Submitted by David Stockman – The Contra Corner Blog
I first posted the attached three weeks ago, and here we are again, knocking on the door of the Bullard Rip low of last October 15th. While we will know soon enough whether this battered and bloodied bull will give up the ghost on this trip down and slice through 1867 on the S&P 500 or stage another half-hearted rebound, one thing cannot be gainsaid.
To wit, all the reasons for a deep correction ahead—–not merely the perennial Wall Street hyped “retest”—— remain in tact; and a passel of new ones have appeared, too.
In addition to the global deflation waves lapping ever closer to these purportedly decoupled shores, we now have a Fed that has decisively rendered itself into a evident state of indecision and cacophonous gibberish.
In the interim, the global commodity collapse has gathered force, and is now spilling over into financial market mechanics in the form of the Glencore meltdown and CDS blowout.
Indeed, as Bloomberg noted today, the three year plunge in commodity prices has now reached 50%, but the collateral effects in financing markets are just now beginning to show their ugly head.
As we have been saying for a long-time, the global financial system is booby-trapped with hidden time bombs waiting for a catalyst. You can be absolutely sure that Stanley Fischer and Janet Yellen, who have been insisting for months that there are no signs of financial excesses or bubbles, had no clue that Glencore was lurking in the shadows:
The 15-month commoditiesfree-fall is starting to resemble a full-blown crisis.
Investors are reacting to diminished demand from China and an end to the cheap-money era provided by the Federal Reserve. A Bloomberg index of commodity futures has fallen 50 percent since a 2011 high, and eight of the 10 worstperformers in the Standard & Poor’s 500 Index this year are commodities-related businesses.
Now it all seems to be coming apart at once. Alcoa Inc., the biggest U.S. aluminum producer, said it would break itself into two companies amid a glut stemming from booming production.Royal Dutch Shell Plc announced it would abandon its drilling campaign in U.S. Arctic waters after spending $7 billion. And the carnage culminated Monday with Glencore Plc, the commodities powerhouse that came to symbolize the era with its initial public offering in 2011 and bold acquisition of a rival in 2013,falling by as much as 31 percent in London trading.
Likewise, China’s supreme leader made his appearance at the White House where he professed his commitment to reform and market driven economics, and then kept the paddy wagons on the prowl for unpatriotic sellers of wholly illiquid red chips—-all to no avail as the Shanghai composite teeters precariously around the 3,000 level or 42% below the June 13 peak.
Indeed, Wall Street’s pathetic rendering of China as the great hope for “growth” was further rebuked by word of August’s $142 billion capital outflow, bringing the two-month total to $270 billion.
More than one-quarter trillion dollars heading for the hills in 60 days from an economy that has sweeping capital and exchange controls and a second formidable fleet of paddy wagons prowling for cheaters does not bespeak a miracle of red capitalism; it signals an economic house of cards being desperately propped up by the mailed fist of the state.
The Wall Street economist meme about China’s capital outflow crisis and mini-devaluation in early August is especially preposterous. Purportedly the earnest market reformers in Beijing got ahead of themselves attempting to give the yuan exchange rate greater exposure to market forces. It had nothing to do with competitive export promotion or loss of control of capital flows, and, instead, was a matter of insufficiently clear communications to the market.
C’mon. That’s fairytale stuff. The reds suzerains in Beijing did not justproactively decide to ease up on the RMB peg to please the IMF. Their hand is being forced by waves of hot capital that are oozing out of every available pore in China’s freakishly unbalanced, credit-saturated, out-of-control economy.
On a nearby page we have a story about China’s largest steel company firing up the first blast furnace at what will be a brand spanking new 10 million ton per year steel complex. Now a facility that size is bigger than any surviving complex in the west and comes on top of 1.1 billion tons of China steel capacity that is massively redundant, increasingly idle, and which has triggered devastating price reductions of upwards of 50 percent in the last three years.
Worse yet, the new complex will be heavily invested in rebar capacity—-just the thing needed to add to China’s 60 million empty apartments and sprawl of ghost cities, malls and other commercial real estate.
Stated differently, China has become a rampaging freight train of deflation, and all that excess capacity to make steel, solar, cars and everything else will be coming toward these shores bearing price tags which do not bespeak 2% inflation. Decoupled, indeed.
Then we have 3rd quarter earnings just around the corner. Last year’s reported GAAP reported results——the kind CEOs and CFOs file with the SEC on penalty of jail—- came in at $106 per share. This means the S&P was trading at 17.6X LTM earnings.
Based on the current just-in-time markdown of the street consensus, the $97/share results reported for Q2 may slip even lower to perhaps $95 per share.
So the question recurs. Why would you now pay 19.6X earnings at the old Bullard low when it is evident that the global economy is slipping into recession and that the Red Ponzi which has artificially propelled the world economy for more than a decade is going down for the count?
Stranded at 1881 the S&P 500 is about at the point it first crossed in May 2014. That’s nearly 500 days of thrills and spills, but going nowhere.
To be sure, after two decades of central bank coddling and intravenous liquidity injections this bull will not succumb easily. Certainly, its demise will be prolonged until the last dip has been bought and the last robo-machine reprogrammed to sell on the issuance of the Fed’s increasingly incoherent word clouds, not buy.
But time is price in a central bank operated casino. On that basis, what is at hand is a top forming hardened resistance.
As we said on September 5, this is not a retest.
This Is Not A Retest—–Its A Live Bear
September 5, 2015
By the lights of bubblevision, Tuesday’s plunge was just a bull market “retest” of last week’s lows, which posted at 1867 on the S&P 500. As is evident below, the test was passed with 80 points to spare at today’s close.
So according to the talking bull heads—–CNBC had three of them on the screen at once about 2pm—–its time to start nibbling on all the bargains. Soon you may even want to just back up the truck.
You can supposedly see it right here in the charts. The market hit the October 15 Bullard Rip low last week, and has gone careening upwards where it is now allegedly forming a new bottom around 1950. Remember, its a process. Be patient.
Not on your life! The world is heading into an unprecedented monetary deflation——with output and trade falling nearly everywhere. That implosion is already rumbling through Canada, Mexico, Brazil, Australia, South Korea, Malaysia, Indonesia, Russia, Japan, the Persian Gulf oil states and countless lesser economies in between. And at the center, of course, is the unraveling of the Great Red Ponzi of China.
In the face of this on-coming economic storm, honest financial markets would have been selling off long ago, and, in fact, would never have approached today’s absurd levels of over-valuation. But financial markets have been hopelessly corrupted by two decades of massive central bank intrusion and falsification of asset prices. Consequently, Wall Street punters and their retainers and cheerleaders cannot see the forest for the trees.
Thus, one of today’s CNBC permabull threesome reassured viewers that the US economy is chugging along in fine fashion and that China is a big problem——but for the policymakers in Beijing, not the S&P 500.
The “1000 points of fright” last Monday is actually a gift. You can now buy the market at 15X, which is tantamount to a steal. So he said, and with no inconsiderable air of annoyance that anyone would think otherwise, let alone succumb to panic.
Well, let’s see. The implied “E” in that proposition is $130 per share on the S&P 500 for 2016. But that’s the Wall Street sell-side’s version of earnings ex-items.
So let’s start with where we are at the end of Q2 2015 in the real world of GAAP profits. That is, the kind of earnings that CEOs and CFOs certify to the SEC upon penalty of jail as fair, accurate and complete, according to well settled general accounting principles.
It turns out that the reported LTM net income (latest 12 months as of June 2015) of the 500 largest US companies in the index came in at $97.32 per share. But that’s down considerably from the LTM figure of $103.12 per share in the June quarter of last year, and was off by 8% from peak LTM earnings of $106 per share in the September quarter last fall.
What this means is that the market is not really trading at 15X at all, but closed today at 20X—–which is an altogether different kettle of fish. By the lights of permabulls like CNBCs 2pm trio, of course, the market is always trading at 15X and is always cheap. You might even think that Wall Street’s ex-items year-ahead EPS estimates are goal-seeked—-and you might well be on to something.
In any event, how do we leap the chasm from $97 per share and falling to $130 per share and soaring? Well, you mount a Wall Street hockey stick, close your eyes to the rest of the world and hope for a swell ride.
In the alternative, you might want to scroll back to nearly an identical inflection point in mid-2007 when the Greenspan housing and credit bubble was nearing its apogee. To be specific, LTM GAAP earnings at the time were about $85 per share and the June 2007 quarter closed with the index at about 1500 or just 4% below its October peak of 1565.
So the market was positioned at 17.6X honest-to-goodness GAAP earnings in the eve of the Greenspan Bubble’s collapse. Needless to say, that was a pretty sporty multiple under the circumstances—–the rot in the Bear Stearns mortgage funds had already been exposed and the sub-prime market had gone stone cold in the spring. Yet it was well below today’s 20X.
Naturally, Wall Street didn’t see it that way at the time. The ex-items consensus for 2008 was $120 per share of S&P 500 earnings, meaning that it was indeed time to back-up the truck. You could buy the broad market for less than 13X, said the talking heads, or more specifically the very same trio that made its appearance today.
Indeed, the chasm between reported GAAP and the forward hockey stick ex-items was $35 per share at that point in time. Ironically, today’s spread between the reported actual and the Wall Street hopium is the exact same $35 per share.
Here’s what happened next. By the June 2008 LTM period, GAAP earnings had fallen to $51 per share and by June 2009, after the meltdown, S&P 500 earnings for the previous four quarters were, well, $8 per share!
That’s right. The great Greenspan financial bubble collapsed; the global economy buckled; and corporate balance sheets were purged of 7-years worth of failed investments and financial engineering maneuvers gone astray, among sundry other losses. In the end, Wall Street’s $120 per share hockey stick got smashed into smithereens.
Eight years later we are at an even more fraught inflection point. The post-crisis money-printing binge was orders of magnitude larger and more radical, and was universally embraced by every significant central bank on the planet. As a consequence, the resulting financial bubble has become far more incendiary than the one which burst in September 2008, and the distortions, deformations and malinvestments in the global economy dramatically more insidious.
Obviously the onrushing collapse of China’s purported miracle of red capitalism is the epicenter of this great global deflation, but every nook and cranny of the world economy is implicated; and its shock waves are already wreaking havoc in areas that were especially swollen by the China trade.
On a nearby page, for example, we outlined the unfolding disaster in Brazil. This chart on the trend in year-over-year retail trade is stunning because Brazil’s inflation rate is above 5%. So when nominal sales plunge from the boom time rate of 11% to negative 1% in June, it means that real sales are shrinking at nearly a depressionary pace.
By all accounts, in fact, Brazil is plunging into its worst recession in the last half century. After years of booming jobs growth fueled by exports and a massive internal dose of monetary and fiscal profligacy, for example, its economy is now shedding workers at an unprecedented pace.
The point here is that Brazil is just the leading edge of the epochal worldwide monetary reversal now underway. During the last 15 years its central bank balance sheet literally exploded, rising by more than 10X, while loans to the private sector more than quadrupled in the last seven years alone.
The consequence was a frenzy of government and household spending and business investment, expansion and speculation that bloated, deformed and destabilized the Brazilian economy beyond recognition. And those distortions were not contained to the Amazon economic basin alone, but where connected by a two-way highway of financial and trade flows that penetrated right into the heart of the US economy.
In the first instance, the massive but artificial and unsustainable export boom to China and its EM satellites generated enormous capital inflows to Brazil which caused its exchange rate to soar, even as its government frantically attempted to contain its rise. During that pre-2012 period, its finance minister even coined the terms “currency wars”.
The effect of the China export boom and the massive capital inflow, however, was to create an economy with apparent dollar purchasing power far greater than its sustainable real wealth and output capacity. This immense distortion is best measured by the US dollar value of its GDP. As shown below, during the six years between 2006 and 2012, Brazil’s dollarized GDP grew at a fantastic 20% annual rate!
It is no wonder Miami became a boom town. Giddy Brazilians who had enough sense to realize its socialist government had not performed an economic miracle of fishes and loaves exchanged their red hot real’s for dollars and trucked northward to condo land in south Florida.
At the same time, its booming economy was a magnet for US money managers parched for yield in Bernanke’s ZIRP repressed market and for US exporters temporarily benefited by a dollar/BRL exchange rate that made them suddenly far more competitive. Accordingly, hundreds of billions of hot dollar capital flowed into Brazilian equity and corporate bond markets, while US exports nearly quadrupled in eight years.
Here’s the point. The US economy was not “decoupled” from Brazil in the slightest during the expansion of the great global monetary boom that has now crested. Nor will it uncouple during the deflationary bust that must necessarily ensue.
The ultimate worldwide hit to US exports is evident in the 20% drop in shipments to Brazil shown in the chart above, and that’s just for starters because its economic depression is just getting underway. Likewise, the panicked flight of hot dollars from Brazil now besetting the global financial markets is only indicative of the turmoil to come as the massive “dollar short” unwinds on a global basis.
So this is not a retest. We are in the midst of an unprecedented global deflation. A real live bear market is once again at hand.