2013 In Review, And A Look Forward
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2013-12-26 13:00 by Karl Denninger
in Editorial , 952 references Ignore this thread
2013 In Review, And A Look Forward

Whew, another one in the bag.....

Yeah, I suppose.  And it's sure been interesting, especially the last few months.  The rally in the market looked at in contrast with a reported 21% decline in retail shopping traffic for the end of the Christmas season is one of those events that makes you cock your eyebrows all-funny and spit your morning (whiskey-laced) coffee.

I mean, really?  One fifth of the shoppers didn't show up and yet the consumer is ok and so is spending?

Really?

Then there's the collapse in mortage applications and refinances (the latter of which, incidentally, will be essentially extinct as long as bond rates go up), with the latter being a big source of consumer spending increases.  After all, it's not coming from real income gains when for the last three quarters (1-3) of this year the spread has been -6.68%, -5.87% and -3.96% (annualized.)  You can argue "CPI" all you want but since every dollar of credit in the economy changes hands with someone when it is created, and the BEA claims they capture all income, including from government handouts, in their statistics (except, obviously, hookers, blow and similar means of income generation) the fact remains that the consumer's purchasing power is, and has been (since 2Q 2012) decreasing -- again.

The interesting part of that latter statistic is that in 4Q 2009 that worm turned -- from the first of 2010 until 2Q 2012, or two and a half years, we saw actual positive annualized income growth (in real monetary-adjusted terms.)  And it wasn't small either -- 8.96%, 10.64%, 9.7% and 6.48% (annualized on a quarterly basis), respectively, before falling back rapidly toward zero.

And again, note that I'm not referring to whether you got any of that benefit individually, but it is irrefutable that it happened for everyone in aggregate, just as its irrefutable that it's going the wrong way now -- and was up until the crash.

Looking at the predictions from last year it's clear that the "white swan" was the irrational exuberance of markets in the face of leverage increase.  We've seen this before, of course, in 2000 and 2007.  You'd think that with a mere five years under our belts we'd be wiser, but you'd be wrong -- and I was.  

So without further ado, here we go:

  • You will see the highs in the first half of the year.  Clean miss; we now have the "featurette" of stocks like Facebook, Twitter and Amazon (again) "leading the way."  Ooook.

  • Europe is out of time and Japan is headed for a blowup.  Neither blew.  But I see neither looking particular good either.  Japan, for all its monetary machinations and a huge rally in the Nikkei, is showing signs of cracking.  Badly early -- aka, wrong.

  • Obamacare's bite comes home and the fallout is severe.  Well who would have thought that Obama would simply (1) ignore the Constitution and rewrite his own law to delay it and (2) get away with it.  Not me, especially the getting away with it part, given how much screaming the Republicans have done over the last three years on Brosurance.  But he did get away with it.  So far the "price" has been 4 million cancelled policies and what's worse is that a recent weekly claims report showed a massive 600,000+ increase in people on unemployment in one week!  "This one is going to hurt -- a lot" looks to be spot-on and what's worse is that it's just getting started.  Score.
     
  • You're going to see a massive shift in the employment picture, all negative, as Obamacare and economic realities bite into margins.  Not yet, although it sure looks like it's happening now.  Sorry, too late, so sad, this one will be repeated for next year though.  Miss.

  • The gun-grabbers will fail.  Score.  Not only did they fail people are starting to wake up in places you'd never think it would happen -- like Chicago.  No, this battle is not over by any means, but the idea that the FeinNazis were going to "win" looks less probable now than at any time in the last decade.  Score.
  • 2013 is the year of the State and city-level blowup initiation.  Wrong on the place, right on the event.  Detroit, anyone?  Since I said we may get through the year without a general-level (state-level) default I take the point for this one.

  • There will remain next year, as there was this year, specific individual investing opportunities that will outperform.  Yes.  A number of them -- some that I caught, many more that I didn't -- and many of the ones I didn't were the stupid no-earnings, all-story-and-hype plays.  Nonetheless there were lots of plays that were wins even against a massive market-level rally, albeit most -- but not all -- were on the long side.  Point.
  • This will be the year in which the high-P/E and so-called "Internet II" stocks will blow up.  Zero, miss, wrong, whatever you want to call it.  The hype machine did not break -- yet.  Welcome to late 1999.

  • The Fed runs out of bullets.   Maybe taper is this, but I can't take credit for it -- that's certainly not what I was expecting when I wrote it.  Zero.

  • Housing Bubble II is forming a visible pustule -- Yep.  And -- I did not call for the blowup this year, but did for next year or 2015.  Point.
     
  • Geopolitical considerations become very bad news.  We evaded this one for the year.  I'm quite surprised, but it happened, despite a lot of armwaving there were few bullets or missiles launched -- well, other than a few chemical shells.  So far.  Miss.

  • The market begins to return to an actual market.  Bah.  Zero.

  • There will be some sort of attack on deferred retirement accounts.  Not yet.  Zero.

So this doesn't look so good.  Five points out of 13.  That's a pretty bad score.

Manias are a bitch, in short.  Among the big winners however were some really nice plays.  Sprint was one of them, although given what's happened in the last couple of months I'd still like to have it.  Nonetheless it was a monster.  Anything Internet and new was a big winner -- Facebook and Twitter to name two of the crazies, along with Amazon.  Among consumer-sensitives there were also some crazy moves, such as Starbucks and Darden.  Priceline doubled.  Tesla was up a factor of five -- with effectively zero earnings, and the few pennies they did make are all coming from federal vehicle subsidies.

Speaking of Sprint as I write this there are claims that Softbank (Sprint's "new parent") now wants to buy T-Mobile US (TMUS) and is finalizing a financing package to do it.  You know that the market is in a manic phase when companies are doing the same sort of deals that blew up the last time again -- with complete disregard for the fact that the last time it nearly bankrupted one of them and it's the same company doing it!

Specifically, T-Mobile and Sprint have different installed technologies that are incompatible with each other.  Sprint did this before -- when it bought Nextel.  The customer defections that followed nearly sunk the firm and in fact it was only when their CEO ditched Nextel's customers on purpose, focusing on among other things bringing high-quality phones to their prepaid Virgin and Boost brands, that my view on the firm's survival and prosperity changed.  Now we have Softbank trying to do the same thing, trying to figure out how to finance it (read: they will be going even further into debt) but expecting a different result.  How's that gonna work out?  Hint: If you have TMUS stock take the money.

The usual screed of the mainstream media for the last three years has been that there is "record cash on the sidelines" and that "cash on corporate balance sheets is at a record." 

First, it is important to understand that there is no such thing as "money on the sidelines."  Funds are all somewhere; to buy something you must sell something, even if what you sell is a low-yielding bond fund or CD.  That is, this is just a flat lie as an utterly inconsequential percentage of funds are sitting in someone's safe in the form of $20 bills.

The second import thing to understand is that the other claim -- "record corporate cash" -- is true but intentionally misleading.  What's also at records is corporate debt and what you must look at it is not tangible assets (which includes cash of course) but rather such assets less obligations, that is, debt.  And when you do and compare against equity prices what do you see?

Let's put not-so-fine a point on it -- leverage, as expressed in the form of stock price to assets less liabilities, is at an all-time post-war high.

Yes, worse than 2000 and worse than 2007.

Assets less liabilities for corporations economy-wide are approximately where they were in the last quarter of 2004 or the first quarter of 2005.  But stock prices are much higher in aggregate.  That's the correct measurement of operating leverage relative to the market -- not how much cash they have, or how many dollars of earnings they return today.  It's what the "corpus", that is, what your ownership interest as a stockholder (that's what you are when you buy stock) is that underlies your investment and thus how much you're paying for a given unit of tangible assets less liabilities.

This chart was bad at the end of 2012 -- in bubble territory for sure -- which was a big part of why I didn't think we'd get through 2013.  Well, we did -- and now it's worse because this is only updated through the end of September and of course the market has gone screaming higher in the last three months.

With that said that which cannot go on forever won't, and this clearly can't -- and thus won't.  The only question is exactly when, and what, triggers the corrective move back down.

The problem for most investors right now is that there is literally nowhere that looks particularly favorable.  Earnings are at arguably-unsustainable levels, firms are using their cash for financial engineering instead of buying property, plant and equipment to expand, the labor force is not expanding the ranks of the working among the labor force as a whole and real earnings compared against monetary inflation is negative and has been for more than a year; in real terms earnings power is about where it was in the mid 1980s.  Yet price levels in equities are much higher, a huge amount of the gain is expansion of leverage by all forms (buybacks and such increase leverage per-share) and yet we're hearing how "stocks are reasonably priced."

Really?

You're free to believe that, and the easy way out this last year was to ride the bubble, exactly as it was in 1999.  The best play then was simply to buy the index and sit.  Oh sure, there were 10 baggers, but a clean double in the Nasdaq 100 is damn hard to argue with when you had to do no work and that is what you got!

But remember too that from that point -- 12/31/99 -- we got nearly another 25% put on that very same Nasdaq in the next four months -- and then it all went to Hell.  For those who tried to rotate into the S&P, you did ok right up until September, and were patting yourself on the back for having "done the right thing" -- after which you proceeded to lose half your account balance.

There's a lesson in there for those who will pay attention, which is unfortunately a very small percentage of the whole.  Manias are illogical but extremely dangerous.

There's another piece to this that I have repeated several times, but nobody listens to: Until your position is reduced to cash you have in fact made no profit at all.

So as this year draws to a close, and the next one comes, rather than do as I have in the past years I choose instead to put my feet up on the desk and sip a nice glass of Scotch.

May the wind be at your backs, and may you have reconciled that which you should, for the time to do so before the coming storm that shall test the mettle of men and women alike draws to a close.