"Least Loved" Bull Hits Euphoria
Wednesday, 6/11/2014 09:58
Nothing has tracked the S&P500's post-2009 bull run like US Fed money creation...
AFTER nearly six years of unprecedented intervention by the world's top central banks, the world's financial markets are hopelessly broken,
writes Gary Dorsch, editor of the Global Money Trends newsletter.
What used to be accepted as market gospel that guided investors' decisions in the marketplace, before the 2008 financial crisis, no longer seems to apply in today's marketplace. Wall Street is no longer the bastion of free and open markets, where the prices of bonds and stocks are determined by the collective judgment of millions of investors. Instead, market prices are determined by political appointees, called central bankers, who pull the monetary levers behind the scenes.
Playing by the older and more traditional set of rules of investing has caused many astute investors to miss out on some of the biggest gains in Wall Street's history. The "Least Loved" bull market is 63-months old, and it's the fourth longest money minting rally in history. It's still running on steroids to new all-time highs, with the S&P500 index now zeroing in on the psychological 2,000-level, (less than 3% away). The Dow Jones Industrials are within spitting distance of the psychological 17,000-level, with most long-term buy-and-hold investors sitting back, snacking on popcorn, and enjoying the show.
Even as the stock market bulls stampede to new stratospheric heights, the trading volume in the most actively traded exchange traded fund – based on the S&P500 index, (ticker symbol; SPY) – has plunged by 60% compared with a year ago. Amid such thin market conditions, a few big blocks of buybacks from Corporate America can jettison the market sharply higher. And for those traders with a fear of heights, there's always the safety net of the secretive "Plunge Protection Team" (PPT) that intervenes clandestinely in stock index futures.
The aging bull market on Wall Street is dubbed the "Least Loved" bull, because it's been accompanied by the weakest economic recovery from a recession since the 1930s. After a recession, the US economy has usually grown by 4-5% per year. However, since the recovery officially began in June 2009, the US economy has been growing at an anemic 2%. The rapidly expanding wealth on Wall Street, accruing to the richest 10% of US households, hasn't trickled down to the average household – whose take home pay of $839 a week in April '14 – was only $20 higher than in January 2008, when discounted for inflation.
Tragically, what the Perma Bears and market skeptics failed to realize over the past 5 years is that when operating in the "Twilight Zone" – in a centrally-planned market – negative news on the US economy is construed as bullish for the stock market. As the Bank of International Settlements (BIS) warned a year ago, on 6 June 2013, "the equity markets are under the spell of monetary easing policies that enabled market participants to tune out signs of a global growth slowdown."
The "Least Loved" bull was able to shrug off weak economic data and instead, continued to extend its relentless gains "fueled by the prospect of further central bank stimulus. Abundant liquidity and low volatility fostered an environment favoring risk-taking and carry trade activity," the BIS observed.
As recently as 20 May 2014, Philly Fed chief Charles Plosser lamented, "It's the Fed's fault that the markets are ignoring the fundamentals."
Since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general, as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment in which "it is all about the Fed. Market participants focus on how the central bank may tweak its policy, and central bankers have become too desirous of managing prices in the financial world," he said.
"I do not see this as a healthy symbiotic relationship for the long term. If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than on economic fundamentals, our capital markets will not deliver the economic benefits they are capable of providing (ie; accurate price discovery). And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank."
The trading desk that controls the formerly free market is situated on the ninth floor of 33 Liberty Street, also known as the home New York Fed.
From a glass-enclosed conference room situated next to a small cluster of trading desks, the uber-secretive "Plunge Protection Team" (PPT) controls the money flows that determine the daily fate of credit, equity and virtually all other markets, that have now been hijacked by the central planners at the White House and the US Treasury.
As the number of shares traded each day in stock market dwindles to a six year low, the PPT has become an even more influential price setter in the stock market, while other market participants are content to let their bets ride on the Fed. One big block in the Dow Jones Industrials futures market can move the S&P500 index several points, with market volumes as pathetically low as they are today.
The biggest winners in the financial markets last year were traders that respected the old axiom, "Don't Fight the Fed." They rode the QE gravy train, and kept their bets focused on the increasing size of the Fed's portfolio of bonds. Under the cloak of "Infinity" QE, the Fed injected $1.5 trillion into the coffers of its agents on Wall Street, which in turn, was used to inflate the market value of NYSE and Nasdaq listed stocks by $6.5 trillion to a record $25 trillion today. In other words, for every $1 of QE, the Fed increased the wealth of shareholders by $4.20.
Propaganda artists at the Fed say the QE injections were bottled up at the Fed itself, in special reserves accounts. However, the chart above shows a 87% degree of correlation between the direction of the Fed's bond portfolio and the value of the S&P500 index.
Even after racking up a stellar 28% gain for all of 2013, the biggest annual gain in 16 years, the "Least Loved" bull market was easily able to shrug-off news of a 1% contraction in the US economy in Q1 of 2014. The S&P500 index ended the first quarter 1.2% higher, despite the lousy economy. The old adage, "Sell in May and Go Away," was also tossed aside into the dustbin and the aging bull showed its agility amid its inexorable climb to new stratospheric highs.
Everyone can stop pretending that the Fed is anything but a machine that funnels out free money to bankers and shareholders with little regard for Price to Earnings ratios.
The "Least Loved" bull is flying on two cylinders. Corporate America – flush with $2 trillion of cash stashed in their US banking accounts – has decided there's nothing more attractive than itself. So the S&P500 companies are spending big bucks to buy back their own shares.
Last year, the Oligarchs plowed about 80% of their profits into the hands of shareholders, while refusing to give wage increases to their struggling workers. As a result, the number of outstanding shares of stock available to be bought or sold on the US stock exchanges has shrunk by nearly 10% since the end of 2010, Investors like buybacks because they automatically increases earnings per share (EPS). And most often, though not always, a higher EPS leads to rising stock prices.
Some notable examples are Northrup Grumman (ticker NOC), the military contractor expects to reduce its shares outstanding by 25% by the end of 2015, with buybacks. Home Depot (ticker HD) announced a $17 billion buyback program that will remove 18% of the shares outstanding at current prices. Shareholders in FedEx (FDX), operator of the world's largest cargo airline, authorized a buyback plan equivalent to 10% of its shares outstanding.
The powerful impact of Corporate QE can be seen with the outsized performance of the Power-Shares Buyback Achievers fund (ticker; PKW) compared with the benchmark S&P500 index. PKW buys shares of companies that have already purchased at least 5% of their shares outstanding over the past 12 months. The goal is to avoid companies whose buybacks go solely toward offsetting stock option grants and don't shrink the share count. Since 1 January 2009, PKW has increased in market value by 176%, compared to a gain of 113% for the S&P500 index fund SPY. In other words, the incredibly shrinking stock market fueled about one third of the "Least Loved" bull market. In fact, analysts estimate that 40% of the increase in the earnings per share of S&P500 companies in the past 12 months was due to the "financial engineering" of corporate treasurers.
Buybacks are also being financed with the issuance of debt. For example, on 29 April Apple Inc (AAPL) issued $12 billion of bonds as the iPhone maker locked in a cheaper alternative to reward its shareholders (and its CEO, whose wealth is tied to stock options) rather than repatriate some of its $151 billion in overseas cash. Luca Maestri, who will soon take over as Apple's chief financial officer, said on the earnings call:
"To repatriate our foreign cash under current US tax law, we would incur significant tax consequences and we don't believe this would be in the best interest of our shareholders."
Apple will spend an additional $30 billion to buy back shares of the company's stock, taking to $130 billion how much it plans to spend on repurchases and dividends by the end of next year.
As a special additive, AAPL's board endorsed a 7-for-1 stock split. "We are taking this action to make Apple stock more accessible to a larger number of investors," CEO Tim Cook added. However, prior to the stock split, AAPL's share price has already soared 23% higher, closing near $647 today. That made the "King of Wall Street" – Carl Icahn – a happy man, with his hedge fund holding 7.5 million shares of AAPL. Part of the proceeds from the AAPL bond sale will be used to increase its quarterly dividend by 8%.
Even as stock prices continue to spiral higher, the S&P500 companies are expected to keep the dividend yields steady at around 2% on average, by raising their dividend payouts by 10% this year. The number of companies boosting their dividend is at a 16-year high, with 421 of the S&P blue-chips expected to pay to a combined $348 billion this year.
There hasn't been a correction of 10% in the benchmark S&P500 index for 34 months. Historically, such a 10% correction occurs about 18 months apart, on average. Yet there was a stealth correction within the US stock market from the beginning of March through the middle of May. It went undetected by the unsuspecting US public.
For instance, the small-cap Russell 2000 index fell exactly 10% from its all-time highs to the 1,100-level, and other segments of the high flying Nasdaq index, such as the social media, bio-tech, and internet retailers stocks fell 20% or more. Some Nasdaq kingpins such as Amazon (AMZN) lost more than a quarter of their market value from peak levels, and even heavyweight Google (GOOGL) stumbled 15% from its highs.
As of 17 May, roughly one-third of all US listed stocks were 20% or more below their 52-week highs (a bear market), with the average Russell 2000 member down 24%.
At its peak levels in early March, the Russell 2000 index was priced at a whopping 103 times its 12-month trailing earnings. Historically, its price/earnings ratio has averaged 35 times. If there is a bubble to be found anywhere in the marketplace, the most obvious place to look is the Russell 2000 index, which is home to two thirds of all listed US companies. It's a homegrown collection of companies that earn about 85% of their revenue within the United States' borders, and is often seen as a proxy for the US economy. The sudden 10% correction through the middle of May shaved the Russell 2000 index's trailing P/E ratio to 73 times.
Typically, when small-caps get in trouble, a sell-off in the big names is next. However, on 7 May, the new Fed chief Janet Yellen sought to prevent the large cap S&P500 Oligarchs from suffering the same fate, by assuring Wall Street traders in a speech before Congress that "valuations for the broad stock market remain within historical norms. Overall, broad metrics don't suggest we are in obviously bubble territory."
And with those magical words, Yellen put a floor under the Dow Jones Industrials at the 16,350-level. As the Dow Industrials and Transports quickly regained their footing and climbed to new heights, the small-caps breathed a sigh of relief. The Russell 2000 index built a base of support at the 1,100-level, and recovered most of its recent losses to close at the 1,165-level today. When the PPT does intervene in the stock index futures market, it concentrates its firepower in the Dow Industrials contract, where it can get the biggest bang for its buck.
Nowadays, the higher the S&P500 Oligarchs climb, the less investors seem to worry. About 353 million shares traded in S&P500 index fund (ticker; SPY) in the week ended 6 June, or 62% less than a year ago. In the previous week, only 279m shares traded.
When the S&P500 index hit an all-time high on 23 May, only about 24 of its 500 companies reached 52-week highs. That's the lowest number in a year. When volume and breadth are weak, even as stocks surge, it's often seen as a warning sign that has preceded losses in the past. However, such warnings signs have been routinely ignored by traders operating in the hallucinogenic world of QE, and the Zero Interest Rate Policy (ZIRP).
The S&P500 index's parabolic surge towards the 2,000-level has been accompanied by a sharp drop in the number of shares changing hands. That's not necessarily a sign of danger, because a certain amount of money will buy fewer shares the higher the stock price goes. Corporate buybacks would lose some of their potency as share prices get more expensive.
Since 1990, there have been four other times when the SPX set a 52-week high with fewer than 10% of its members peaking and the overall volume trailing the average. In 3-out-of-4 occasions, the SPX fell at least 5% in the next two or three months. But for now, most traders are reluctant to jump off the Fed's QE-gravy train, and the safety net of buybacks.
Warren Buffett told CNBC on 4 March 2014 that US stock indexes will go a lot higher and advises investors not to pay so much attention to short-term moves.
"Games are won by players who focus on the playing field, not by those whose eyes are glued to the scoreboard," Buffet said. And there is no need for investing expertise. Buffett recommends a low-cost S&P500 index fund for nonprofessionals. "Forming macro opinions or listening to the macro or market predictions of others is a waste of time," he adds.
His bottom line fundamental advice:
"Ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm."
In other words, just buy-and-hold, and never sell.
Apparently, traders don't see the need to buy ultra-cheap insurance either, against the possibility of a nasty market correction. The CBOE Volatility Index (VIX), also known as fear gauge, can be bought as a hedge against falling markets.Yet the VIX plunged to its lowest level in 7-years this week, reflecting the lack of fear of even a slight pullback. Instead, a serene sense of calm and tranquility reigns over the stock market.Investors on Wall Street are living in a calm and predictable universe, where there is no demand for protection against turbulence, while sitting upon $25 trillion of equity wealth. What's sedated this market is all the money printed by central banks, and the safety net of corporate buybacks.
Outlook? The "Least Loved" bull market is still running on steroids, even though it's now 63-months old. The median lifetime of the Top-12 bull markets is 55-months. So it's lasted 8-months beyond its mid-life. A 10% correction hasn't happened for the past 34 months, far beyond the average of 18 months between corrections. Yet it looks as though the S&P500 index has entered the Euphoria stage, or the fourth a final phase of the bull market.
It wouldn't be surprising to see frustrated investors jump off the sidelines to buy equities, along with indiscriminate buyers such as corporate treasurers. The Euphoria stage could see the S&P500 index reach for the 2,200-level, or just over +10% higher from today's close of 1,950. The ultimate market top would be reached when valuations get too stretched and prices would begin to fall under their own weight. The longer the Fed waits to lift interest rates, the bigger the ensuing bubble and the harder the eventual crash over the distant horizon.
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