Saturday, September 16, 2006

Impending Crash?

I have a feeling that Dr. Martenson (, Mr. Denninger (, Mr. Martin ( and other economic bloggers are going to be very popular – very soon. I have attached a few articles below from these gentlemen and others who say that a stock market crash is coming.

It’s simply a matter of when – not if – stock markets are going to fall.

When I say fall – I’m talking about a collapse that at a minimum will rival 1929 or 1987. Most likely though – we’re looking at something no one has ever seen before. The coming stock market collapse will most likely result in the suspension of stock trading for a significant period of time – possibly forever.

jg – August 31, 2009

Impending Crash?

Monday, August 31 2009

Posted by Karl Denninger in Editorial at 10:51


You have to wonder when you see statistics like this (through 9:30 this morning):

Remove SPY, ETFC and LEHMQ (none of which trade on the NYSE) from the list and you get 606 million shares.

How many shares have traded in total with one hour in?

1.491 billion.

Forty percent of the volume is comprised of four used dogfood stocks, just as we've seen for the last couple of weeks - all people passing shares back and forth among each other, many of it being "computer HFT games."

The other used dog-food stocks (LEHMQ and ETFC) are really no better; they just don't trade on the NYSE. Lehman is particularly ridiculous as that's a formally-bankrupt company!

Fannie and Freddie are two of the most outrageous abuses I've seen in a long time, second only to AIG. All three of these should be delisted as their equity value is quite literally bupkis.

This just goes to illustrate - the market is currently being levitated on literal trash. Again today we see the Casino trying to suck in people; I got emails from two more associates over the weekend telling me that their "advisors" are telling them "you have too much cash allocated; now is the time to buy."

Now is the time to buy, after a 50% move?! Where the hell were these so-called "advisors" at SPX 666!

Nobody - and I do mean nobody - is talking about what this sort of volume pattern means. Well, I will: this is the sort of pattern that precedes an all-on equity market collapse. It strongly implies that the only volume support that the market has is from "hot money" speculators. Lest you think this is sustainable let me point out that just a few weeks ago the very same so-called "commentators" said the same thing about China's market.

Here's what happened:

The white box down below is the target on the break downward out of that flag last night - the top of the box is the critical "must hold" level from the first retrace off the bottom and the bottom of the box being the start of the entire move. If they're lucky the market holds around the 250-275 level, but I wouldn't bet on it.

That's nasty - The Shanghai market has already lost roughly 25% from its recent peak, and it took just three weeks to lose what required roughly three months to put on.

How do you like those odds folks? Pay close attention to the lessons from the East, least you get to learn them the hard way right here.

A 25% loss from the recent highs on the SPX places the S&P 500 around 775.

I smell a repeat of 2001/2002, when the very same "analysts" said the bear market was over and everyone jumped back into the pool going into the end of 2001, only to get destroyed in the collapse that followed and took out the 2001 low.

Heh, I might be wrong on this, but those who "believed" in the Shanghai market are missing 1/4 of their money - so far.
Nathan’s Economic Edge

Debt, Interest Rates, and Monetary Trends - Click...

Inflation or deflation… economy bad, economy better… it’s a massive ball of confusion, so let’s see if we can very simply take a look at the BIG picture to see where we are and where we are heading…

In 1971 President Nixon removed the Dollar entirely from the gold standard. Rapid inflation immediately followed to the point that in 1980, then Fed Chairman Paul Volcker raised interest rates to 20% effectively killing the concept of Usury.

From the peak in interest rates in 1980 until 2008 interest rates where in a structural decline and have now reached zero as seen by this chart of the Effective Federal Funds Rate:

Note that with each recession (shadow areas), interest rates went lower, then lower, then lower, then zero.

They will NOT go below zero (don’t quibble, I know what you micro-managers are thinking, we’re looking at the big picture).

While interest rates were declining, DEBT was GROWING. This is what I call the era of leverage. Debt is financial leverage, and when interest rates are declining, holding debt gets easier and easier. The more debt that everyone has, the more credit dollars they have to drive up the price of houses, of cars, of gasoline, of food, of everything – to a point.

Here is a chart of the gross federal debt from about the late 1930s. Note that the DEBT began its parabolic rise shortly after interest rates began to decline:

Here is a chart of Total Public debt from about 1967. Note that the growth was slow and steady until about the peak in interest rates (1980), it then rose much more swiftly until the year 2000 when the move went parabolic and now is pointing almost literally straight up:

Guess what? That is not going to continue like that forever.

It takes INCOME to service debt. When the income no longer grows, if debt saturation has occurred, then debt must fall as the ability to pay it back falls with income. Here is what personal income is doing:

Personal Income is FALLING.

Consumer Credit is FALLING.

Household financial obligations are falling.

That would be an appropriate response, would it not?

Yet, in our own government, their income is falling:

Yet, their debt is growing exponentially. NOT an appropriate relationship unless bankruptcy is your goal.

Consumers who have less credit available spend less money. International trade falls. Corporate profits, those at least marked to reality, fall… and therefore stocks go up, right?

Of course there’s a historic disconnect there somewhere, if only I could put my finger on it… hmmm. It’s Sooooo difficult to figure out, why heck, NO ONE could have seen any of the financial turbulence coming.

And what are those same "visionaries" now saying about the stock market? Oh boy.

Once again, the people who see near term inflation are looking at the money supply charts, but they are not seeing the destruction in credit dollars which, I believe, is vastly greater than even the government charts show due to the leverage/deleverage of the shadow banking system that cannot be clearly seen. What can be clearly seen is that the big banks, who comprise the shadow banking world, make BIG profits when they MARK their “assets” TO their own MODEL, yet they have losses when they are forced to MARK them even slightly TO MARKET reality.

So, as interest rates have declined to zero, debt and incomes grew until incomes could no longer support further growth in debt and now they are both falling back. After all, the people who actually PRODUCE REAL THINGS in the rest of the world will produce for far, far less than we will. Thus in a more open international trade market, one would expect wages here to fall and wages there to rise, meeting someplace in the middle.

To confuse this otherwise pretty clear picture, the Fed jumps in and begins printing money. Why? Because the real economy can no longer support the paper economy. They have lowered interest rates to zero and so the next thing to do is to print.

Now let's look at the chart of Federal Funds Rate again...

Note that following each recession and each lowering of rates there is a rebound that requires rates to rise, but in the past 30 years, never as high as they were before. In the 2000 to 2003 recession rates were lowered by Greenspan to just 1% - almost zero but not quite. And he did not have to resort to open printing. The next cycle rates hit zero AND they had to print.

Let me ask you this, what happens on the next cycle? People seem to want to argue with that chart, but zero is zero. There are only two possible paths of motion, sideways or up – OR self destruction. Trust me on this, zero is NOT any more normal than 20%!

We are at the end of an era, the era of leverage. We are now staring down the end of a loaded gun with our own finger on the trigger. We can choose to normalize interest rates and suck up the fact that debts don’t grow forever, OR we can pull the trigger and continue to print and to run up debts that we cannot service. The latter is fiscal and governmental suicide. The latter will lead to a loss of confidence in government and the demise of the dollar. That is NOT INFLATION!! That is a LOSS OF CONFIDENCE in a fiat money system, two different things – they are not just a matter of degree.

And thus CHANGE is COMING. You and I both hope that our leaders do not pull that trigger and commit suicide – so far they are doing exactly that, I can hear the click, I’m waiting for the BOOM.

Chris Martenson

Three Reasons This Stock Market Rally Is False

Sunday, July 26, 2009

Executive Summary

• Data is either good, murky, or unreliable. The good data says we are not yet at the bottom.

• Stock trading volumes are way, way down.

• High frequency trading (HFT) harmfully obscures true market activity.

• S&P 500 earnings indicate that stocks are still expensive.

• The recent stock market advance is lacking a solid fundamental story to base itself on, it is running on hopes and fumes.

On a recent leg of a flight heading between Denver and Detroit, a kindly, middle-aged woman took the seat next to me and made small talk. As she hailed from Detroit, I had all sorts of questions for her. Did she know anybody who is out of work? How did the city 'feel' these days? What had she noticed lately?

When she inquired as to my interest and I told her a little bit about my work, she asked for my prognosis. I said, "Not good, not yet; the base data is very weak." She immediately replied, "But the stock market has been going up. How do you explain that?"

She said this as if she had just played an undetected trump card; as though I was missing out some incredible secret. Given the power of the stock market to communicate to the masses (as exemplified by this exchange on the plane), and given how easily large, self-interested parties are able to manipulate and influence people, I consider the stock market to be among the least reliable of indicators.

So, understanding that all bull markets climb a wall of worry and that I could well be wrong, here are my three main reasons for discounting the messages implied by the recently rising stock market:

Reason #1: The good data is still bad

As I tell people in my seminars, I divide my data (or facts) into three buckets: good, murky, and unreliable.

Into the good bucket I put all sources of data fitting the following important criteria: The data itself is not statistically massaged before release, it is not 'sampled' but rather tallied up in its entirety, and it squares up nicely with other good sources of data.

Good Data

• Sales tax data (still pointing downwards)

• Income tax data (falling sharply, no bottom in sight yet)

• Truck tonnage moved (down 11% yr/yr, but possibly stabilizing)

• Port shipping container traffic (still in a record-setting slump, no bottom in sight)

• Air transport (down more than 20%, industry execs have fingers crossed)

• UPS, FedEx, and other major shippers' volume (still falling)

Into a bucket of lesser importance goes the murky data. This data is based on sampling, usually conducted by self-interested parties (National Association of Realtors data for example), or is seasonally or statistically adjusted, and/or does not square up with other, better data.

Murky Data

• NAR home sales data (UP! UP! UP! But nearly a third are distressed sales...)

• Continuing claims (said to be moving down, as long as we mysteriously exclude those whose benefits run out)

• Retail sales data (Surprising to the upside! Improving!)

• Trade deficit reports (Improving! Exports from US beat all expectations!)

Into the final bucket goes the utterly unreliable 'data,' so bad that I need to use quotes around it. This 'data' is modeled or otherwise manufactured out of thin air with no accountability, does not square up (at all) with good sources of data, has massive errors in methodology that have never been explained, consists of survey data for reasons covered in an earlier Martenson Report (Survey Says...), is self-referential (e.g. LEI or 'leading indicator' data), and/or has been proven repeatedly in the past to be consistently biased for political or self-serving gain.

Unreliable Data

• New home sales data (Oops. Still slipping)

• Employment data (due to the Birth-Death model, which has added 879,000 jobs since January)

• All survey data (such as builders sentiment - improving!), including all sentiment data (such as consumer confidence, which is now fading a bit)

• Leading indicator data (Up, up, and away! Never wrong!)

My takeaway from all this data-diving is that the hard data still tells a tale of continued economic contraction, while the murky and unreliable data tells a confusingly mixed tale of both improvement and slippage. The reason for this is that the murky and unreliable data is massaged and manipulated by self-interested parties to achieve a particular view, which is, inevitably, always rosier than expected. This leads to mixed messages and confusion.

Back in the 1930's, our officials similarly attempted to paint a rosier picture, but had to wrestle with much cruder tools of psychological persuasion and a still-intact sense of honesty. But this is not the case now. The current combination of a rising Dow and a synchronized chorus of propaganda from television virtually assures that a majority of people will be appropriately buoyed.

But will they spend more? If not, then these tricks will fail.

Reason #2: Where's the volume?

One of the keys to a healthy market is healthy trading volume. All solid turns, whether to the upside or the downside, are accompanied by volume that is well above average. Volume implies that there are a lot of participants and is one of the signs that most traders look for when assessing whether a change in trend is afoot.

Curiously, recent stock trading volume is not just down, it's way down:

Stock Trading Slowdown Is Steepest in Two Decades

July 24 (Bloomberg) -- Stock trading in the U.S. hasn’t slowed this much midyear in at least two decades, causing some investors to worry that the steepest Standard & Poor’s 500 Index rally since the 1930s will fizzle.

The CHART OF THE DAY shows 84 percent as many shares changed hands daily on the New York Stock Exchange between May 1 and July 20, compared with the average from Jan. 1 to April 30. That’s the steepest slowdown since at least 1989, according to data compiled by Harrison, New York-based research firm Bespoke Investment Group LLC.

We can see this quite clearly in the chart below of the Dow Jones Industrials Index. Note that the blue horizontal dotted line indicating the volume seen in mid-May is well above the blue line marking the most recent volume. While the recent trail of 'white candles' is certainly impressive, the volume is not. This is a quite puzzling turn of events and not at all encouraging for the bull case.

So where's the volume gone?

High Frequency Trading

Interestingly, this reduced volume is happening even with high frequency trading (HFT) computers running at full steam. Of the volume that is there, nearly three-quarters of it is fictitious in the sense that it represents the activity of black-box computers that have no intention of holding onto the stocks they buy for more than a few minutes or seconds.

For example, high-frequency trading firms, which represent approximately 2% of the 20,000 or so trading firms operating in the U.S. markets today, account for 73% of all U.S. equity trading volume.

These companies include proprietary trading desks for a small number of major investment banks, less than 100 of the most sophisticated hedge funds and hundreds of the most secretive prop shops, all of which operate with one thing in mind — capture profit opportunities by being smarter and faster than the closest competition.

The New York Times has a reasonable description of HFT in a recent article:

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.

High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits — and then disappear before anyone even knows they were there.

By way of commentary, while we can be impressed with the technical skill displayed by the operators of these HFT programs, their actions are harmful, not helpful. The HFT programs merely skim money off of the stream of capital that is flowing through the system (possibly yours) and do absolutely nothing to assure that it flows to the right places and does the right things. HFT programs bleed off money put into the market by actual investors. It is a skimming operation.

To speculate a bit, I am concerned that insiders with deep knowledge of how these programs operate can more easily rig the markets to move upwards, should they chose to do that, by simply sending out batches of orders that imitate buying pressure and thereby fool the HFT programs into an orgy of buying. The string of white candles seen in the chart above may represent nothing more than a stampeding herd of computers sent off in that direction to create the impression of improvement. Certainly my seat-mate on the plane ride approved.

The presence of a massive army of programmed computers means that if the Treasury or Goldman Sachs wanted the stock market to go up (for whatever reasons), they could easily arrange this outcome by the application of a relatively minor amount of capital at the right times and places to fool the black boxes into running off in the desired direction. While building confidence through a rising market may be a laudable goal, a false rally is still a false rally, and these always end in tears. Especially for those lured into the markets by rising prices, as always happens.

One significant problem with HFT-driven markets is that they will experience much higher volatility, both on the way up and the way down. This is because the programs operate on millisecond timescales and command an enormous share of the market. Think of an open microphone in front of a live speaker, and you'll have the idea.

"Good volume" in the stock market is driven by renewed investment interest and comes from pension funds, 401ks, mutual funds, and other sources whose presence brings money to the market. Volume created by HFT programs represents money that has been skimmed out of the markets.

Short Covering

Another source of the "volume" in this market is something called "short covering." For those who don't know what this means, some market participants will sell stock shares they don't have (having borrowed the shares from someone first) in the hope that the price of the stock will fall. A short seller makes money if they can buy the shares back at a lower price than they sold them for. It is the exact opposite of buying stocks 'long.'

One hallmark of a short covering rally is a brief, intense spike in the stock market like we've seen the past few weeks. In the chart below, we see that this rally has been accompanied by a 72.19% decrease in the short interest across all equities. That's a whopping decrease, and short covering was both a component of the price rise in the market and its anemic volume.

Bottom line: There is no "good volume" in this rally, and what volume there is may be largely due to HFT (and other related black-box programs) and short covering, rather than the sober assessment of millions of individual investors that stocks are a compelling buy here.

Reason #3: Stocks are not cheap

When it comes to the ultimate driver of stock valuations - earnings - we've really reached a quite silly level of departure between those who wish to see a new bull market before them and those who see a bear market.

Earnings, of course, drive everything. One would think that measuring earnings would be a relatively straightforward task, but over the past 15 years, earnings have been subjected to some quite ridiculous accounting shenanigans.

Before we move on, let's get a pair of distinctions out of the way - the difference between so-called "operating earnings" and "reported earnings."

Let’s just discuss the two main earnings numbers that Wall Street, in general, uses when discussing valuations. They either take the "reported earnings" or "operating earnings". Typically, the bulls use "operating earnings" and the bears use "reported earnings" because operating earnings are higher and reported earnings are lower.

The only difference in the 2 main earnings estimates used is that operating earnings exclude "write-offs" while reported earnings include "write-offs". That is the only difference!!!


The top down numbers are reflective of the various strategists on Wall Street who look at the macro economic factors as well as profits and profit margins in general. The bottom-up methodology studies each stock in the S&P 500 by the analysts at S&P in conjunction with consensus estimates of Wall Street analysts.

I tend to gravitate more towards the "reported earnings" side of things, mainly because I've observed a lot of companies excluding things as "one-time" write-offs that seem to me to be just a part of doing business. For example most of the Credit Default Swap (CDS) disaster has been written off by the banks as one-time expenses, when it seems to me that making and losing money on financial paper is pretty much the only thing banks actually do.

So I don't understand why their CDS losses should be excluded from their "operating earnings," as these losses seem to qualify as a normal part of their business model. If a bank lost money in a failed foray into composite airplane wing construction, in a case like that, I'd say, "Okay, write that one off." But not in this case and the banks are not alone in the practice of excluding losses that really shouldn't be.

At any rate, now that we can compare the difference between "operating earnings" (which do not include write-offs) and "reported earnings" (which include write-offs), and "bottoms up" (the sum of individual analyst guesstimates) and "top down" (big guesstimates made by economists based on macro factors), we can decide for ourselves what to make of the latest earnings estimates for the S&P 500, as a proxy for the entire stock market.

Below is a table that I got from Standard & Poor's (source), showing that the current gap between operating and reported earnings is the difference between a current price-to-earnings (p/e) ratio of 24.29 and 768.73 (purple arrow)! Now that's some difference.

If we take the "bottoms up operating earnings" (the bullish case), we see that as long as earnings grow by 45% over the next year and a half, the S&P 500 is trading at a quite reasonable p/e of 13.19. However, Wall Street analysts are notoriously optimistic and have missed the mark quite badly the entire way through this recession. If, instead, we use the "top down" estimates, we find that the stock market is anything but cheap and will still have a p/e of over 21, even with a hefty 13% earnings growth built in.

On the other hand, if we take "reported earnings," we discover that in a year and a half we end up at a P/E of 26.20, which historically was associated with market peaks, not troughs. Additionally, the current dividend yield of the S&P is a measly 2.2% which, again, is a value historically associated with market peaks, not bottoms.

Finally, we might note that operating earnings are now estimated to be roughly 100% higher than reported earnings - one of the largest gaps on record. It's a huge difference.

Someone's got it wrong, and so far it's been Wall Street and their "operating earnings" that has proven to be most wrong over the prior six quarters. Maybe they'll be better over the next six? Hopefully, but I'd be hesitant to bet the farm on that outcome.

Low 'Quality of Earnings'

I need to point out here that all of these estimates assume vigorous earnings growth, beginning now and continuing uninterrupted for the next six quarters. A reasonable person might ask, "But what if earnings do not grow as much, or even fall from here?"

It's true that recent earnings have surprised to the upside (mainly because the bar was set so very, very low), leading many headlines to proclaim such things as "Earnings Reports Give Stocks Big Boost," but once the dust settled, calmer heads noted that the earnings improvements mainly came from corporate cost cutting, not revenue growth or improved sales. The wrinkle here is that cost-cutting is not really a legitimate profit center, as there's only so far you can go with that strategy. Eventually either cost-cutting stops or a company goes out of business.

Earnings that result from cuts to the business under duress are said to be 'low quality earnings' as they are not as repeatable and robust as earnings resulting from legitimate revenue growth.

Really Suspicious Earnings

One other claim in the prior article (linked above) needs to be investigated:

If you scroll down to the early 1990s on the S&P website you will see that the earnings and PE on both operating and reported earnings were virtually the same. But then we entered the greatest financial mania of all time in the late 1990s (including many write-offs) and the earnings numbers diverged.

This is an interesting claim. Was there some shift in earnings reporting that we can detect in the late 1990's? It intrigued me enough that I decided to analyze the data to see if it was true and, if so, what we could glean from it.

It is certainly true that if we look at a simple cumulative sum of operating and reported earnings, we can indeed detect that the above claim seems to be true. Up through the mid 1990's, there was be pretty good alignment between the two, but then things departed in earnest in the 2000's and went completely off track over the past few quarters.

A different way to view this would be to look at the percentage gap between reported and operating earnings (formula = (reported)/(operating)-1) in each quarter over the same time frame. What's presented in the chart below is the difference each quarter between reported and operating earnings. A negative value means that reported earnings were less than the so-called operating earnings and vice versa. Recessions are marked by the peach-stripes:

What I see here is simply stunning. To begin with, in the green circle we can see that, up until the early 1990's, operating earnings were sometimes higher than reported earnings, and sometimes not. They switched places back and forth, which is what we would expect under a system of fair reporting, although we might detect a slight bias in favor of operating earnings being slightly greater than reported earnings.

Next, we might note that recessions seem to trigger some really large departures between reported earnings and operating earnings of -30%, -40% and more. While quite large, this makes intuitive sense, because recessions are when companies typically write off everything they can to clean out the books.

The real finding here, though, is that (with one lone exception in March 1995) from June of 1992 onwards, "reported earnings" have consistently been below "operating earnings." This persistent bias is not just an occasional thing, it has been practiced with utter consistency and it is cumulatively quite enormous. What does it tell us?

It tells us that corporate management has been "writing things off" for more than 15 years. Isn't that an awfully long time to have to endure "one-time" losses that would need to be excluded? Shouldn't the "one-off" exclusions every so often work in the favor of corporation earnings resulting in higher reported earnings than operating earnings? What have our corporations been buying/doing that results in constant write offs of this magnitude?

This information tells us that corporations are not entering this recession in quite as good a shape as we've been led to believe. It means that if we want the next 15 years of stock growth to equal the last, we're going to have to continue this practice of excluding all these "one-time" items from our corporate earnings statements.

Ultimately, we might infer that the numbers we have been fed (thanks, Wall Street!) are detached from reality and are little more than pleasant lies, told in the interest of continuing to sell expensive stocks to unsuspecting investors.

The earnings picture is just one more reason to be suspicious of this stock rally as a signal that a new bull market has begun.


The recent stock market advance is lacking a solid fundamental story to base itself on, at least if we choose to rely on good data. Further, volume is down considerably, the most in decades, and this is another missing component that might make us view the stock market advance more favorably. Finally, earnings suggest that the stock market, even after its run, is not cheap, by any historical measure.

There is growing evidence that the price movements we see in the stock market are best explained by activities that are essentially hidden from public view. High Frequency Trading (HFT) is one example, and it's not a grand stretch to suspect other forms as well.

Remember, one of the most famous traders of all time said, "The stock market can remain irrational longer than you can remain solvent," which I am tempted, for anyone considering shorting the market, to paraphrase as, "The stock market can remain manipulated longer than you can remain sane."

I would caution anyone from jumping in here in an attempt to chase the market, and would further recommend that this would be a good time to lighten up on any stocks, should that be part of your strategy for the year.

I am still holding for another test of the stock market lows, with my favored timing being the Sept/Oct timeframe.

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