Tuesday Troubles – Dow 20,000 Getting Further and Further Away

Only 4 trading days left to 2016.

But it’s been 16 days since Barron’s put Dow 20,000 on the cover (12/10) and that nut is looking harder and harder to crack as days keep passing without making the mark.  Undaunted by the first week of failure, Barron’s doubled down the next weekend by rounding up 10 analysts who think 20,000 is just the start (even tough we’re not there yet).  Here are their S&P targets:

Now, to be fair, this group (mostly the same) pretty much nailed it for 2016 and I guess we’d have to say they were right, despite the fact that they were wrong until November 7th.  Not Stephen Auth, he predicted 2,500 – I’m surprised they asked him back.  The rest of the group averaged 2,200 in their predictions and essentially nailed it for the year.  They also predicted a 10-year note yield of 2.5% and we’re at 2.543% – that’s really impressive given how unpredictable the Fed is.

For 2017, the average prediction is only 2.8%, which seems very unlikely given that we’re at 2.5% now.  GDP growth forecasts average 2.4% and earnings estimate for the S&P 500 range from $116 to $135 and that’s really enthusiastic since S&P companies are still not back to 2013 earnings levels – a lot of this enthusiasm is based on a reviving energy sector.  

My “confusion” as to all this bullishness, is that I’m not sure that rising gas prices, removal of Obamacare, cuts to Social Security and Medicaid, etc are going to be good for corporate sales?  Of course, you don’t need to make more sales as long as you make more profits and less corporate taxes = more profits and less outstanding stock (buyback) means more earnings per remaining share.  

Also, there is a lot of anticipation that US companies will be granted another repatriation tax-holiday, as the $2.5Tn they have stashed overseas to avoid taxes under Obama can finally come home without penalty under Trump – well worth the wait when you can avoid $1Tn in taxes, right?  And please, it’s not like the Government needs the money – $1Tn would only pay off 5% of our debt.

A lot of that repatriated capital can go to stock buybacks which, as you can see from this chart, are still at an incredible pace.  As of Q3, the S&P 500 spent $400Bn on buybacks after a 2015 total of $572Bn but many big Q4 announcement may bring us back to that level when the quarter closes.  

Apple (AAPL) alone bought back $31Bn of their own stock and with $250Bn of CASH!!! hiding overseas, they may as well, right?  That’s 5% of AAPL’s entire market cap bought back, which boosts their EPS by 5% which makes AAPL and the whole S&P 500 (SPY) look like they are making more money when they are only dividing the same or less money by a smaller number of shares.  

As a short-term shareholder, this scam shouldn’t bother you – it’s being done for your benefit (well the board’s benefit) but, as a long-term shareholder – it would be nice to see companies investing in the future, rather than milking the past.  AAPL does spend a ton on R&D, which is why I like them as well as (IBM), (GE) and a few other manufacturers who are worth long-term plays.  

So there are ways this rally can continue but they are all based on artificial moves (Tax cuts, tax avoidance, artificially low rates, share manipulation) and, again, this is all fine for a short-term investor but what are we really building here?  You can’t stimulate the markets forever.  I know it seems like you can but forever is a long time and they’ve only been doing it for 8 years – we have wars that last longer than that.  

The difference between being a long-term and short-term investor is that, when a stock we like drops 20% with the market, we buy more.  If you are short-term and get caught in an event – that’s usually that.  So how do we know when a bubble will burst?  

In China, for example, house prices are up 12.3% this year with 8 of the 10 largest cities over 20% and Nanjing up 42.9% – in a year!  New York City Apartments are now averaging $2M (and that’s for 2Br, so consider how many kids you want in millions) and Vancouver home prices are up 24%, prompting the Bank of Montreal (BMO) to become concerned enough to do some studies and make a video warning of a potential collapse:

Speaking of unwanted kids, Japan simply isn’t having anymore as less than 1M children were born to 126M people, well below the replacement rate, which is leading to a very sharp decline in the total Japanese population.

It’s hard to grow your GDP when your population is shrinking and, of course, the strain put on the retirement system as more people retire than enter the workforce can become catastrophic.  Still, this is a logical reaction in a country with high real estate prices and stagnant wages – children are simply a luxury item that have to be cut from the household budget.

Nonetheless, the Bank of Japan loves the Japanese stock market and has been the Nikkei’s single-largest buyer in 2016 at 4.3Tn Yen in ETF purchases, up 40% from 2015.  Remember, it’s not just that they buy the stocks – it’s that they never sell them.  That’s the same as taking them off the market, which decreases the net amount of sellers to buyers and artificially makes demand for their stocks seem higher than it really is – good for everyone except the retail suckers who pay top Yen for those stocks.

As the FT recently noted, “the central bank’s overwhelming dominance of ETFs, combined with the structural oddities of Japan’s most famous but esoteric equity benchmark, the price-weighted Nikkei 225 Average, has given the BoJ indirect but massive positions in many of the country’s biggest corporate names.” Normally, this kind of activity would be associated with command-style, centrally-planned economies such as that of the USSR. Now, however, it is considered part of the “new normal.”

“The BOJ’s ETF program has propped up share prices but distorted the formation of stock prices”, said Shingo Ide of NLI Research Institute. Alternatively, one could say that the BOJ’s ETF program has made the very definition of “market” a joke. The ETF-buying program allows, and in fact mandates, that the central bank purchase a wide range of stocks regardless of the issuing companies’ business results.

This means that zombie companies which would otherwise be insolvent and bankrupt, are kept artificially alive thanks to central bank intervention, which in turn leads to deflation as in the race to the bottom, “zombie companies” around the globe are willing to undersell all their competitors in “hail Mary” hopes of survival, leading to lower interest rates and even more Central Bank intervention.

So we will be doing a zombie lurch into 2017 as we all search for “brains” but we’re playing it very Cashy and Cautiously – probably through Trump’s first 100 days.  That doesn’t mean we can’t find good things to trade.  Over the weekend, I published our Secret Santa’s Inflation Hedges for 2017 and our 2016 spreads are already up $8,969 for a 254% return on cash – so it might be worth checking out, right?  

Be careful out there, 

– Phil

Provided courtesy of Phil’s Stock World.