This Week in Barrons – 10-12-2014:
“What line were you in when they were giving out testicles?” … The Judge (the movie)
Dear Ms. Yellen:
Do you remember in 1973 when FASB (the Financial Accounting and Standards Board) began regulating a company’s financial reporting according to GAAP (Generally Accepted Accounting Principles)? GAAP is an excellent, ‘real’ representation of a company’s health. It seems, because GAAP is so clear and hard-hitting, that we have allowed our companies to fall back and report on a ‘Pro-forma’ basis. ‘Pro-forma’ accounting allows a company to EXCLUDE any transactions (mostly expenses) that it believes can obscure the accuracy of its financial outlook. These excluded transactions (called ‘ex-items’) are reported separately. For example, between 2007 and 2010, companies reported $1.87T in real earnings, and correspondingly over $550B in Pro-forma ex-Items. It was this $550B, which allowed over 78% of our corporations to ‘make’ (rather than ‘miss’) their earnings estimates. I was thinking (as we enter yet another earnings season), what if we forced companies to return to GAAP accounting? If you forced companies to ‘Man-Up’ to their real earnings, wouldn’t that be a good thing in terms of transparency and understanding?
Ms. Yellen, when QE was first introduced – did you realize that it would have such a ‘slowing’ effect on the ‘velocity’ of money. I have to think that when Ben Bernanke can’t refinance his mortgage – banks aren’t lending enough. And you can’t blame them because banks earn larger returns by investing all of your interest free money back into the stock market. But, by investing in the stock market, it means that banks are NOT investing in mortgages, and that does fairly dramatically slow down the ‘re-circulation’ of money. It also slows down inflation. Honestly, inflation should be between 3% and 4% by now; however, the CPI (Consumer Price Index) is only up 1.7% and your inflation measure (the PCE deflator) is only up 1.5%. On one hand you have 5.9% unemployment, you’re stopping QE, and increasing rates – while on the other hand you have deflationary pressures and the dollar is rallying. I think you’ll agree that the strong dollar (although good in the short-term for the voters - lowering gasoline prices) is bad for the markets, government debt and deficits. Aren’t we all going to have to ‘Grow a Pair’ and just realize that our stock market should be around 10,000 and not 16,400 – and accept the crash that is coming?
Ms. Yellen – globally we going to have to grow a ‘Major League pair of Cajones’ in order to continue to ignore:
- Germany’s industrial production crashing to lows not seen since 2009 – due mainly to U.S. sanctions on Russia.
- Yields on French Bonds are seeing their lowest rates in 250 years.
- Greece is defaulting – yet again.
- China is creaking and groaning due to over-building – not to mention clashing with Hong Kong.
- Russia is still invading the Ukraine,
- ISIL is still attacking IRAQ and Syria,
- The International Monetary Fund (IMF) lowered its estimate for global growth for the 3rd time this YEAR.
- And Ebola is beginning to have a real impact on travel and decision-making.
Lastly, Ms. Yellen your FOMC meeting (on October 29th) directly precedes the November 4th midterm election. If you stick to your path of ending QE and continue talking about increased interest rates – you could really sound the ‘death knell’ for the Democrats in the midterm elections. Wouldn’t it be easier and more ‘democratically’ accommodative to announce QE4 – on October 29th – just 6 days before the elections? And let us not forget, the last time the FED announced a QE (QE3) it was September of 2012 – directly before the Presidential elections. So I truly think on October 29th, every member of the FED is going to have to figure out: “Which line they were all in – when they were giving out Testicles.”
A couple weeks ago I devoted a large portion of this newsletter to a potential pullback in the market. I explained all the reasons, the warning signs that were flashing, and how we could be looking for our first, true 10% correction in over 3 years. We did get the pullback, and (as usual) it magically stopped when the market was down 4.5%. That is exactly what happened on Wednesday when we got that ‘insane’ 280 point bounce, which looked (once again) like they were going to just let it rip back to the upside, and take us right back to the highs. But on Thursday – someone didn’t get the memo – because instead of following through with a nice green close – we fell for 300 more points. And then (as if to add insult to injury) we lost another 115 points on Friday – falling over 445 DOW points in 2 days.
Therefore, we are at a very interesting place indeed.
- The Russell 2000 has completely broken down,
- The VIX (fear index) jumped over 30% on Friday,
- The TLT (bond index) increased substantially on Friday,
- The DOW is under it’s 200-day moving average, and
- The NASDAQ and S&P are sitting at their 200-day moving averages (that have not been broken since 2012.)
This week starts earnings season. On Tuesday and Wednesday we're going to receive earnings from most of the major banking institutions. Will they show enough ‘Pro-forma’ earnings to make everyone believe that all is well and jam us higher, or are we really going to finally see our first real correction? I want to say that this time it is different, and they're NOT going to reverse this any time soon and jam us higher. But just saying that brings ‘shivers’ to my spine.
I think that the FED will try for a bounce on Monday, because the bond market is closed for the Columbus Day Holiday. I think that ‘bounce’ will carry into Tuesday and Wednesday and then it’s all up to the earnings in the financial sector. I think if the financial sector cannot ‘kick it in gear’ in a major way, then ‘yes’ we are headed considerably lower.
For Monday, watch the 200-day moving average on the S&P. If that fails (with or without the banks), we are going considerably lower. FYI: If we get a real 10% correction, the DOW will be dropping an additional 1,000 points. So hold on to your hats.
1. Bloomberg reported that companies in the S&P are poised to spend $974B on buy backs this year, which is 95% of ALL their earnings.
2. Wal-Mart (the single largest employers in the U.S.) announced that it is ending healthcare for its part time workers because it's too expensive.
3. The difficulty with the markets gaining any footing quickly is the huge headwind coming from the energy sector, where the combination of horizontal drilling and fracking is transforming the industry. Supply is simply booming and prices are falling. Back in 2005, the US was importing ten-times (10X) as much oil as it was exporting; now that ratio is down to two-times (2X) and headed lower. In the next few years, the US could easily become a net exporter of petroleum. These forces are creating disarray in OPEC. Saudi Arabia is willing to accept lower prices for oil, undercutting other oil exporters in the Middle East as well as Russia. West Texas Intermediate, which was $104/barrel in late June is now approximately $86/barrel, and probably has further to fall.
I predict that the next FOMC meeting (at end of October) will sound far more dovish, and will halt or reverse course from their current mentality. For optics sake, they may wind-down and end the QE3 program, but that will be coupled with a new accommodative policy and certainly long-term zero interest rates. If they maintain their hawkish tone, this market will come under a huge amount of pressure and it would be damning for the Democrats in the upcoming midterms. Remember, the market saw corrections of 15% to 18% following the ending of QE1 and QE2. And, other than the midterm elections – why should this time be any different?
In terms of my own portfolio, I’m fairly ‘ruthless’ in cutting stocks that are declining in a downturn. My mantra is: “Re-Entry is just a Commission away.” I either use the a) 2-closes below the 21-day moving average rule, or b) trailing stops to sell during a downturn.
My current list of potential candidates is as follows: I still like the indexes RUT, SPX, and NDX. As far as individual names: CME, CBOE, MON, UA, PRU, STJ, ABT, WYNN, IYT, TRV, FDX, UTX, MYL HERO and TEX. I like the biotech sector as well with names such as VRTX, AMGN, REGN and IBB beginning to look interesting.
My current short-term ‘Larger-Cap’ holds are:
- KO (Beverage) – in @ $41.17 – (currently $44.42),
My short-tem ‘Small-Caps’ holds are:
- IG – in @ $7.27 – (currently $8.43),
To follow me on Twitter and on StockTwits to get my daily thoughts and trades – my handle is: taylorpamm.
Please be safe out there!
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