Mercenary Trader SIR 113
March 6th, 2016
MACRO VIEW: The Meaning of Trump
In the long (long) run, American rule of law, and respect for
basic freedoms, is likely to survive. Look out below for stock
market valuations though. The 2016 political upheaval now in
progress comes at a vulnerable market moment. For the past
twenty years, congress has had minimal influence on equity
valuations. Recent stock booms were fueled by deregulation,
shadow banking and trade globalization, with a backdrop of
extremely easy monetary policy via Fed Chairman Greenspan
(then continued by his successors). Rescue efforts and market
bailout measures all throughout the 2000s were led by
central bankers too — again via the mechanism of monetary
policy — with politicians mostly standing on the sidelines.
“Really?”
~ The Economist
“This isn’t about whether he’s going to do a better job or not.
More or less, it’s the statement: Listen, we’re sick and tired of
what you people do. And we’re going to put somebody in
there – now that it’s our choice, we’re going to put somebody
in there that basically you don’t like.”
~ Ken Magno, 69, Massachusetts Trump supporter
We are now witnessing a fascinating evolution in the annals
of American politics. The big phenomenon unfolding in 2016
is much larger than Donald J. Trump… or Rubio, Cruz, Sanders
or Clinton… or any other individual candidate for that matter.
The good news, in our view, is that America can handle this
chaos. The strength of American institutions — and bedrock
respect for the rule of law — is stronger than any candidate.
We’ve been through some turbulence in the past 240 years,
and this is just a little bit more… the resilience of American
institutions, and the ability of governing structures to remain
above those in power, is not at all present in most countries.
Usually you can’t just “throw the bums out” while keeping a
resilient system intact — an important ability Americans take
for granted. Just look at Venezuela or China for alternatives.
(They are now banning foreign media and clamping down
harder on free expression and political dissent in China, even
while building the most intense “cult of personality” around
Xi Jinping since Chairman Mao. Venezuela, meanwhile, is a
borderline failed state experiencing daily food shortages and
hyperinflation, as Maduro holds on via ties with the military.)
© Mercenary Trader 2016 All Rights Reserved
Now, though, the central bankers are “out of bullets.” They
took rates to zero… and yet nothing really got better. As we
have explained in these pages, NIRP (negative interest rate
policy) does not really work. It kills bank profitability without
stimulating economic activity. So next up in trying to revive
the patient is fiscal policy, which means the involvement of
congress. Central banks cannot disperse helicopter money,
not really and truly. Policy votes are needed for that. You can
thus soon expect more language from central bankers to the
effect of: “We’ve done all we can with monetary policy. Now
you people – you politicians – have to authorize spending.”
But what if the politicians don’t want to authorize spending?
What if they would prefer to embrace some quack theory that
says it is better to fiscally “bleed out” the patient? In 1799
George Washington died from a sore throat this way, after his
doctors extracted large quantities of blood from his body. In
retrospect this method of treatment was insane, though it
appeared logical at the time. The state of Louisiana, now deep
in fiscal crisis, is dying in metaphorical fashion, with essential
medical and social services on the verge of being shut down
(the prior Republican governor cut taxes, depriving the state
of revenues; then came a brutal oil and gas bust). Ex-Bank of
England Governor Mervyn King notes the whole of southern
Europe (under the hand of the Germans) is being fiscally bled
out this way too, with whole generations of unemployed
youth seeing their future career paths destroyed.
There are still many economic physicians in the American
political realm who think such bleeding is a good idea. These
doctors think it makes sense to give heavy tax cuts to wealthy
individuals and corporations who then, quite literally,
transfer those funds to offshore savings accounts, producing
zero economic growth even as the debt burden is increased.
Under the next president these economic theories may be
tested, again quite literally, by those with a deep aversion to
strategic debt use — even for logical things, like rebuilding
infrastructure at super-low financing rates — comparable to
the blanket rejection of antibiotics by Christian Scientists.
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March 6th, 2016
Imagine what would happen were America to fall into a full
recession in the next year or two. Some observers (like Jim
Rogers) argue the odds of this are high, even approaching
certainty. The big question is what policy moves congress
would authorize if deep recession comes to pass. The Federal
Reserve, for reasons we’ve explained, might essentially say:
“We got nothin’. Now it’s on you guys.” That is when things
would get truly interesting, because millions of rank-and-file
Republicans (spread across the red state “heartland”) would
then realize they are not actually fiscal “conservatives” at all,
but instead want more protection, more job help, and more
social safety net… even as these things run directly against
the small-government grain the party supposedly stands for.
Then someone might suggest: “Hey, if America can borrow for
ten-plus years at less than two percent, why don’t we borrow
enough to fix all these roads and bridges that are out of repair,
while creating millions of jobs here and now?” And then the
debt-haters will have to explain that, no, we can’t do that
because, umm, all debt is automatically bad, even debt that
one can accrue at insanely low financing rates and put to
immediate good use for the benefit of the country. There may
soon be enough cognitive dissonance to make heads explode.
Moving on to something slightly less depressing (or perhaps
not)... Donald Trump, as a Presidential candidate, has shown
every sign of being a closet fascist. He has openly made dark
threats toward anyone who annoys him (John McCain, Paul
Ryan, the Washington Post, etc). He has promised to gut the
first amendment (by “opening up libel laws” to allow for press
lawsuits). And he has suggested, with straight face, that a
good response to terrorism is killing terrorists’ families (the
US military should commit war crimes). That’s just a sample.
But Donald Trump is mainly an opportunist with a nose for
media coverage. He doesn’t actually believe most of what he
says, which is why it is possible to comb through old media
files and find a once-opposing Trump stance for almost every
single position held. Trump is a keen reader of moods with his
finger in the wind. He has said out loud, often outrageously,
things much of America has been itching for someone to say.
The fact Trump has no policy opinions is actually strategic
genius. Trump has understood at least three things in regard
to presidential policy. First, that his supporters don’t actually
care about policy details (they are voting with their “gut”);
second, that committing to policies too early would merely
give opponents and journalists a stick to beat him with (and a
boring stick at that); and third, that a “policy of no policies”
for now will make him a fearsomely flexible candidate in the
general election later. He’ll comfortably attack Hillary Clinton
from the left as easily as the right. He will potentially even
attack from left and right both at once, even while presenting
himself as a moderate centrist. It will be amazing to watch.
© Mercenary Trader 2016 All Rights Reserved
And make no mistake, Donald Trump has a very real shot at
becoming the next President of the United States. Various
journalists have pooh-poohed Trump’s chances, arguing that
he will be absolutely destroyed by Hillary Clinton in the
general election… but these same journalists pooh-poohed
Trump’s chances of getting this far in the primaries, and their
analysis seems geared toward helping readers sleep better at
night. We see odds of a Trump win in the general election —
thus beating Hillary Clinton — of at least 50/50, and possibly
even a little better (making Trump the marginal favorite).
Now we will cover a few things: How the Republican Party got
to this point; What the big trends are behind Trump’s rise
(which are impacting Democrats too); why Trump has a very
good chance at beating Hillary in the general election; and
what this sort of means for the future. Okay, here we go…
First note that America is somewhat unusual for only having
two political parties. As such, these parties are very “big tent”
in size and scope — the Republican Party now has a wide
variety of competing viewpoints and interests, united under
one uneasy banner. (So do the Democrats.) Roughly speaking,
we can divide up the Republican Party into five interest
groups which are distinctly separate and very much unequal:





Fiscal conservatives (allergic to debt and spending)
Social conservatives (gay marriage, abortion etc.)
Immigration conservatives (imm. is “The Problem”)
Deregulators (fewer rules for corps and Wall St)
Globalizers (free movement of labor and capital)
Membership in the various groups can overlap. For example,
your cranky uncle might be a fiscal, social and immigration
conservative all simultaneously. But make no mistake, these
are different constituencies. Schwarzenegger Republicans in
California, for example, were fiscal conservatives but not at
all social conservatives. Seniors in the bible belt, driven by
fear of moral decay and the preservation of Social Security
and Medicaid benefits at any costs, are social conservatives
but not truly fiscal. And there are plenty of conservative
voters for whom one issue (the national debt, gay marriage,
illegal immigration, etc.) drowns out all other considerations.
But here is what’s really interesting about the five-way split:
The Republican “rank and file” are ruled by “the
establishment.” Deregulators and globalizers control “the
establishment” by wielding vast sums of money, influence,
and high level connections... yet have few popular votes. The
ultimate representation of deregulators and globalizers,
sitting high atop the Republican Party Establishment, is the
Koch Brothers — Charles and David Koch, worth about $43
billion each. Their company, Koch Industries, is possibly the
largest private enterprise in the world (neither government
owned nor publically traded). They generally call the shots…
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The Koch brothers wield a massive amount of influence over
the Republican Party Establishment, as do many movers and
shakers, bankers and CEOs. But the primary interests of these
people are in the areas of deregulation and globalization,
because that’s where the money is. They are worried about
things like keeping Environmental Protection Agency rules at
bay (to the benefit of their oil and gas operations), or making
sure they maintain unrestricted access to overseas markets.
In the modern day Republican Party, the deregulators and
globalizers have the money and Washington influence, but
rank and filers (the first three groups) have a far greater
amount of voting power. This was a marriage of convenience
in which the moneyed interests at the top of the Republican
Party figured out how to control large swathes of the popular
vote (which they couldn’t control otherwise) by convincing
rank and file Republicans that their interests were the same.
And so the Republican many (in the heartland and red states)
are controlled by the Republican few (the Koch brothers and
those of their ilk… wealthy capital wielders and corporate
industrialists who want to minimize corporate regulations
and taxes while maximizing free trade. The “little guys” had
long been convinced their interests were the same as the “big
guys”… but in recent years that assumption was abandoned.
And thus the Republican Party has reached a point of civil war
between the moneyed “establishment” and the rank and file
base. The full-on co-opting of fiscal, social and immigration
conservatives by the ruling deregulators and globalizers (who
really don’t care at all about rank and file issues) was a
sleight-of-hand move in the first place. The base then came
to realize, over time, that they were being ignored and/or
screwed by the establishment... which gave them a mind to
tell the establishment to go to hell. With Trump, they do this.
A hapless Jeb Bush was the perfect establishment candidate.
He was exactly the type of guy that big business wanted:
Longtime insider... compliant… happy to play ball… knew Wall
Street… committed to deregulation and globalization... able
to keep the general populace happy while more or less doing
the bidding of those at the top. And of course, the “Jeb!”
candidacy was a full-on disaster. Jeb Bush spent $130 million
and it was a total waste. He could have spent $360 million and
it would likely have been the same result. That is because the
mood in this election cycle was “screw the establishment.”
Donald Trump has bragged he could shoot people in the
streets and his supporters would still vote for him. (Nice.) He
is probably right because a vote for Trump is a protest vote…
a direct middle finger to the establishment and “the system.”
Many Trump voters don’t even like the guy — they just want
to get revenge on the establishment. Imagine a guy who hates
his ex-girlfriend… being given the opportunity to choose her
next boyfriend. A vote for Trump is a political hate valentine.
© Mercenary Trader 2016 All Rights Reserved
This also explains why the media has been at such a loss to
explain the Trump phenomenon… and why Republican Party
leadership attempts to derail Trump have been so pathetic.
Many political journalists have become woven into the
political establishment themselves, making it hard for them
to see how hated the establishment is… and how they, the
journalists, in some measure too are hated for being loyal
enablers of the party line. As such, attacks from journalists
and establishment party figureheads have probably helped
Trump more than hurt him. When Mitt Romney attacked
Trump, it likely made Trump enthusiasm increase. Why?
Because Romney is a failed establishment figurehead. And if
that suck-up Romney hates Trump, so much the better…
There is a psychological phenomenon called “the blowback
effect,” which shows that attacking someone’s views with
clear logic can cause those views to only get stronger. You can
show someone highly credible evidence they are wrong… and
it can make them commit to their current position all the
harder. We are potentially seeing this with Trump support
also in the face of attacks. The more vigorously he is outed,
the more his supporters do an emotional transfer and take it
as a personal slight. In addition, severe discomfort and even
panic from the establishment makes supporters happy. The
system enablers are freaking out over this guy? Well good!
Trump is such a poor choice of candidate for elected leader
of the free world, he is practically a badly drawn cartoon
character — like a giant practical joke, made to prove a point.
But Trump’s success with the rank and file is, indeed, meant
to prove a very serious point. And that point is that the rank
and file of the Republican Party… those who do not break
bread with the wealthy deregulators and globalizers… are so
disgusted with the status quo — a status quo that doesn’t
care at all about them — that they would rather blow up their
party, and the system, rather than see the status quo persist.
One of the greatest political novels of all time is Animal Farm
by George Orwell. Every high school student in the Western
World should read it (and many probably have). The book
(spoiler alert) tells the story of a group of farm animals who
rise up to assert animal rights against their human masters.
Except the pigs — the smartest of all the farm animals — are
elected to negotiate with the human farmers and eventually
betray the other animals completely. The last sentence of the
book is the most powerful, describing the scene inside the
farmhouse as the pigs play cards with the farmers:
The creatures outside looked from pig to man, and from man
to pig, and from pig to man again; but already it was
impossible to say which was which.
The rank and file are the farm animals, on the outside looking
in. Establishment pols are pigs, traitors to their constituents.
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Consider two of the most powerful driving forces of the age:
Technology and globalization. Technology has enabled vast
fortunes to be made. But technology is also hollowing out the
Middle American job base. Where hundreds of high school
educated workers used to be employed in a factory, fifteen
college educated workers now oversee a sophisticated array
of robotic machinery. Jobs in the United States are becoming
more scarce and more skills-oriented simultaneously, as
fewer workers are required with more demanding skill sets
for those clear a higher bar to get the job. Factories not
suitable for overhaul, meanwhile, are being moved overseas.
These trends are excellent for multinational corporations, for
educated workers, and for wielders of capital in general —
but the rank and file of Republican America is not that. Huge
swathes of America do not have much higher education, and
no investment capital either (the majority of Americans are in
notable debt, and have nothing or not much at all to commit
to the stock market). These are the angry left behinds, who
feel the world has ceased to care about them – and on many
measures there are correct. Trump has promised to care
about their plight, and to “do something.” They don’t know
what he intends to do, but they know he has moxie, and it
sounds better than the alternative (doing nothing). These
fears and general anxieties further extend into the general
middle class, touching anyone who is discontented or angry
or fears falling down a job ladder. Then too, Trump’s ranks
contain many would-be chaos agents and gleeful bomb
throwers, who just want to see what actually happens when
an orange-faced blowhard takes control of the oval office.
But surely Hillary Clinton will beat Trump, yes? If Trump
makes it all the way to the general election, fending off Ted
Cruz and the threat of a brokered Republican convention as
his last obstacles, then sanity will prevail and Hillary will be
elected in a landslide, saving America from madness. Right?
Don’t count on it. Hillary Clinton, for starters, is one of the
most hated establishment figures in all political history. Few
individuals in the history of American politics are loathed as
deeply as Hillary (and not just on the conservative side). As
the joke goes, she has all of her husband’s baggage and none
of the charisma. This matters because, in an election mainly
fueled by anti-establishment emotions, the candidate who
inspires more passion will have a potential winning edge in
voter turnout. Trump has already inspired major passion
among his supporters, leading to record levels of Republican
turnout. Hillary Clinton, in contrast, inspires all the passion of
a Fortune 500 Corporate merger. Democrats associate her
with Goldman Sachs – not a good thing. Even as turnout in
the Republican primaries has hit record highs, turnout for the
Democratic primaries is hitting record lows. Turnout could
make a huge difference in this election — in favor of Trump.
© Mercenary Trader 2016 All Rights Reserved
Then too, Hillary is simply a terrible political candidate in
many ways. Even her supporters admit as much. She has very
little charisma and sometimes makes disastrous choices. Her
public defenses in Benghazi and email-gate were notable for
how wooden, robotic and detached they appeared. Hillary’s
campaign management style is also alarmingly haphazard and
chaotic, with many of her 2008 management issues already
showing up against Sanders in the primaries. Hillary’s loathing
of the press, and wooden inability to pivot or improvise, could
be a significant liability against the media maestro Trump,
who will attack her in no-holds-barred fashion on every topic
imaginable (Vince Foster, Bill’s adultery, cattle futures, Wall
Street cronyism, on and on) in vastly entertaining ways.
On matters of policy and political promises, Trump will have
the maneuverability to attack Hillary from any angle — left,
right or center. Democrats are used to hitting Republicans in
reliable conservative “weak spots.” With Trump this will be
like trying to hit a shape-shifting ghost. This in turn could give
Trump a real chance at collecting blue collar union workers
and disenchanted Sanders voters, extracting rich veins of
support from the traditional Democrat base. Because Trump
is not a true Republican (and never was in the first place), he
will have no problem championing extremely labor-friendly
policies in the general election… while smashing Hillary’s left
flank for not going as far. And Trump’s authoritarian streak, a
point of appeal for many Americans, will also appeal to many
lifelong Democratic rank and filers who have seen enough of
the Clinton dynasty (and who like Donald Trump’s blunt antiimmigration stance and “bring the jobs back home” talk).
Even a chunk of Sanders voters could wind up voting Trump
— out of a desire to inflict pain on Hillary, as payback for their
man (Sanders) getting steamrolled by the Clinton Machine.
One young female Sanders voter summed up the view
towards Clinton by suggesting that, every time Hillary speaks,
you get the sense her words were sponsored by someone.
Sanders inspired passion among his supporters because he is
seen as passionately honest and passionately against “the
system;” Hillary is like Darth Vader to Bernie’s Luke Skywalker
when it comes to these things. Hillary’s popularity among
liberal youth (a traditionally important element of Democrat
support in the general election) is now so low it is practically
negative — a situation she makes worse by attacking Sanders
with low-blow tactics, not thinking about alienation damage.
What about social conservatives? Won’t they stay home,
hurting Trump? No, because of the Supreme Court issue.
Conservative talk show host Hugh Hewitt has made clear he
would vote for Trump on the importance of Supreme Court
vacancies alone, an area where a conservative-friendly
president could have the potential to fill multiple seats (and
thus influence American judicial policy for decades).
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Last but not least, the anti-establishment mood is brewing in
general terms among Democrats as much as Republicans… it
was just less apparent in the run of Democrat primaries due
to low turnout and dominance of the Clinton Machine (which
has made establishment deals with many union leaderships
for example, even as union members feel the Bern in their
hearts). Like their Republican counterparts, countless rank
and file Democrats are feeling completely screwed over by a
Washington regime that has done nothing for them. The Wall
Street bailouts under an Obama presidency — essentially a
“socialism for the rich” program mean to run up asset prices
without helping main street — has reinforced this bitterness.
Hillary Clinton will largely run as a “safe pair of hands”... but
who in the world wants a safe pair of hands attached to the
current establishment, aimed at maintaining the status quo?
What it will likely come down to is “Which side’s voters are
more passionate,” with no obvious Trump card (sorry, no pun
intended) on either side. Hillary would be the far saner
candidate in Wall Street’s view, but she also inspires hatred
and boredom even among some Democrats, which will lower
her turnout. Many will claim “Stop Trump!” as their voting
mantra, but “Anyone but Hillary!” effectively cancels that out
too. All in all you’ve got a coin flip which could go either way…
From a bigger picture perspective, the past way of handling
politics is now obliterated. American politics will likely never
be the same because the moneyed interests, who used to
hold most of the cards if not all of them, have now lost their
anointing power, thanks to social media and the rise of the
wild west internet. This was the first election where attempts
by the establishment to “control the narrative” were wholly
and completely hijacked. Even a massive $130 million in a
primary contest, as Jeb Bush showed, is a drop in the bucket
when stuck on the wrong side of public opinion in a social
media age. The candidate of choice can no longer be vetted,
approved and coronated by a hushed consensus of elites. This
in turn means American politics will be a lot more chaotic and
weird moving forward. Less behind-the-scenes control means
a lot more food fights and wildly competing viewpoints.
© Mercenary Trader 2016 All Rights Reserved
In political discourse, the “Overton Window” describes the
range of acceptable ideas. In the past, establishment party
elites held control of media outlets and candidate talking
points in such a way as to maintain a deliberately narrow
Overton Window — so that only the topics the establishment
wanted to be discussed would actually get talked about.
Now, though, the Overton Window has been thrown wide
open. “Outrageous” ideas, even flat-out wacky or insane
ideas, can get play in the public arena. It’s as if a conversation
censorship ban has been lifted from the Thanksgiving dinner
table, and now your outspoken cousin Morty can say all the
fringe-like things he believes (and provoke a strong reaction).
This is chaotic in a way, but in the long run it is also good…
because we are finally forcing a real dialogue to take place.
Did the old way of doing things make sense? Did it really make
sense for moneyed interests of the establishment to have
such firm control, on both sides of the aisle, that candidates
were basically talking hand puppets? Not really.
The ability of a protest candidate like Trump to crawl through
(actually cannonball through) a gaping Overton Window —
widened by the free-for-all communication medium of social
media — is not a sign that we need to go back to the bad old
ways... when an empty corporate suit delivered a bunch of
scripted lines that moneyed interests told them to say… but
instead a wake-up call as to the fact that the nation’s voters
need a real voice, and they also need to understand whom
and what they are actually voting for. Voters in the past were
like mushrooms as the old saying goes — “keep ‘em in the
dark and feed ‘em bullshit.” Donald Trump is a voter temper
tantrum on the way to systemic change. It’s scary, but it’s a
start. Grass roots populism is only going to become stronger
as a force in the coming years. America will be forced to have
more open dialogue about it (even if the party elites hate it).
As for market impacts, Wall Street would be genuinely
terrified of a Trump presidency… but Clinton and Trump alike
have shown strong anti-free-trade streaks, which naturally
appeals to the rank and file on both sides. While libertarians
accuse Republicans and Democrats of being like Coke versus
Pepsi, the irony is how similar the basic instincts of rank and
file voters actually are for both: “Protect my job. Protect my
benefits. Protect my physical safety.” There might be an
added geopolitical wackiness premium added to a Trump
presidency, given that no one really knows what he might say
or do in a tense situation… but as far as markets go, the real
threats are 1) the possibility of a Smoot-Hawley style trade
war and/or 2) the possibility of a deflationary downward
spiral, with central banks “pushing on a string” and congress
then gridlocked and inactive. Those things could happen
under any candidate. One macro forecast is all but certain:
stock market volatility will be coming back with a vengeance.
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TACTICAL VIEW: Sucker’s Rally
The major indices have rallied off their February lows (along
with global risk assets in general). The S&P 500 has pushed
through “W” area resistance and surged back above the 50
day moving average. It’s been a move to confound bears and
generally force short covering. It also smells like baloney.
The psychology of bear markets is such that optimists don’t
give up hope easily — especially in the beginning. This leads
to non-sustainable optimism jags (secondarily powered by
short covering) and repeated attempts to “buy the dip” after
the worm has turned. Money managers are still driven by
FOMO in the beginning — the fear of missing out — before
psychology truly turns, and thus find themselves tempted to
rebuild reduced exposure levels for fear of being left behind.
This all serves to draw investors in before the trap slams shut.
We don’t know how much further this creeping rally will go.
We only know that, based on odds and probabilities, it looks
like a booby trap that is closing in on the vicinity of failure.
Price action in DIA is representative. The trading range has
narrowed considerably on the way up, even as volume has
tailed off. Those are classic symptoms of waning momentum.
Wall Street’s top-rated technical analyst is also skeptical. Says
Jeff deGraaf, the top-rated technical analyst as ranked by
Institutional Investor over the past 11 years: “This entire 150point rally has been one of the weaker rallies in my 25-year
career.” Primary bear trends in the major indices are still very
much intact. The move so far has the classic feel of a
weakening countertrend rally. And the fundamentals are so
bad, it would take a very powerful narrative shift indeed to
counter the darkening picture. Great backdrop for a fake-out!
© Mercenary Trader 2016 All Rights Reserved
Factset estimates 2015 saw the weakest earnings growth
since 2009, the WSJ reports… and that meager growth (less
than half a percent) was based on “pro forma” accounting
figures. But when you go with GAAP accounting figures —
which stands for “generally accepted accounting principles”
that take out the hemming and hawing and B.S. corporate
fudging — earnings per share then fell by 12.7%, the largest
amount since the 2008 crisis. GAAP earnings were also a full
25% lower than the “pro forma” version, a record. By this
estimate, corporations are fudging as much as 25 cents out of
every reported earnings dollar. And earnings are declining…
Analysts are also accelerating the pace of their earnings
downgrades. Per Bloomberg:
The pace at which earnings estimates are being cut is getting
worse, not better. While bulls cling to predictions that profit
growth will resume for Standard & Poor’s 500 Index
companies in 2016, analysts just reduced income estimates
for the first quarter at a rate that more than doubled the
average pace of deterioration in the last five years. Forecasts
plunged by 9.6 percentage points in the last three months,
with profits now seen dropping the most since the global
financial crisis, data compiled by Bloomberg show.
Speaking of falling profits… since the year 1900, JP Morgan
analyst Dubravko Lakas-Bujas reports, there have been 27
back-to-back instances of two straight quarters of earnings
per share decline (what the market is dealing with now).
According to Lakas-Bujas, this has “been closely followed by,
or coincided with, a recession 81% of the time since 1900.”
The 19% of the time when back-to-back earnings declines
haven’t led to recession, Lakas-Bujas adds, involved “some
form of stimulus” to give markets a boost. Except guess what?
We’ve been doing the fiscal stimulus thing for six years now…
and central banks are out of bullets with interest rates at zero.
Ray Dalio argues that the next big move from the Federal
Reserve will be quantitative easing. This is still news to
Federal Reserve officials, who are stubbornly sticking to rate
hike forecasts. But even if another QE is in the cards, that’s no
guarantee risk assets would respond the way they did before.
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If earnings keep falling and outlooks keep deteriorating…
which now seems to be the case… no amount of magic pixie
dust will keep investors from selling. Monetary stimulus is an
invitation for investors to indulge risk appetites if they are in
the mood to do so, not a forced means of keeping valuations
up when the speculative urge dries up. When reality sets in
and earnings start to fall, it’s like Dumbo’s feather in reverse.
To make matters worse, world trade is collapsing… as such,
Citibank analysts now warn of rising global recession risk. The
trade angle is also a growing concern given the upcoming
2016 election… as both likely presidential candidates, Trump
and Clinton, are protectionist and anti-free trade in their
rhetoric and promises. Again the big question looms: If we get
another global recession this time around, where will the
coordinated rescue efforts come from? ZIRP didn’t work and
NIRP is toxic. What else have the central bankers got?
High yield bonds have rallied smartly these past few weeks.
As shown by JNK weekly above, however, from a distance the
move looks like the mother of all dead cat bounces – not yet
powerful enough to take out the major downtrend. So is the
worst really over for high yield bonds? A whole bunch of too
clever by half investors seem convinced of this. US junk bond
funds attracted record inflows last week, the FT reports,
notching their biggest numbers since record-keeping began in
1992. This comes even as Standard & Poor’s “distressed debt
ratio” rose for the ninth straight month, with more than 274
US groups at a negative outlook and B3 rating or lower. That
number peaked at 291 companies in April 2009 near the lows.
© Mercenary Trader 2016 All Rights Reserved
So investor activity in the high yield market seems to suggest
that, given this surge of optimism, the February 2016 March
lows are comparable to the March 2009 lows (!) after the
2008 financial crisis. This notion is beyond ridiculous. None of
the major bearish tail risks for this market – oil collapse, China
debt implosion and transition stumble, Europe slowdown, EM
malaise, earnings decline – are showing sign of resolution or
healing. If anything they are showing clear sign of getting
worse (with “Brexit” waiting in the wings for Europe). Reading
the basic shape of things, bottom calls here are looney-tunes.
More color on distressed corporate debt… current levels are
the worst since the financial crisis, Wolfstreet reports. And we
have reason to believe that pain will increase – think falling
earnings that reduce income available for debt service, rising
recession risk, and the potential for a USD short squeeze that
kills multinational profits and further wrecks balance sheets.
In sum this multi-week global risk asset rally has “SUCKER”
written all over it. The primary trend for most major indices
remains down. The jag-type action pushing various vehicles
higher is wedge-like and comes with lackluster volume. The
high yield buying feels vaguely panicky, possibly manipulation
orchestrated, and out of synch with the worsening earnings
and debt situation. Safe haven US Treasuries look possibly
bullish, though, with a bullish wedge inverted to the Dow’s.
SIR 113 | Page 7 of 8
Mercenary Trader SIR 113
March 6th, 2016
SPOTLIGHT: Dragon Bait
A bit of Amazon.com trivia: Jeff Bezos originally wanted to
name his e-commerce baby “Relentless.com.” It changed (to
Amazon) but the attitude stuck. Amazon has now become a
sort of wrecking ball for competing biz models, as Bezos uses
endless patience from Wall Street – and a gusher of cash from
Amazon Web Services – to pay for expansion in all directions.
This includes global shipping and delivery, services for which
Amazon shelled out nearly a cool $12 billion in 2015, which
represented more than 12% of Amazon’s net sales. Twelve
cents out of every dollar is a lot for shipping, especially when
customers wind up complaining about service and delays. So
it is now little surprise Amazon wants to get into package
delivery, and has been gearing up to do so behind the scenes.
A memo obtained by Bloomberg reveals an Amazon project
code named “Dragon Boat,” which has been proceeding for a
number of years (initiated 2013) and could start bearing fruit
in 2016. The goal is to compete not just with FedEx and UPS
as shipping rivals, but to challenge China’s e-commerce giant
Alibaba, with ultimate plans for a broad scale venture called
“Global Supply Chain by Amazon.” This would fit the modus
operandi Amazon has used to expand in other areas – first
building logistical capabilities for its own internal business
needs, then taking that knowledge and know-how and using
it to expand into external customer service fulfillment.
Analyst Colin Sebastian of Robert W. Baird & Co. says a global
logistics operation could be a $400 billion business for AMZN.
The synergies Amazon could exploit include shipping services
for its third party vendors as well as its own needs. This would
not happen immediately, but things are moving along. “They
take baby steps along a path,” Sebastian tells Bloomberg,
“which allows some companies that could be disrupted to
remain in a sense of denial. Amazon rarely takes one big step
forward that shocks the market.” Amazon describes its vision
as “a revolutionary system that will automate the entire
international supply chain and eliminate much of the legacy
waste associated with document handling and booking.”
© Mercenary Trader 2016 All Rights Reserved
In other words, there could be a lot of existing fat to trim…
and potential competitive advantage for a large-scale user of
shipping services (the same evolution path as Amazon Web
Services). Investors in FedEx and UPS may now scoff at
Amazon.com’s shipping ambitions. But then again, Wal-Mart
(WMT) had its share of Amazon scoffers too, and the stock hit
multi-year lows last year as e-commerce costs rose and net
sales declined. Could the same thing happen to the global
shipping giants (Fedex and UPS)? It’s certainly a possibility.
Morgan Stanley analysts argue that “an emerging ecommerce
logistics network” could be competitive at $4-$5 per package
in dense delivery areas (think big cities). While the pressure
would be limited at first, the per-unit economics cost for the
rest of the legacy shipping business might start to turn south.
While Amazon potentially provides medium-term pressure
on shipping margins – and who’s to say AliBaba won’t step up
that fight also – shorter term concerns revolve around global
slowdown risks and US recession risk. If the USA fully avoids
a recession and the macro environment improves, David Ross
of Stifel argues, FedEx would see buying as investors move
back into cyclically sensitive names. Yet the opposite, of
course, also applies. If the global economy deteriorates
further, and slowdown at home and abroad becomes more of
a reality, then transporters could feel the pain. FedEx and UPS
have both been treading water for years, first registering their
peaks not in 2015 but some ways back in late 2014.
In final note, FedEx’s free cash flow to equity has already
declined sharply in recent years – we wonder how that metric
will look if FDX is forced to start a cost-cutting war with Bezos,
or to give up urban area revenues even as the United States
and / or global economy experiences slowdown or recession.
SIR 113 | Page 8 of 8