DAILY DIARY
Tweet of the Day
Oh, and One More Thing...
"Just one more thing."
- Lt. Columbo
The quote of the day:
"All these algos know everything about price and know nothing about value. How do you get rich by buying strength and selling weakness?"
- Lee Cooperman on Fast Money Halftime
Good Night, and Good Luck...
Thanks for reading my Diary today. It's nice to be back.
Here are some thoughts:
* Always consider the upside reward vs. the downside risk in determining whether to buy, sell or short stocks.
* Be disciplined, be independent in your view and do your homework.
* I will repeat the importance of avoiding the plethora of self-confident "talking heads" that parade in the media. (In the main, they are miles long, but only inches deep).
* The talking heads also lack transparency and accountability, and sweep the losers under the rug, while emphasizing the brilliance of their winners -- because it would reveal the limited value of their opinions.
As to the news of the day, the tariffs on Chinese imports -- I have long been of the view that a comprehensive agreement was not in the cards over the short -- and maybe intermediate -- term. In fact, as I have noted, it was likely "dead at birth."
The conflict with China is not a real estate deal in NYC, but a fight for hegemony -- with broad social and economic issues that are unlikely to be resolved by the Trump Administration, which favors policy hastily drafted and delivered by tweet.
Astonishingly, in a press conference, the president just said the tariffs "won't cost American consumers anything" -- which indicates that he has no idea, whatsoever, what the impact of tariffs is.
I find this more than alarming. China's economy is the most vulnerable economically, followed by Europe, which is already looking at sub-1% real economic growth, and then by the U.S.
The increased uncertainty associated with lengthy negotiations means that global trade will be reduced, business uncertainties will rise, and capital spending will be put on the back burner.
We have experienced a 10-year subpar economic recovery goosed by a massive tax relief package and extraordinary monetary largesse, which produced generational lows in interest rates.
The Fed is now pushing on a string, and starting an easing at historically low Fed funds rates. When the market realizes that the economy's problem is not the cost or availability of capital, equities may be much lower.
Worrisome is that, in a year in which stocks have risen by +20% (with absolutely no earnings per share growth over the first half of 2019) stocks are uniquely vulnerable now.
Enjoy the evening.
The $2 Billion Question
Nearly $2 billion to sell market on close.
Shopping in Dillard's Again
At $67.10, I am back in Dillard's (DDS) , my favorite trading sardine of the last five years.
I have probably traded the stock 15 times since 2015, with cumulative gains of well over $100 per share.
The stock is down by almost $7 per share under the weight of the China tariff announcement (which will fall heavily on retailers).
I like the reward vs. risk -- on a trading basis.
David Einhorn's Greenlight Capital recently took a small position in this retailer.
Out of VXX
I sold my entire (VXX) position at $24.65 just now - this was a very large long position and I recorded a sizable gain.
I am doing this as a reflection that this ETF is a trading sardine and not an eating sardine.
Tariff Trouble
Market caves on news that the Trump Administration will impose 10% tariff on $300 million of Chinese goods.
Selective Narrative
It's the time of the day when the talking heads say they bought the low yesterday.
The narrative is always selectively selective.
Pressing BEN
Franklin Resources (BEN) is down in a bullish tape and continues to underperform the market and its asset management peers.
BEN was placed on my Best Ideas List (short) at $35.14 on April 11, 2019, and is currently trading at around $32/share.
I have recently pressed this short.
Here is my investment thesis.
The Data Mattas
* The use of tariffs to achieve non tariff related goals was a mistake and the negative impact is now magnifying
"Comments from the panel reflect continued expanding business strength, but at soft levels. July was the fourth straight month of slowing PMI expansion...Respondents expressed less concern about US/China trade turbulence, but trade remains a significant issue. More respondents noted supply chain adjustments as a result of moving manufacturing from China. Overall, sentiment this month is evenly mixed."
- ISM
Further weakness was seen in the manufacturing data this morning.
Look for GDP estimates to drop a bit from this release.
On manufacturing, the ISM July index fell to 51.2 from 51.7, and that was below the estimate of 52. The last time it was lower was in August 2016 leading up to the election when it broke below 50. New orders did rise by +0.8 points but only after falling by -2.7 points in June. Backlogs were terrible, dropping to just 43.1 from 47.4 and that's the weakest since January 2016. Exports fell back below zero again at 48.1 from 50.5, the lowest since February 2016, while imports fell to 47 from 50. Inventories were up slightly but are still below 50. Employment fell -2.8 points to 51.7, the smallest figure since November 2016. Lastly, prices paid were down by -2.8 pts to 45.1, the least since February 2016.
Of 18 industries surveyed only half saw growth, the least amount of industries saying so since September 2016. That's down from 12 in June.
In response, Treasury yields are falling to the low of the morning (-5.5 basis points on the 10 year US note to 1.96%) and the 3 month/10 yr spread is inverting to 11 bps from 5 bps as of yesterday's close, and just 1 bp on Tuesday and prior to the Fed's rate cut.
Global manufacturing is in a recession and U.S. manufacturing is on the cusp of recession.
The data mattas.
ISM MANUFACTURING
BACKLOGS
Source: Peter Boockvar
I Shorted More Apple Yesterday
I added to my Apple (AAPL) short on yesterday's gap in the morning.
I listened to the universally upbeat commentary post quarter and read the research reports but I am still not sure what the hoopla is about.
Once again iPhone missed, services missed...and then there is this on their net cash. While Apple has a rock solid balance sheet and is a cash cow that generates more cash flow than any other company, they now have far less dry powder to use on buybacks.
While Apple's gross cash (not net of debt) was $15 billion lower sequentially to $210 billion, net cash dropped again and is now at only $102 billion - the lowest level since the end of 2011.
I will have a more thorough analysis of Apple next week - but I wanted to give you a quick idea of my reaction to the earnings report
Apple's pretax income has not improved since 2015 - I don't know what the fuss was about, to be honest.
* Profits peaked 4Q2015
* Trailing 12 month revenue has grown by only +10.1% cumulatively (that's a +2.6% compounded rate of growth) and operating income has dropped by -0/6%.
* Since 2015 reported EPS have risen by +28% - reflecting the tax relief in late 2017 and company repurchases (shrinking the share count by 18.5%).
Apple is the premier financial engineering play but paying 19x for a tech stock requires both top and bottom line growth.
In technology I would buy FB , (AMZN) and (GOOGL) before AAPL.
And I am doing so.
P.S.: Another ludicrous forecast... We have seen peak buybacks.
The Stock Market Is Uniquely Vulnerable Now
* Yesterday's abrupt market reaction (and near rout) in response to the Fed/Powell's comments (of a "mid cycle adjustment") underscores the outsized role of the Federal Reserve on market prices and valuations
* Low interest rates have been the straw that stirs the drink to market gains and share buybacks
* Stocks don't deserve a higher multiple for lower rates if the reason for lower rates is slower growth
* A less dovish Fed is more bearish for the markets - plain and simple
* A conversation with Lee
* Bank stocks are the beneficiary of yesterday's policy announcement and so are some of the FANG stocks (I have been adding to these long positions)
On Tuesday afternoon I had a discussion with my dear friend and hedge fund legend Lee Cooperman about the markets and, specifically, about the pessimistic conclusion contained in my Tuesday column,It's A Wonderful World?
Here were some of the major conclusions and observations I made in It's A Wonderful World:
* The U.S. is still the best house in a bad neighborhood
* Non U.S. economies are weakening (badly) and, in an interconnected world, S&P companies are vulnerable and increasingly dependent on non domestic markets
* Given the current S&P earnings slowdown/recession, it is reasonable to conclude that the market's recent rally has been predominantly based on the liquidity associated with a global central bank easing
* Don't take Fed's actions on face value - consider second-level thinking ("The Fed is Pushing on a String")
* Valuations are now elevated to historical extremes that are typically seen at or near important market tops
* Investors are increasingly complacent and fearful of missing out - this has spurred recent market gains
* My view is that investors should be more fearful for the return of their capital than about the return on their capital
But let's not bury the lede.
Lee disagreed with my bearish overview (though I would not describe him as a full fledged bull).
In Tuesday's analysis I cautioned that the Federal Reserve and the central bankers (with their delivery of an abundance of liquidity) are responsible for a large portion of the S&P gain in 2019, if not all of the gain. (This view is in marked contrast to the opinion of many commentators on RMP and elsewhere).
"While un-provable, I believe the liquidity provided by global central bankers over the last decade is the principal causal factor - providing fuel to company share buybacks (chart above), leveraged buyouts and mergers. This activity has resulted in a halving in publicly traded equities and, for those remaining companies still listed on the Exchanges, for a near 20% reduction in outstanding shares. Besides this favorable backdrop of demand vs. supply, when coupled with generational low (and even negative rates on $13-$14 trillion of global debt), valuations have not surprisingly expanded in the face of little advancement in corporate profitability (pretax operating profits) over the last 3-5 years.
The monetary largess delivered by the world's central bankers have contributed to a remarkable decline in global interest rates. This not only has provided a favorable valuation backdrop (as interest rates are a key factor in determining the value of future expected cash flows) but have resulted in the massive and record accumulation of corporate, individual and sovereign debt loads (totaling more than $251 trillion) - see chart above. It has also led investors to drop their collective guard in the search for yield, as similar to other times in history. This has resulted in all sorts of distortions: taking junk bond spreads lower, an avalanche of covenant lite offerings at a time in which the global economic trajectory is long in the tooth, over $13 trillion of negative yielding debt, BBB rated debt is the largest factor in overall corporate debt and even 100 year bonds are being placed."
Given the market's reaction to Powell's comments on Wednesday, I would say that my view that the market is dependent upon the Fed continues to have merit.
Where I Disagree With Lee
"Price is what you pay, value is what you get."
- Warren Buffett
At the core of Lee's more constructive view than mine is that he believes that stocks relative to existing interest rates are not expensive:
"The stock market is not expensive if you believe two percent fed funds and two percent ten-year governments... In the last fifty years when the market multiple averaged 15x and the ten year government was 6.5% and is now 2.00% the fed funds was five and is currently two. The multiple is ten percent higher today than historically but rates are a third of historical levels."
- Lee Cooperman, CNBC Fast Money Halftime
Lee's view on interest rates, as expressed in his CNBC appearance, is that while they might go down over the near term they are overvalued in the intermediate term. The later point is something I agree with wholeheartedly (and I am short (TLT) ).
I argued (as I have in the past with Lee) that comparing equities to bonds - which almost everyone recognizes to be an overvalued asset class (especially in an intermediate term sense) - represents a slippery slope to support current and elevated stock valuations.
I went on to suggest to Lee that stocks don't deserve a higher multiple for lower interest rates if the reason for lower rates is slower growth. (Imagine what the price earnings multiples of European and Japanese stocks would be if the level of interest rates were a factor in their valuations!)
I would remind everyone of consensus expectations for rates a year ago - not one single business media commentator, "talking head", or investment strategist was looking for lower interest rates. (I was looking for lower rates (15 Surprises for 2019) with a projected low in the 10 year US note of about 2.25%). Pure "group stink."
Today almost everyone is calling for lower interest rates. But, bond traders and investors may be picking up nickels in front of a steam roller.
As well our interest rates are depressed and anchored because of the proliferation of negative rates in Europe (something Lee also discussed on CNBC) - and we have to consider (as I suggested earlier) why those rates are negative "over there." Again, second-level thinking might be called for.
Lee went on to point out (with the assistance of his partner and my old pal Steve Einhorn) that 2Q 2019 S&P earnings, previously expected to decline by about 2%-3%, should now show a small increase. Steve and Lee are forecasting 2019 S&P earnings of $168/share.
Here I would point out that we started the year with consensus S&P EPS above $172/share - so Lee's $168/share estimate is lower, during a time in which S&P prices rose by over +20%. (See Warren Buffett's quote above)
As noted by Peter Boockvar (in the chart of the S&P 500 Index and the consensus 2019 earnings estimates) and as I noted in my column - price earnings multiples have advanced in 2019 (from 14.5x to 17.5x) without ANY growth in S&P earnings. In fact, the 2019 S&P EPS estimates have been continually downgraded throughout the first seven months of this year (I remain at around $160/share, and that's where I was since November, 2018).
S&P 500 price in yellow, S&P earnings estimate in white ($165.60, a new low for the year)
Lee on CNBC
To finish with Lee's view, he has grown less bullish on the market (he still thinks it may have a little to go to the upside this year) and followed up our conversation with a great appearance on CNBC.
Here is a summary of Lee's thoughts expressed on Fast Money:
*Article
*Videos: here, here and here.
Presidential Wars With The Federal Reserve Rarely End Well
Despite his repeated tweets on the subject, President Trump knows little about Federal Reserve policy.
Like President Lyndon Johnson who went after Fed Chair William McChesney Martin or President Richard Nixon who influenced Arthur Burns - Trump is making the same mistake, just as the others did, in threatening the Fed's independence with their his policies (and political aspirations).
These sort of presidential threats haven't ended well in the past and probably won't in the future.
As an aside, Chairman Powell underscored several concerns in justifying the rate cut - slowing world trade, low inflation, weak business fixed investment and manufacturing weakness.
These are precisely the areas that were supposed to benefit from the 2017-18 tax rate cut. They did not as the only benefit was seen via trickling up and with more aggressive share buybacks by corporations.
With real GDP growth already backing down to the +2% area, to me, the evidence is that supply side economics is voodoo.
Knock-On Implications of a More Dovish Fed
Here are some more knock-on concerns (all these factors were previously discussed in Tuesday's column) that are going to be raised in the weeks ahead following the Fed's comments on Wednesday:
* Less dovish Fed policy in the face of non U.S. central bankers more aggressive easing means that the US dollar will remain much stronger. (Note the euro is at a 26 month low relative to the US dollar).
* This means that S&P earnings expectations will continue fall in 2019-20 as about 40% of S&P profits are non U.S. based.
* And what about the $17 trillion of U.S. denominated debt owed by non U.S. entities? A firmer US dollar is problematic to repayment.
Bottom Line
In terms of market strategy I continue to believe that volatility is underpriced and stocks are overpriced.
I would remind everyone that if indeed a market trend change develops, one-sided market structure (the enormous popularity of ETFs and the leveraged risk parity players which has placed "everyone" on the same, long side of the boat) could result in selling ... but to whom(?) - providing the potential for a October, 1987 "Portfolio Insurance" rout and a sequence of flash crashes.
The Fed is Pushing on a String - and a meaningful market decline might lie ahead once investors realize that the cost and availability of capital is not what is holding back the global economy.
Nevertheless, several market sectors will likely benefit (on a relative basis) from the Fed's pronouncements yesterday - notably bank stocks (I recently purchased short dated bank calls).
I also want to buy weakness in FANG stocks (particularly Facebook FB , Amazon (AMZN) - which hit by buy level yesterday afternoon and I initiated a small long) and Alphabet (GOOGL) (recently reestablished)) as EPS growth is likely to be a rare condition in the year ahead.
Long BAC common and calls (large), C common and calls (large), WFC common and calls (large), GS (small), FB (small), GOOGL (small), AMZN (small), VXX (large).
SHORT TLT (large), SPY (large).
The Book of Boockvar
The Fed and overseas data from Peter Boockvar:
As if we needed another reminder of the dominant place the Federal Reserve has on markets was the tick for tick move in stocks and bonds to every utterance of Jay Powell following every word change in the statement. Also, let's be clear, the Fed is completely winging it. All I implore the Fed again is please don't repeat the mistakes of the BoJ and ECB and get trapped in the vortex of continuously cutting to the point where the reaction function in one's economy becomes negative. Of course, the 'mid cycle' adjustment message Powell tried to convey is one looking to avoid that but you can see where this is going. The dollar rallied, the yield curve inverted and a lower cost of capital will not matter to an economy where the cost of capital was no impediment to anything anyway. So I'll raise the Vietnam analogy again, please Fed, don't keep sending in rate cuts hoping for a different result if you don't achieve the soft landing we all hope you can accomplish. As for Trump's desires with monetary policy, again look at the BoJ and the ECB and see how that's working out.
By the way, with the 1995 analogy of a mid cycle cut in rates people have to remember that it was just 4 years into an economic expansion, not 10+ that we are in now. Hope springs eternal when faith in the Fed is as high as it is.
Here is a quick rundown of the manufacturing PMI's we saw today overseas. China's private sector Caixin PMI did rise .5 pt to 49.9. The estimate was for no change. The rest in Asia were mixed: Taiwan 48.1 vs 45.5, Malaysia 47.6 vs 47.8, Japan 49.4 vs 49.6, Thailand 50.3 vs 50.6, South Korea 47.3 vs 47.5, India 52.5 vs 52.1, Indonesia 49.6 vs 50.6, Vietnam 52.6 vs 52.5, and the Philippines 52.1 vs 51.3. The common thread? Most are below 50.
South Korea confirmed the initial weakness in July exports as they fell 11% in July y/o/y, about as expected. It's the 8th month in a row with y/o/y declines.
The eurozone July manufacturing PMI was tweaked to 46.5 from the first print of 46.4 and this is down from 47.6 in June. All the major countries have figures below 50 with Germany in particular at just 43.2, France at 49.7, Spain at 48.2 and Italy at 48.5. On the heels of the election victory of Mitsotakis in Greece, their manufacturing PMI rose to 54.6 from 52.4. I'm bullish on Mitsotakis.
Likely captured before yesterday's selloff, individual investors were all bulled up ahead of the Fed as AAII said Bulls rose to 38.4, the highest since early May, up 6.7 pts w/o/w. Bears fell 8 pts to 24, the least since also early May.
Pssst, We Got the Whisper Number!
Watch out for ISM new order data according to my friend Danielle DiMartino Booth:
- QI has estimated today's ISM New Orders by marrying new orders from the Fed Districts and regional PMIs on an ISM scale with 50 as the expansion/contraction line; based upon the data, QI's whisper number for New Orders is 47.3
- Future Inventories is the leading indicator for ISM New Orders, QI's Future Inventories Proxy broadens out beyond manufacturing to incorporate services and retail; as it were, it's contracted in five of the last six months amplifying downside risks to ISM New Orders
- If ISM New Orders do disappoint, the Fed's 25-bps-point "insurance cut" will heighten investors' anxiety that the Fed is behind the curve as the Treasury curve flattens further into inversion territory
There's no market for whisper numbers. There never has been. If there was, why bother whispering? Investopedia edifies us as follows: "a whisper number refers to the purported, unofficial and unpublished earnings per share (EPS) forecasts that are believed to circulate among professionals on Wall Street. In this context, whisper numbers were believed to be generally reserved for the favored (wealthy) clients of a brokerage. A whisper number can also refer to a company's forecasted future earnings or revenues according to the collective expectations of individual investors. In this sense, a whisper number would be compiled by a website polling its visitors. Individuals come up with a whisper number using their own analyses of company financials, market trends and gut feelings."
Whisper numbers are valuable when a consensus estimate is conspicuous in its absence. That's the case with today's ISM Manufacturing report. No, we're not talking about the headline number. The consensus of the 71 surveyed has the headline coming in at 52.0.
At QI, we aim to aim higher. As such, we've created a whisper number for the bluest of blue chip global leading indicators - ISM New Orders. No, it's not based on instinct, but rather a simple average of numbers. Maybe you didn't ask for it, but we're going to draw you the line in the sand anyway.
QI's ISM New Orders whisper number equals 47.3. We arrived at this level by first converting the seven new orders indices from the New York, Philadelphia, Richmond, Kansas City and Dallas Fed Districts as well as the Milwaukee and Chicago PMIs to the same ISM scale with a 50 expansion/contraction line. After that transformation, we averaged all seven numbers to arrive at the whisper. It's not a complicated calculation by design.
Now rewind to the July 25th Feather, where we first discussed the Markit PMI Quantity of Purchases Index. It's a reflection of what procurement professionals do, as in buy supplies. The contraction in July (48.3) raises the risk that New Orders will be under pressure from the reduced purchases. Granted, the movement in the Markit Quantity of Purchases index and the ISM New Orders index is not one for one, but the correlation is a decent 0.71 over time. Therein lies the risk.
It's a tautology that one company's purchases are another firm's orders. In the normal course of business, there are products and services that supply managers endeavor to obtain without any lead time.That means they receive it in less than one month's time. Think of downloading software. Think of just-in-time ordering to go with just-in-time stocking in today's supply chain. Part of the weakening signal from the Markit Quantity of Purchases index raises the risk for an outright contraction in July's ISM New Orders. By the way, ISM New Orders downshifted to the neutral 50.0 level in June. There is no room for error.
There is such a thing as a leading indicator of a leading indicator that equates to a holy grail in the forecasting community. Future Inventories fill that role for ISM New Orders. The rule of thumb: "If you want to cut future supply, you cut current new orders." This dynamic works in reverse as well. But the context in the here and now suggests downside risk to New Orders tied to already reported reductions in future supply.
For our purposes, the larger and broader the future supply signal is, the better. The innovation in our Future Inventories Proxy illustrated above is grounded as it gauges not just from the manufacturing sector, but also those of retail and services. This broader read on current new order flow has been contracting in five of the last six months. The buildup of downside risk for ISM New Orders has become more evident with each passing month.
Circle back to the whisper number. Now that you know what you know about which direction the risk leans, it's time to answer the real question: What's the over/under on 47.3? Take a position. Will it be a modest decline validating the Fed's insurance cut or a sizable contraction that commands a Fed easing cycle?
At least Fed Chair Powell made it easy for us. At his press conference, he queued up asymmetry by saying that a 25-basis-point rate cut isn't necessarily the start of an easing cycle. Insurance cuts it is, Mr. Chair.
Now stop and think how the Treasury market will react if ISM New Orders disappoints...with a contraction in the bellwether of leading indicators coming in south of the whisper line...after the Fed cuts by only 25 basis points? The yield curve will delve deeper down the rabbit hole of inversion. And rates traders won't be whispering. They'll be shouting, "The Fed is STILL behind the curve!"