategies.
First, we rely on “special situations,” or Specific Purpose Companies we want to own regardless of the up and down trends on Wall Street.
Second, we also follow a strategy based on contributor Michael O’Higgins’ “Dogs of the Dow” approach.
O’Higgins found that simply buying the cheapest stocks can pay off.
The problem is stocks are often cheap for good reason. Companies go broke. Their stocks go to zero and never come back. That almost never happens with entire stock markets.
Which is why we’ve modified O’Higgins’ approach. Instead of buying the cheapest stocks on the Dow, we buy the cheapest country stock markets around the world.
This is our “Dogs of the World” portfolio.
Last week, we reported that the U.S. stock market is now the world’s most expensive, judged by a range of different tried-and-tested valuation metrics.
That makes the U.S. the least-attractive country market right now.
In our Dogs of the World portfolio, we look for the world’s cheapest country stock markets and update it annually. One choice. Once a year. Easy-peasy.
Of course, this is not for people who check their portfolios daily… or even monthly.
Among the world’s cheapest now, for example, are Turkey and South Korea.
Turkey is cheap because its government just narrowly survived a coup d’état in which military jets tried to shoot down the president’s plane.
South Korea is cheap because North Korea aims its missiles in that direction.
Maybe these dogs will turn out to be good investments. Maybe not. But by our reckoning, they are safer bets than the pampered pooches of North America.
The Doom Index is made up of 11 indicators:
1. Bank loan growth
2. Credit downgrades
3. Junk bond prices
4. Stock market valuations
5. Margin debt
6. Investor sentiment (contrarian indicator)
7. Manufacturing sentiment
8. Railcar traffic
9. Nonfarm payrolls
10. Household debt to disposable income
11. Quarterly building permits
These are updated on a quarterly basis. And each quarter, they award Doom Points based on what these indicators are saying.
When the index hits six or seven Doom Points, it’s time to be cautious. When it hits eight or nine Doom Points, it’s time to raise the tattered “Crash Alert” flag.
The Doom Index stands at six now, which is our “soft warning” level.
Here are the highlights from the second quarter: The Fed reported credit growth at 0.8%. This number is down from the Fed’s first-quarter report of 1.5%.
We also saw an uptick in corporate bond downgrades this month. You can almost feel the tension in the credit markets. But junk bond prices are still holding up strong.
Stock valuations remain high relative to historic levels. But our bullish investor sentiment indicator is coming back relatively low. The euphoria that precedes a major crash is not there.
Household debt-to-income numbers are still at moderate levels as well. On the other hand, auto loans and student loans are through the roof.
So, all in all, the data coming in for the second quarter is a mixed bag.
In the short term we like Microsoft for their recover and cloud technology. Also, still investing in SKF in dips down to $22.50 but as a dog is a dog lets not bury this bone yet.
Disclosure: I am/we are long SKF, NUE, MSFT.