Friday, June 24, 2016

The Post Crisis Comb Over

From Wikipedia:A comb over or combover is a hairstyle worn by bald or balding men
in which the hair is grown long and combed over the bald area to minimize the evidence of baldness.Sometimes the part is lowered so that more hair can be used to cover the balding area."

 Bad comb overs. We’ve all seen them, and there is a very good chance that someone in your immediate family sported one of these unfortunate hairstyles at some point in their life (for me, it was my Grandpa). While some comb overs have enjoyed “reasonable” success in creating the desired effect of creating confusion about the actual existence of male pattern baldness (think Donald Trump), most attempts fail miserably.

It would seem logical then that the relative success or failure of a bad comb over is therefore determined more by two main things:

1.       the proximity of a viewer to the comb over and
2.       the level of attention and interest paid to the person sporting the comb over

Obviously, the closer the proximity to the disingenuous hair style (and the higher the level of interest) the more the illusion of hair gives way to the bald, sad truth. It’s probably at this very point in the discussion that you start to wonder, “What a very odd thing to talk about. Where exactly are you going with this?” Stay with me – it will make sense in a second!

You see, it is my belief that the ‘recovery’ and the ‘fundamentals’ that have been driving the stock market higher since the end of the crisis in 2009 are in effect, very bad comb overs that can only be seen from a distance. As such, these comb overs are making it very difficult for regular people to see what’s really going on.

To add to the confusion, Wall Street, Central Banks, Financial Reporters on TV and the paper, have all been very active in pushing a narrative that supports the view of a strong recovery and healthy market. It seems like every week someone ‘of influence’ is out there bragging about what a full head of beautiful hair the US economy and stock market. They assure you that given their exclusive access (which is much closer than you or I can get), they can confirm that all is well and growth is present.

For years now, the Federal Reserve has referred to the decline in the unemployment rate as proof positive that the US economy is back on track after the crisis. In May of this year Janet Yellen was quoted as saying “we are close to an unemployment rate that most economists would associate with our full employment goal”.  
And if we look at the unemployment rate from across the room, it certainly does look impressive.

 But here’s the problem: when you take time to learn HOW the unemployment rate is determined, you will recognize that it too is a ratio, one that measures the number of unemployed people divided by the Labor force. So – as we do a little investigating, and look closely at the labor force participation rate – we see something odd.

What would cause the labor force participation rate to decline to such low levels? To understand that, we need to look more into what this data point measures. As the name suggests, the labor force participation rate is yet ANOTHER ratio that measures the “number of people who are either employed or are actively looking for work” versus the number of total people in the labor pool. One important aspect to note about this rate is that “people who are no longer actively searching for work would not be included in the participation rate”. So, going back and reviewing the rate, we can see that much of the decline in the unemployment rate discussed above has been a function of an unusually large number of people who have left the workforce.

Now when presented with this information some in the “comb over crowd” will suggest that the decline in the labor force participation rate is because of demographics, and therefore the drop is merely a function of baby boomers starting to retire.
 Here’s an example from Barrons (link:

So, as someone who is motivated to get to the truth of the matter, we take a bit of time to investigate the validity of the story.  To accomplish this we go to one of the best macroeconomic sites on the internet: The St. Louis Federal Reserve FRED

When you go here and search the database for “labor force participation rate” – you will find that FRED has already done the hard work for you, and has divided the labor pool into various age categories: 25 to 54, 55 to 64, 16 to 19, etc.

So let’s look at the labor force participation rate of the prime retirement age, 65:

 That’s odd, the labor force participation rate for people 65 years and older is INCREASING. It probably explains why we are reading stories like this more often (link:

 Okay, let’s put the 65 year old cohort aside for a moment. What about workers in the 55 and over category, maybe they are the ones leaving the labor pool.

Again, we see a huge increase. So if the overall labor force participation rate is declining, but it’s not coming down from the 55 to 65 age group (where one would expect it to decline given the “baby boomers are retiring” narrative), then where is the labor pool seeing leakage? Let’s take a look at the prime working age, which is the 25 to 55 category:

 Hello! There is the source of your labor pool shrinkage and it certainly fits the stories we have been reading since the crisis started. As such, this would seem to confirm that the “strong job market” narrative spun by Janet Yellen and the rest of the members of the Federal Reserve is not exactly accurate.

What we’ve learned here is that when you read reports discussing the ‘strong jobs market’ where the unemployment rate is used as ‘proof’, you can be fairly certain that you are looking at a pretty bad economic comb over.

 That was fun! Are there any other comb overs out there? Well if you’ve ever walked around the streets you know there is always more than one bad comb over out there. Let’s take a look at another possible comb over of the ‘economic recovery’ narrative: The US consumer.
 The US consumer has long been cited as a key component of economic growth.
 Consider these two recent stories -




(PS: did you notice in the quote above they mention an already identified comb over in the labor market?? You will find that comb overs tend to serve as positive feedback loops to other comb overs)

 So apparently the significant increase in auto sales we’ve seen since the crisis in 2009 suggests the consumer is back on track financially, and therefore we should expect the US economy to begin firing on all cylinders very soon.

Now, as you can see below, there is no denying that auto sales have been very robust (link:

 Not only are the car companies selling more, the transactions per vehicle are increasing significantly as well –

 So logically it should follow that the US consumer has indeed recovered from the crisis, and their financial health is back to pre-crisis levels. Maybe all of the bullish news is correct!

Then why do we keep reading stories like this?


 Or this – taken from Federal Reserve’s “2014 Report on the Economic Well-Being of US Households” – link:

 So 66% of Americans have “no savings” and 47% say they couldn’t cover an emergency bill of $400.00 without selling something or borrowing? What? How you can afford to buy a $33,000 vehicle but NOT have enough money to cover an unexpected $400 bill? This sounds very much like a comb over, so let’s investigate!

First – let’s look at how auto sales are happening. Given people have “no savings” and can’t cover an unexpected bill of $400, it makes sense that consumers are finding other ways to finance the purchasing of their vehicles.


Our instincts were correct: what's driving auto sales? A big jump in loans! And there is one loan in particular whose name you might remember from my letters from a few years ago -

Sub prime loans - remember them? Well they've made a comeback, only this time it’s in the auto market.

One thing I puzzled over for a while was how a consumer who has zero savings and can't absorb a $400 emergency bill is able to swing buying a $33,000 car. Surely the payment on such a vehicle via a typical 4 or 5 year car loan would be rather onerous would it not? A little digging finds the answer to my puzzle -

96 months (that’s EIGHT years!!!) on a "gently used" car?

But yes (sadly) despite the warnings, this is indeed happening

apparently people want a new car more than they worry about their finances - so loans and terms are rising.

Ironically given the low interest rate environment, the securitization of sub prime auto loans has been a very hot commodity of late. Given the demand for these kinds of loans, there is a very similar kind of ‘frenzy’ going on, as loan demand is high, and puts pressure on finance companies to reduce lending standards to borrowers with lower and lower credit scores…. (stop me if you’ve heard this one before).

So, the big driver of auto loans is not the “health’ of the consumer per se, it is the accessibility of credit. But if the consumer is borrowing more, surely they must be MAKING more, right? A simple look at the FRED data on 'real median household income" confirms what we had already assumed: income is not growing, it’s still well below it’s high. In reality the “strong consumer” is yet another example of a horrible economic comb over.

Okay we will play one more game of “spot the bad comb over” and then I will leave you alone to enjoy the sunshine! One of the most important components that investment managers use to determine the suitability of a particular stock, or a stock market is earnings. Obviously the more profitable a company, the more attractive the company would be to invest in. Conversely, most investors would not be as excited to invest in a company that was losing money year after year.
Here is a fantastic graph of the earnings of the S&P 500 group of companies going back to 1981 (the black line) versus the performance of the S&P 500 (red line). It’s clear that there is a very close correlation between the two inputs: as earnings increase, the market increases – and as earnings decline, so too does the market.

Given the stock market was sitting yesterday at over 2,100 points, within 35 points of the highest level in recorded history, a look at the relationship above might lead a person to assume the EARNINGS on the S&P 500 are rising and approaching “all time record highs” as well. Hmm, could this be an economic comb over?

Let’s investigate! A look at the Factset data

(link here:

shows that earnings fell from $1400 per share in June 2007 to a low of $875 by June 2009. They then bounced back significantly to approximately $1800 a share in late 2014.

But – one thing to note is that earning referenced here is “earnings PER share” – exciting, another ratio! So let’s dig into this a bit more.

One thing we've discussed before is how many companies are using their cash, or raising debt to buy back their shares. Factset has done an exceptional job of tracking this over the years - here is their latest chart to Q1 2016


as per the report - the magnitude of the buybacks of late are not insignificant levels -

in fact many research reports suggest that the amount of corporate share buybacks could top a whopping $2 trillion dollars since 2009!


and, knowing what we do about ratios, a company buying back shares in an aggressive fashion might be doing a bit of a 'comb over' when it comes to earnings per share growth.

Consider the share count on the S&P 500

Now as with the question we asked above relating to the financing of auto sales, I think it would be helpful if we investigated how these companies are raising funds to buy back their stock. Is the cash coming from profits, it is excess cash? How have they raised almost $2 trillion? The clip above already states that companies were "on pace to spend 95% of their earnings on repurchases and dividends" - but another report tracks debt issuance -

clearly this is beginning to resemble the Mother of all comb overs: Over $2 trillion dollars has been poured into the market by companies in an effort to improve the appearance of their "earnings per share", which in turn makes it 'appear' as though there is organic business growth when in fact there is none (which as we pointed out earlier is the exact definition of a comb over!). So here is what is troubling, over the last 5 or six quarters both revenues AND earnings have been declining.

As per factset:

5 or 6 quarters of declining revenues and earnings is a big deal. You will recall the graph at the top of this section that showed the close correlation between GAAP earnings and the performance of the S&P 500? Well here is a closer look at what's been happening since late 2014

Earnings declines of this nature are not typical, and should serve as a huge red flag to investors that there may be "danger ahead". Given the exercise we've just gone through in learning how to investigate and identify 'economic comb overs', the last thing we want to do is be caught by an unexpected gust of wind (you know, like an unexpected Brexit vote where the UK leaves the EU) that exposes the secret that the comb overs that the market is so desperately trying to conceal..

which of course is......

(there is NO GROWTH!) 

Thursday, June 2, 2016

Finding a solution

Caroline Baum tweeted a piece by Greg Ip in the Wall Street Journal today that caught my attention

I replied with a link to my "View from 30,000 feet" piece and a unduly cheeky little jab that in retrospect was crappy and just plain old rude. I had been attempting to have a bit of a discussion a bit earlier in the morning with someone who just rubbed me the wrong way and I unfortunately took out my frustration on Caroline - something I still feel really crappy about as I am better than that and always try to be respectful while talking to people.

Caroline rightly lit me up.. and I realized I came across as a bit of an ass, to which I apologized. 

She then asked me a pretty damned good question - 

I provided a bit of a response (you can see the whole conversation here), but her question rolled around in my head all day. 

So, given I have a little time and it was an exceptionally good question. I thought I'd take a bit of time to lay out SOME of the solutions I would suggest. 

I think the obvious thing to say here is that the "very" best solution to this economic issue is to not allow yourself to get into this position in the first place. It's kind of like asking for a solution to the Titanic's problems AFTER it hit the iceberg.  

The second key thing that I think is important to point out and remind people is that we are still asking for SOLUTIONS today. That means whatever the problem happens to be, it's still here, it's still a problem. In light of that, let's PLEASE dispose of the 'a recovery is just around the corner' stories that follow any and all remotely positive data points. It's been seven years of waiting for the recovery Godot - enough already. 

All of those requests aside - there are a few things that I think could and would truly help get the economy back on track. 

First and foremost, since the consumer makes up a huge part of the US economy, and for reasons I laid out in "The View from 30,000 Feet" - I think the first place to start would be to help the consumer lower their debt loads. While I haven't seen 'official' data lately, I know credit card debt balances are still quite high. NerdWallet did a review for 2016 and here is what they found:

 Average Credit Card Balance in USA - $15,762.00

Average Car loan Balance: $27,141.00

Now, some (but not all) of these cards still are able to charge some pretty mind boggling rates. It's even more amazing when you see where GIC/CD and Bond rates are.  tracks average rates on all credit cards in the US - and here's the number for June 1st..

I don't need to tell you that a rate like that is ridiculous given we still basically exist in a ZIRP world. Yes Banks need to charge a certain level of interest to compensate for the risks and service.. but 15.19% AVERAGE?

I know here in town the rate on some department store credit cards is 28% !

So yes - one solution would be to mandate a cap on rates. TO be fair I'd suggest that the banks are only allowed to charge X% over a certain reference rate. 

Secondly - I'd start up a Federal government loan repayment program whereby a consumer can transfer a certain amount (say $5,000 max) to an account that is held but charges NO interest. The consumer's credit limit is not increased, and they have to make minimum payments on this amount. The details are sketchy yes, but in essence you are enabling consumers to get a bit of shelter and responsibly pay down their debts (rather than just forgive them). Yes bank profits would be impacted - but I think they've done rather well over the years charging 19%.. no? 

Once the $5k is paid off, the consumer can reload the account and do it all over again. The idea is as the consumer works down these debts - the amount of money NOT spoken for in interest payments increases.. which will help boost overall consumption and therefore GDP.

Another program that I will admit is NOT my idea but a dear friend of mine - allow people who can't afford to put money into their RSP accounts to SELL their unused RSP contribution room to someone who can afford to buy it. Some people have literally hundreds of thousands of dollars worth of UNUSED RSP contributions that they will NEVER be able to utilize. Enabling them to be able to sell it 

a) allows them to use the proceeds to pay off debt (ideally)
b) spend it

it allows someone who is well off to expand their tax deferral more than they normally would - but it also suggests the Govt would be able to TAX more than they normally would once the funds are transferred into a RIF.

this would also create a bit of a new industry and trading market - this means jobs, revenue.. etc. 

I see no real downside in this option and while some would say it helps the rich at the expense of the poor.. I'd suggest it's a far more balanced approach than simply ramping the stock market to create a 'wealth effect' - which ONLY helps the wealthy. 

One final idea before I sign out would be to change executive stock compensation so that there is no incentive to focus on boosting stock prices over the short term at the expense of the longer term health of the company. As we all know, much of the 'share buybacks' and earnings shenanigans we are reading about now are being done to keep prices high so executives get fat bonuses. Let's work on figuring out a way to align the board with shareholders.. perhaps naive.. but let's at least give it a try.

Yes - infrastructure is a big one, and there are a million more ideas.. but here are a few for you..

From the consumer side - people just need to be better aware of their budgets - live within their means, and SAVE. The stock market is not going to answer your retirement prayers. Juicy returns in the stock market from 1980's to 2009 convinced people that they didn't need to save much in order to retire comfortably.. this is wrong. 

You don't need to make $300k a year in order to be able to save up enough to retire comfortably.. you just need to live modestly, within your means.. and have a very strict saving discipline. Ask yourself "do I really need this right now, or do I just WANT it.."

that simple little process will make a huge difference over the years. 

anyhow - there are a few ideas off the top of my head.

thanks for getting my brain working this morning Caroline.. and I'm sorry for being a jerk. : (


Friday, May 20, 2016

Being mindful of the bigger picture

Just look at those fat stacks, should I grab 'em????

As I have admitted before, I am hard wired to be cautious. While this has certainly kept me out of trouble (mostly..) it has also probably held me back from enjoying one or two big wins over the years as well. As I look back on my career to date, I can see that I tend to identify problems very early on, and my knee jerk reaction is to reduce my exposure to the issue immediately. That being said, what I have also learned over the years is that these problems, can (and do) persist for extended periods of time. 

As J. M. Keynes once said, 

  "Markets can remain irrational longer than you can remain solvent."

Now I've already gone on a bit of a rant (here) on some of my pet peeves on Keynes' views related to career risk, and the idea above that you just need to always 'go with the flow'. Sure, it might work if I was trading for myself, or my investment mandate was different, but the reality is that I run "other people's money", so I feel it's my duty to be aware of where ANY risks may lie.

While I am certain my approach works best for me (and by extension to my clients), I am certainly not arrogant enough to think that it makes sense for everyone. Obviously different portfolio managers and different clients have unique views on how best to invest and that's great. 

One thing that I have noticed over my career (and have spoken about a a fair bit on this blog) is how UNPOPULAR it is to take a bearish view on the market, even when history ultimately proves that it was the prudent and correct move to make. 

I marvel at this phenomenon, although it has obviously been the source of much frustration over the last few years as well. Why? Well after correctly calling the crisis in 2007, I continued to promote caution after the rally started and the bailouts began. While the price action of the market has certainly made me look relatively foolish since March 2009, I felt (and continue to feel) that we haven't hit the absolute bottom yet. That being said, I've been reasonably pleased with my calls over the years. What I find amazing is that even as the risks increase and my views continue to be confirmed.. no one cares because of PRICE!

think about that - 

After years of debating, we now accept that the 'recovery' has been anything but: US economic growth, while positive, is the weakest recovery in history, and we are still reliant on the Fed to come to the rescue at the first sign of trouble. So all of those optimistic narratives that we heard over the years relating to "green shoots", "housing recoveries being driven by first time home buyers" etc was wrong.  

Interest rates have NOT increased - in fact bond yields are down. Save the crazy movements during the taper tantrum in 2013 (which proved to be a huge buying opportunity if you used McCulley's nominal ISM model like I do..)

The rise of politicial discontent is also something I've discussed in great length - my focus started with the rise of the Golden Dawn party in Greece - but voter discontent certainly rings true given the rise in popularity of Donald Trump and Bernie Sanders as well. 

I started talking about the rally in housing in 2012 and suggested it was NOT a signal for recovery driven by first time home buyers and a stronger economy, but rather a function of large institutional and private buyers..

I admitted that I was wrong on the recession call for 2012.. as the negative data got revised away. But was happy to have erred on the side of caution. as I said before - that's how I am wired.

Throughout the rally we weren't seeing anything other than Central Bank support of the stock market. There was no strong GDP growth and no quality increase in earnings. Given I'm a strict value guy who needs fundamentals, this was clearly NOT the market for me. 

I was also early in pointing out the massive expansion in multiples..

and early in discussing the impact of share buybacks on making earnings per share metrics look better than they actually were (from an organic perspective).

I was also VERY early in talking about income inequality

I have been a big believer in lower rates for longer (and therefore a long bond buyer)  this has been a very good move for my clients and I.. although 2013 & the taper tantrum was indeed my worst year EVER versus the market. 

I was also very early to realize that Ben Bernanke's "Wealth effect" was a no go, and wouldn't help stimulate the economy..

But - I have certainly made some mistakes - most notably I was very early on gold.. 

and I did not see this decline in oil coming as that was my hedge against my being wrong on the economic recovery. 

I'm human.. and certainly not anything close to perfect. 

I write this blog to vent, and to record my thoughts and views so that I can go back and see how I did  where I was right, and where I was wrong. Obviously I am not the only one saying these things, and there have been many who have been earlier in their calls, and far more accurate than I have been. I am certainly not trying to suggest I am the only one who sees this. I am just laying out the risks as I have seen them in the past, and how I see them going forward, because I think that is an important aspect of what I do as a portfolio manager. 

As for grabbing that "fat stack" of cash shown at the top of the post..

this is where having a strong idea of the bigger picture will help you decide if it's a good idea or not.


Gubb ; )