The Pattern of The Market
The Market Ticker - Commentary on The Capital Markets
2017-02-12 06:00 by Karl Denninger
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The Pattern of The Market
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Looks awfully similar to 2008.

Rotation back and forth, with most of the gains coming in a handful of big names with big stories -- but no earnings to back them up.  Claims from the media, including most-notably CNBS, citing 2018 earnings projections that have built in 50% or more increases in earnings -- that have not happened yet -- to "justify" P/E ratios that today stand in the area of 40, 50, 100 or more on current earnings.  These same firms are themselves showing slower growth rates and increases in both spending on "new things" and decreasing margins, along with near-zero growth of customers in the United States.

In 2008 this was happening in banks and...... big tech.

Today it's happening (mostly) in big tech.  But those firms today are even further down the road (if they existed at all) than they were in 2008, and yet..... suddenly, we seem to have magically grown a few new continents for them to expand into (never mind that the revenue available from people in those places, thus far, appears to be near-zero on a per-person basis.)

The market always balances fear and greed; along with this nebulous thing called "liquidity" -- the availability of cheap credit to leverage forward results. What everyone intentionally refuses to consider is that leverage works both ways; it both amplifies profits and losses.  Every turn of the crank irretrievably impacts both in exactly the same amount.  If you buy back shares and reduce the float of your stock by 50% then your earnings are doubled on an EPS basis -- but when the worm turns and you take losses, the losses on an EPS basis are doubled as well.

Nobody believes there will be losses, you see, therefore there is no cost, no penalty, and no risk to turning the crank.

Uh huh.  Sure.

If you think firms like Netflix, Amazon, Facebook and similar are going to grow trees to the sky you're deluded.  Amazon managed to somehow nearly double SG&A expense this last quarter over the same quarter last year.  How did that actually happen and where was that expense from?  By the way, their sales did not double -- not even close. 

You can argue, if you'd like, that there's something special -- "water walking" of some sort -- by these firms.  There's not.  There is plenty of accounting gaming going on, but it's legal to do that within broad limits.  The onus is on you as an investor or trader to actually read said releases and figure out, if you can, what they're doing.  Like, for instance, exactly why Amazon's SG&A doubled -- from what section of their business are they hiding broken-out expenses to prevent you from evaluating, on a fair basis, what the forward profitability of that segment of the business is.....

I have considered banks uninvestable since before the crash.  The reason is simple: I cannot get my arms around their contingent liabilities because the law allows them to hide those liabilities to a degree that putting a number on them with any sort of accuracy is impossible.

You could forgive most of the people in the so-called "analyst" community in this regard up to a point.  You see, the world of ever-lower interest rates has been firmly in place since the 1980s.  That's driven better than half the gains in the markets since 1980 as a purely mathematical matter.  Without that the DOW would stand at 10,000 and the S&P at about 1200 today.

But how do you continue that pattern today when it's not possible to continue the ever-lower interest rate paradigm?  It's entirely possible that we could stall out here and never reverse -- that is, the 10 year Treasury could trade in a range of around 2.2-2.5% for decades.  It has before, and it might again.  But if it does that still doesn't help you expand leverage because you've already borrowed the money at the low rates of the last 10 years!

Note that firms like Netflix, with negative operating cash flow that has persisted through a period spanning yearsonly exist because of their ability to continue to turn that crank!

If that ability to disappears the firm is literally out of business because they have contracted to spend money over the next several years that they do not have, do not generate from operations and cannot raise -- this means their stock suddenly becomes worth zero.

It is not the absolute rate that determines which direction leverage goes it is the change in rate and direction of that change.  If there is no change then there is no change in the bias for leverage.  If rates rise then you wind up with a forced de-leveraging because any money borrowed not to be paid back but simply to be paid coupon upon cannot be held out -- either you pay back those loans or you default, and in a corporate environment that means the firm goes bankrupt and the stock value of said firm is zeroed.

When you look through the economy of today in the United States from 20,000' you find two things that stand out:

  • Forced extraction of money, often apparently in violation of black-letter felony law (e.g. 15 USC Ch 1), supported by either intentional refusal to prosecute or even government involvement in same.  Health care is the standout example, but not the only one. Forced "net neutrality" was one of them from the Obama era, and is the reason Netflix exists at the scale and pricing that it does in the US.  Anything that upsets that apple cart will detonate all the businesses dependent on it.

  • Ridiculous borrowing for uneconomic purposes such as stock buybacks and similar.  Borrowing funds is always dangerous.  It also, however, is sometimes a risk worth taking.  There is no such thing as life without risk.  The question is what's the risk, what's the reward, what's the timeline on that risk and what forward assumptions and their probabilities are you using to measure all three?  That last question, in the last 30 years and especially in the last six or seven has never been asked and expanded upon in public by any firm's public filings I've seen.

Finally, we appear to have a President that cares not for the boundaries of the Constitution when it comes to said extraction, nor will he enforce existing law.  The fact that Trump supports "civil forfeiture" is enough to disqualify him as a President standing alone.  That he has demonstrated no intention to act on medical monopolies is far worse, however, as while civil forfeiture is unlikely to impact you medical monopolies will, with near-certainty, impact either you or someone you love and care about at some point in your life.

You need only get into a car accident that you cannot foresee nor are at fault for to be victimized by this system even if only to a mild or moderate degree.  Your mother or father, or child need only get injured in a pure accident, such as by a snake bite to get rat****ed beyond words and face a quarter-million dollar charge they never consented to.  Unlike many of the injustices this one hoses nearly everyone at some point in their life and yet there is exactly zero outrage in the streets, state-houses or directed at the cops and other law enforcement agencies over any of it.

It was obvious to me in 1997 that the stock market was going to crash and the pets.com wonderkind would be zeros.  What people cite as "different" today is that firms like Facebook and Amazon have "actual earnings."  Well, perhaps, but that just changes whether the bottom number for their price is zero, or some small number over zero.  That you have a functional business that actually does generate something beyond what you spend doesn't make your 2% operating margin delivering goods, and what is rapidly trending toward a commodity-style 10% operating margin delivering services, worth the near-200 times earnings your stock sells for today on the premise that you can manage to hold 50% service margins along with the necessary companion expectation that sales volume will expand by a factor of 10.

Last time around the stupidity centered on the premise that the S-1 filings claimed somewhere north of 10x Global GDP for "expected outcomes" -- a radically stupid proposition that should have met with exactly zero willing buyers in the market.

This time around it centers on equally-stupid premises -- such as the idea that AWS is a $200 billion a year business operating at a 50% margin -- a pair of assumptions that together mean (1) there will be no competitors and (2) there will be no corporate data centers.  Either one of those presumptions standing alone is laughable.  Together they are hucksterism far worse than anything P.T. Barnum ever cooked up.

This sort of "analysis" by Wall Street and their willing mouthpieces in the media ought to be good for felony indictments because they are claims that have a statistical probability of occurrence less-likely than an asteroid hit on the White House in the next 72 hours.

Yet just as was the case in 2000, and in 2008, exactly nobody will face any sort of sanction for any of it -- just as nobody has for nearly 40 years in the medical industry for violating 100+ year old law.

You, on the other hand, will pay the price -- just as you will for the medical monopolies -- because we, the people refuse to demand that it change now and that this crap be put to a stop.

As for exactly when the roof will fall on your head, that's unknowable.  Every time it happens someone calls it right, but hundreds, even thousands of people call it wrong, and usually the person who called it right got it wrong previously for the same event.  The underlying cause of 2008 was clearly visible early in 2007, yet the insanity went on (and the market continued to rise) for more than 18 months.  In 2000 the insanity was clearly visible in 1997, I exited in 1998, and yet from the point that "this is stupid" was obvious until it blew was close to three years -- and well more than a double in the Nasdaq later.

I have utterly no remorse, however, over sitting out the "last burst" of run-up in either case -- because the odds are nearly 100% that you won't get the call on the exact time right to exit, and you risk far more than you can make by trying to do so -- or even worse you wind up second guessing on what you think is a "dip to be bought" and finding out that what you just walked into with your money is an elevator shaft on the 100th floor -- with no car. 

The math is never wrong.

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User Info The Pattern of The Market in forum [Market-Ticker]
Nevertoolate
Posts: 1289
Incept: 2007-08-26
A True American Patriot!
San Antonio de Bexar de runover with illegals, Texas
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Thanks again for wisdom and insight.

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Democracy is a conversation between 2 wolves & a sheep discussing what's for dinner. A Constitutional Republic is found when the sheep pulls out a gun & makes clear that his 2nd Amendment Right will be exercised should the wolves attempt to hold such a "vote."-KD 9-29-15
Oldno7
Posts: 2534
Incept: 2008-11-14

RECALL STATE USA
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Yes Karl you are so right but many people are sick of hearing that a crash is coming and as always happens they tend to get in at the top. My wife had a friend ask if I would offer some advise and I said I would be willing but I am not a financial advisor so the important question is how much money do you want to loose which also relates to how much you now have. You can pretty much set a course of action based on those two questions and a simple spreadsheet showing how long your money will last based on what you spend. It has served me well.

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IT'S THE SPENDING STUPID The US must become less a government of men, and more a government of LAW.When people lose everything and have nothing left to lose they lose it -Gerald Celente
Quik49
Posts: 3845
Incept: 2007-12-11

ut
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Mbeen preaching to to those around me it's 2007 all over again for about a year.... Except worse... I see it in my industry doing exactly the same ****.... Out of market ..Out of debt...Prepared to hunker down best we can and enjoy life in meantime

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Long Vaseline....

Bds3151
Posts: 4
Incept: 2014-03-25

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Karl, thanks for the information. It may not be possible to forecast a major market event far from the occurrence, however, as you approach the event, there seems to be a "bell ringing" business failure (Lehman). Last time it seemed clear mortgage banking would be the target way before but now so many areas seem exposed. Are you saying that big tech will be the area of this failure or just that it is exposed like many others? If it is big tech, Is Amazon large enough to start this event by itself?
Flappingeagle
Posts: 2538
Incept: 2011-04-14

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Quote:
I have utterlynoremorse, however, over sitting out the "last burst" of run-up in either case -- because the odds are nearly 100% that youwon'tget the call on the exact time right to exit, and you risk far more than you can make by trying to do so -- or even worse you wind upsecond guessingon what youthinkis a "dip to be bought" and finding out that what you just walked into with your money is an elevator shaft on the 100th floor -- with no car.


I have been out of the market since late 2007 and I've not gotten back in for the reasons you list above. I know I can't time the market and, with everything so overvalued, I feel like I would be trying to pick up pennies in front of a steamroller.

Too much risk, too little reward.
All surprises would be to the downside.

I'm going long physical fitness and enjoyment of the simple things.

Flap

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Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave the Rat Race to the rats...
Sondergaard
Posts: 720
Incept: 2007-07-13

Big Trees
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It seems the biggest wild card is the unprecedented involvement of central banking.

I know they can't print value. I know their ability to manipulate price discovery is not infinite. But when I see charts like this (published Feb 8 at http://www.fuw.ch/article/snb-haelt-fast.... I wonder how any sane person could bet against these issues?

Granted, a $1.7B position in Apple is small compared with its nearly $700B market cap. But these are just direct purchases. The ECB is buying corporate bonds, which could indirectly fund further stock buybacks. The BOJ holds 40% of the entire outstanding balance of JGBs and shows no sign of stopping.

One often hears that the central banks are "out of dry powder" as David Stockman's been saying for over a year. I'm not seeing it.

How much worse can fair price discovery get before it gets better? I'm guessing worse. Much worse.
Inline

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And it won't make one bit of difference if I answer right or wrong; when you're rich, they think you really know. --Fiddler on the Roof
Flappingeagle
Posts: 2538
Incept: 2011-04-14

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Quote:
It seems the biggest wild card is the unprecedented involvement of central banking.


Yes, and we are NOT controlling the wildcard, someone else is. It is like playing poker with wildcards in the deck and your opponent gets to set the value of the wildcards and you don't.

It is rigged so the only thing to do is not play.

Flap

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Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave the Rat Race to the rats...
Dennisglover
Posts: 528
Incept: 2012-12-05

Huntsville, AL
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Flappingeagle wrote..
It is rigged so the only thing to do is not play.
A whole lot of people I see out at the smoke shack at work had long faces and were looking to get out of stocks until a few months ago. Many of them are now gazing worshipfully at their phones, watching the market, and muttering stupid things like, "Easiest twenty thousand I ever earned."

I don't even try to convince them that it might be time to reconsider their strategies. SMH.

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TANSTAAFL
Maynard
Posts: 245
Incept: 2007-11-27

The Lowcountry
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I don't think Amazon will take it down as they have "the market". But the waterfall effect will eventually get them. Netflix might start it, as they have plenty of competition. Face**** might as well. I think anything in the tech sector could get this ball rolling. Not sure about the banks this time, Fed has shown they have their backs.
Bodhi
Posts: 87
Incept: 2008-02-23

Georgia
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As regards Netflix, they recently sent me an email to come back on a 30-day free trial. They've never done this before. I'm 2 weeks into the free trial and I have already canceled due to their embracing Dear White People. You'd think the liberals would finally realize that continuing to alienate the "deplorables" is not good for business. Oh well.
Mekantor
Posts: 136
Incept: 2009-01-12

Houston, TX
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I have a gut feeling that twitter will set it off
Asimov
Posts: 109292
Incept: 2007-08-26

East Tennessee Eastern Time
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More likely it'll be some stock you've never heard of that sets off the algos and starts a sell off.

I'd give very low odds it's one of the big names.

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It's justifiably immoral to deal morally with an immoral entity.

Festina lente.
Bagbalm
Posts: 5221
Incept: 2009-03-19

Just North of Detroit
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I'm no longer worried about the market. Been out of it for several years. I've written off what my wife has in her retirement account since she won't retire and cash it out.
I'm just hoping it isn't so bad we lose basic services due to the concentration of so many things in fewer companies, and the regulatory barriers to any recovery.
Thanks to Karl I've lost 70 pounds and am still working on it.
Due to him and a few other sane people we owe nothing, pay everything off we buy monthly, and have a decent cushion of cash.
I am hoping when Amazon dies they spin off the e-book sales because that is treating me very well.
Aztrader
Posts: 7702
Incept: 2007-09-10

Scottsdale, AZ
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The biggest issue that has kept this Ponzi running is fake news from the companies. Never a negative item, phony accounting, phony growth numbers, phony earnings beats and not a peep out of the SEC. We have watched retailer after retailer hit the skids and yet the indexes keep rising. They keep buying Amazon, Apple, Google and the rest of the phony growth stories.
The whole system is rigged to keep it going and we will need a major event to get it to implode. I truly look forward to that day when the truth rings out and the crooks get hammered.
Rufust445
Posts: 729
Incept: 2007-08-11

Emerald City
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Last real market activity I did was in 2008. Covered my Countrywide Financial shorts in Jan., 2008, and the Lehman Bros. short on Sept 11. Been living frugally but comfortably since, waiting for the other shoe to drop, perhaps.

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"The stock market isn't bullish, it's bull$hit." -- Alan King
Ewtnewbie
Posts: 1
Incept: 2017-02-13


Banned
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When I go to Schwab and look at the earnings statement comparing 4Q 2016 (green)to 4Q 2015 (blue), it states in the green box 8949 and blue is 6450. That doesn't seem like a doubling, but up 39%. I have not yet looked elsewhere, AMZN website, etc... Yes, revenues were up only 28%, so that means SG&A are increasing faster and will be problem at some point. I hope the screen capture is big enough, but the 100kb image limitation and framing of the screen shot to prove it is "legit" is the best I can do at the moment.
Inline
Tickerguy
Posts: 147938
Incept: 2007-06-26
A True American Patriot!
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Why do I put up with this **** from people with one post who can't be bothered to LOOK AT THE ****ING FILING WITH THE SEC?

https://www.sec.gov/Archives/edgar/data/....

Inline

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Winding it down.
Geckogm
Posts: 4229
Incept: 2007-06-26

Canyon Lake
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It happened so quick you probably forgot, but you did not put up with his ****!
Tickerguy
Posts: 147938
Incept: 2007-06-26
A True American Patriot!
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smiley

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Winding it down.
Tsherry
Posts: 770
Incept: 2008-12-09

Spokane WA
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I think I felt the breeze from that banhammer, and I'm a solid 2500 miles away. BAM!
Tickerguy
Posts: 147938
Incept: 2007-06-26
A True American Patriot!
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BTW if you look at what Schwab did you'll understand the deceptive nature of it. By not breaking out COGS from G&A it rather cleverly obscures the accounting chicanery that Amazon used.

If you're dumb enough to read someone's EDITED **** when the actual filing is available with a couple of clicks you deserve to have a zeroed account.

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Winding it down.

Chuck1981
Posts: 196
Incept: 2012-07-07

SE PA
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Karl, I've never invested personally, just have what my employer does automatically. But it seems to me that if Schwab and probably most of the other investment firms fudge the numbers, it's no wonder armchair investors get hosed.

Yeah, we be ****ed. Rat ****ed.

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"Screw'em, let's get this **** show started already!"
Tickerguy
Posts: 147938
Incept: 2007-06-26
A True American Patriot!
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They're not fudging it, just adding things together. It still winds up being misleading.

Take half that G&A increase, add it to cost of AWS and then tell me what you think of where their margins are headed. That, by the way, is what I think they did. I can't prove it, and if they did do it it's almost certainly legal, but if so AWS is in big time margin trouble and when the market figures that out the stock will get cut in half.

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Winding it down.
Chuck1981
Posts: 196
Incept: 2012-07-07

SE PA
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I should have said " not as clear as possible" aka misleading. And while it may be legal, how much of this "obfuscation" is the average investor being led by.

I'm not taking the blame off of the individual, the information is out there for anyone to see as you've shown. However, if it's systemic, it's no wonder the markets are so screwed up. Everyone lies and everyone believes those lies and their very own, just to hopefully make a buck.

I remember reading in a Clancy book where the Japanese destroyed the financial system with a computer bug or something. Long story short, Ryan explained that the economy was just as psychological as it was mathematical. Granted, I understand that now, but I read that book quite a long time ago when I still considered myself a proud conservative. I've learned a lot since then.

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"Screw'em, let's get this **** show started already!"
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