“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

Tremors Before the Quake

At close to 7% off this month’s sky highs, U.S. equity market leadership found in Microsoft is fleeting. Trading at nearly 12x sales, MSFT investors have started to rotate out of big tech this week. The insanity of paying 12x sales for large-cap stocks speaks to the greater fool theory. You really need the next guy to come in and lift you out of your shares at an even higher price. At nosebleed valuations, that’s your ultimate investment philosophy. After founding Sun Microsystems in 1982, years later Scott McNealy once said, “At 10x revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years and dividends. That assumes; shareholders approve, zero-cost goods sold, zero expenses, no taxes, zero R&D, + we maintain the current revenue growth run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency, any footnotes. What were you thinking?”

“If everyone is thinking alike, then someone is NOT thinking.”

General George S. Patton

Size Matters

It’s now very close to 40% of the S&P 500, yes BIG TECH. Looking back, the only other sectors to ever position themselves even remotely close to this lofty level is Energy** at 29% in December of 1980, and Financials*** at 28% in 2007. We know what happened next to those two sectors. Beware, the inmates are running the asylum.

**Exxon $XOM lost 45% 1980-1982
***JP Morgan $JPM lost 74% 2007-2009

Microsoft Earnings Come Wednesday

Wall St.’s collection of brain trusts just love Microsoft MSFT, they’re falling all over themselves to upgrade the stock. With the energy of a mad mob, thirty-six analysts cover Microsoft equity; 32 “buys” vs. 4 “holds” and ZERO sells. Of course, when MSFT was on sale in March-April we heard crickets from this crowd, they were too focused on the “great depression.” Today, they’re in a better mood, expectations for MSFT’s sales growth are up at 8%, near $37B, with earnings per share close to $1.40. The situation is much like the analysts’ former darling, Exxon $XOM. In the summer of 2014, the stock was priced for absolute perfection. There wasn’t a bear to be found across all the Wall St. banks -then shares lost 71% of their value. By now, who doesn’t know Microsoft’s cloud portfolio products are clear beneficiaries in the “work from home” boom? The Information points out, “In this quarter, it is worth watching the rate of growth for Microsoft’s Slack-killer product, Teams, which saw surging usage in the March quarter. A related question is whether people are taking advantage of Teams’ video function, which competes with Zoom. And will Microsoft executives talk about their success in dealing with capacity shortages in their cloud business?”

Memories of 2011

Of course, back in 2011 when the stock traded at 12x earnings (vs. 36x today) and sported a healthy 4% dividend yield (vs. 1% today), the Street was all beared up on Microsoft at $28, comedy.  Keep in mind, from 1999 to 2016, the stock was unched – bulls were hard to come by. In Q1 2002, it looked like Microsoft was on a comeback, the stock rallied to $35 and the Wall St. upgrades came rushing in, by September of that year the shares were down to $21. They wouldn’t see $35 again until 2007, but by the end of 2008, the shares were back down at $15. The stock goes on sale a lot, don’t chase.

Microsoft MSFT From the Lows

Mar 2020 Lows +63%
Dec 2018 Lows +130%
Feb 2016 Lows +350%
Mar 2009 Lows +1354%

Love this Quote

“Higher prices bring out buyers. Lower prices bring out sellers – size opens eyes. Time kills ALL trades. When they’re cryin’ you should be buyin’. When they’re yellin’ you should be sellin’. It takes years for people to learn those basics – if they ever learn them at all.”

Larry McCarthy, Former Head of Distressed Fixed Income trading at Lehman Brothers

Major Trend-Break Alert – Microsoft
Microsoft, very quietly lost $100B this week. On Friday, MSFT equity closed BELOW its March 2020 trendline, a VERY bearish signal for BIG Tech. When leadership acts poorly, lookout.

Passive Overdose

ETFs now hold nearly $5T up from $500B a decade ago. Per Bloomberg Intelligence, new research has directly connected the explosive growth of passive investing to deteriorating corporate performance over the long haul.  In a paper posted this month, a trio of academics tracked share-buyback activity for a range of companies and found those with higher passive ownership spent more on stock repurchases but saw worse financial outcomes. Having disengaged owners “lowered the association” between buybacks and future performance, according to authors Brian Bratten and Jeff Payne of the University of Kentucky and Meng Huang of the University of Toledo. It was also positively associated with “suspect” repurchases — those that resulted in companies meeting or beating near-term earnings expectations. “Our study provides evidence that passive investment may allow opportunistic management behavior that negatively affects future firm performance,” they wrote. “The growing influence of passive investment may lead firms to make repurchase decisions that are inconsistent with the interests of investors.”  The findings are the latest twist in the raging debate about the rise of passive investing. A growing body of literature has raised issues such as the erosion of rivalry between companies, but research over the role of index-tracking funds in corporate governance has delivered mixed conclusions. One notable study in 2016 strongly connected passive investing to improved management.

The Active vs. Passive Debate
As passive flows surge, they flow into MSFT, not Berkshire*. Over the last 5 years, there’s an additional $2T that’s flowed into the passive bucket relative to active asset management. Total returns last 5-years? MSFT 380% vs. BRK/B’s 32%. But the flows since March are all about the colossal overweight tech crowd (pure madness) and the perception of a new US cloud-based economy. So you have a double barrel mania going on here. First, the explosion of PAM (passive asset management assets under management) and then the afterburners kicked in. You have a large number of asset managers trying to keep up with the S&P 500 index performance, and a panic that they’re not long enough of our new cloud-based, remote living world companies (like Microsoft). Over the last 50 years, Berkshire BRK/A does not trade at valuations of < 1.2x book for very long. Most times, significant rallies ensue regardless of the rest of the market’s performance. In the summer of 2016, there were only $32B of (passive) assets in QQQs vs. $121B today. A large portion of those new assets have been forced into MSFT shares, there is NO choice on the matter, see below.

*For every $100B slowing into passive asset management (S&P 500 Index Funds), close to $6B of those new assets under management moves into MSFT vs. a little over $1B into BRK/B.  The QQQs offer the real juice, for $100B of new AUM, $11B flows into MSFT vs. $0B for Berkshire. Some of the AUM above is price appreciation, not necessarily new dollars in the QQQs.

Indexing and Share Ownership Structure, Beware

Indexing doesn’t ramp value like growth because “value” has a far more dispersed ownership-base and higher float. Growth tends to be “new” money with high internal ownership, with a small float easily pushed around.  The bottom line, the distortion is caused by indexing.

Microsoft MSFT Key Technicals
In another disturbing turn of events, for only the second time since the March lows, MSFT closed BELOW its 20-day moving average (purple line above). In our view, this is sure to bring in algos and momentum selling next week. Some of the high impact machines are (programmed) triggered to exit on key technical levels. MSFT has held the 20-day since March. Holding this level brings in momentum buyers, failing will bring in a flush of exiters. The SELL Signals are lining up at the traffic light.

The Great Rotation
The Russell 2000 Index ripped higher by nearly 4% on Wednesday while the Nasdaq was relatively flat. Looking over the past 2 decades, when the Nasdaq (growth stocks) experiences this severe an underperformance vs. the Russell 2000 (value) it has usually coincided with the peak and/or downtrend of a cycle. A similar dynamic has played out with Berkshire Hathaway which as of yesterday’s close, has outperformed the Nasdaq by over 6.5% in the past 3 days. This is only the 3rd time since 2012 where BRK outperformed the Nasdaq by this much.

Watch Global Capital Flows

This week it’s important to note, as the US technology sector moved close to correction territory – capital was flowing into China. The total value of shares trading on the Shanghai and Shenzhen exchanges surged to near $10T, the best level since 2015. The U.S. dollar’s recent plunge puts big tech in an uncomfortable position. In recent years global calamities (Brexit, Trade Wars, COVID Phase 1) have pushed capital into the USA, NOT out.  As the U.S. struggles relative to the RoW (rest of the world), for the first time in years, dollars are leaving U.S. shores. 

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

Nasdaq Volatility Surge, Divergence from VIX
The Chicago Board Options Exchange NDX Volatility Index rose to 38 on Tuesday, an 8+ points premium to the CBOE VIX Index. That’s the widest spread since 2004. The gap between volatility in large-cap high fliers and the broader index has run the gamut in a matter of months, going from negative to non-existent to a multi-year high. Investors are paying-up for downside protection on NASDAQ high flyers.

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

Breaking *ELON MUSK PASSES WARREN BUFFETT ON BILLIONAIRES RANKING

Breaking: Monday, Tesla $TSLA:  close to an -18% interday-reversal on a $300B equity market cap company, today’s high to after-hours low, significant price action, TELLING. BEARISH.

Oh, The 90s

Besides Michael Jordan’s Rings, The Clinton’s and White Ford Bronco’s – what we remember most about the 1990s was the colossal spread which formed between Wall St’s 12-month price targets on stocks and the actual insanity found in the last trading price. Across the Street, in many cases, the analysts could NOT keep up with the mad mob bidding shares higher. Very large spreads were formed. What does this tell us about the summer of 2020? Let’s explore.

You Can Drive a White Ford Bronco through this Spread
Both at Bullish and Bearish extremes, when analysts are this wrong, bad things happen. Tesla’s shares closed at $1544 on Friday, July 10, 2020, but the Street’s twelve months price target is down at $780? Close to 40 analysts cover TSLA stock; 16 Sells, 11 Buys, and 9 Holds. The highest price target is $1500, the lowest is $70, Barclays and Cowen are down at $300, JP Morgan at $295. In June, Goldman downgrades the stock to Neutral and kept their $1300 target. 

What on Earth is Going On?

Call it the great Front-Run. To be considered for S&P 500 inclusion, the company needs more than 3 consecutive quarters of profitability, thus TSLA has NEVER been in the index. With a total enterprise value now close to $300B, and Tesla reports on July 22., speculators are betting the people at S&P are eager to add TSLA equity to the index.  By buying up Tesla TSLA now, front-runners are forcing the S&P Indexes to give the stock a higher and higher weighting (the S&P 500 is a market-weighted index, the higher the companies value, the higher the weighting). Thus, ETFs / Indexes will be forced to pay up, buying even more shares. Then the hot money exits, leaving indexes holding the bag. If inclusion doesn’t happen, look out below.

Buying pressure from S&P Inclusion

There is approximately $3.9T of pure index capital following the S&P500. These are mostly index funds, including ETFs and mutual funds that mimic the S&P. TSLA market cap is $278B but Musk owns 18.4% of the stock. The free-float market cap is therefore $220B. Base on the S&P market value of $27.8T that means TSLA should get a 0.8% weight in the S&P. This implying $30B of buying power from index buyers. Note that every $100 on TSLA stock price means $3B additional buying power from index trackers and vice versa.

All Important July 22, 2020

Tesla reports earnings on July 22nd after the close, if they’re able to able to churn out even the smallest profit, there’s a real chance it could happen, one large new addition to the S&P 500. On Friday, well over $1B was traded in TSLA’s options expiring July 17th, with millions betting on the $2500 strike (stock closed at $1544 Friday). Insanity.

*To be included in the index, a company must meet eight primary criteria having to do with market capitalization, liquidity, financial viability, and other factors. Share-based compensation affects GAAP earnings. S&P inclusion requires a minimum of 4 quarters of GAAP income. Musk’s award was $770m, they previously accrued most of it and ‘delayed’ performance reviews for all the other employees. Some say this part is covered. With Kunal Shah, we believe this to be true.

“As an index committee member (local) in the past. Inclusion is not on autopilot. They may still refuse if they think accounting is dodgy. Second, if it goes in it should be on some watch list for a while, so inclusion is more likely in Dec. That’s a long time. But in a big picture yes – if he manages to pull it off, he (Musk) would take his billions in bonuses and do a huge offering, which might allow for the shenanigans with reporting to be reversed.” – Grigoriy Isaev

NY Fed on Inclusion

Per the NY Fed, the pre-inclusion changes in firm characteristics are substantial. “For our sample, on average, the increase in market capitalization in the two years preceding inclusion, adjusted for changes in the aggregate market level, is 56%. ” The increase in market value reflects the pre-inclusion price momentum, and it coincides with the strong earnings performance of the event firms. The total increase of EPS in the fiscal year before inclusion and the year of inclusion is about 57%, per the NY Fed. In other words, there’s a heavy incentive for companies to juice earnings ahead of inclusion. 

On the Changes to the Index Inclusion Effect with Increasing Passive Investment Management

Per the University of Pennsylvania, empirical analysis of the S&P 500 index inclusion effect for additions to the index between 1981 and 2015 is revealing. The analysis finds that between 1990 and 2015 the average excess return for additions from the announcement to effective day was 5.64%. This is a low number because of all the gamesmanship pre-inclusion. Over the years, more and more investors have been drawn into this front-running game. The large the colossal passive index flows (now in the trillions), the bigger this contest will become. UPenn’s research was executed before the recent explosion of capital coming into passive index funds.

The bottom line,  more passively linked funds create a larger shift in the demand curves for the stocks around inclusion, but some results do not yield such conclusions. Keep in mind, UPenn was NOT looking at a MONSTER $300B new addition to the S&P 500, this is a rare event indeed (by far the largest ever). S&P 500 inclusion is a career decision indeed, we wouldn’t want to make it. The life cycle of Tesla as a public company has been highly unusual, to say the least. For years, there have been questions about the company’s accounting and departing CFOs. Busier than musical chairs, Tesla has had more chief financial officers than Lehman Brothers went through during the company’s last years before its “Colossal Failure of Common Sense.” For years, the company’s junk bonds provided a yield of 7-9% in a land of near 0% cost of capital (thanks to central banks). At the same time, the company commanded a $50B to $100B equity market cap. For a number of reasons, the company has NEVER been included in the S&P 500, Tesla is one VERY late bloomer indeed. One can make the argument that true capitalism died years ago. Without a mountain of assistance from the federal government (solar / energy subsidies) and wide-open capital markets forged on the back of central banks, Tesla would not be with us in its current form.

A Top 15 Position Weighting in the S&P 500?

Keep in mind, Procter & Gamble is the 10th largest position holding in the SPY SPDR S&P 500 ETF Trust with an equity market capitalization of $306B. So we can safely assume Tesla with a current market cap close to $300B, TSLA would crack the top 15 upon entry (if the shares hold on to current, extreme valuation level). This is one colossal addition to the index, a significant event.

The Bulls Case

The most optimistic bulls are looking for $21 to $23 earnings per share in 2021, so TSLA is trading nearly 71x those rosy assumptions, and made $0.20 last year per Bloomberg.  Tesla is trading near 11x sales with a total enterprise value of just under $300B. Last year’s sales came in at $24B, with $27B expected this year, and close to $40B is the Street’s outlook for 2021. The bulls will tell you TSLA has just a 0.5% share of global seasonally adjusted annual running rate (SAAR), or 16-18% share of electric vehicle sales worldwide. The bottom line, the bulls assume large market share additions in the 2021-2030 period.

*Tesla Model 3 = 1/8 Of World’s EV Sales In 2019. Tesla accounts for 1 out of every 6¼ global plug-in vehicle sales. The Tesla Model 3 alone accounts for 1 out of every 8 global plug-in vehicle sales, 13% of the global market. – Clean Tech.

“I have spoken to battery engineers at NON-frauds; i.e., not Tesla. The realistic hope is that solid-state batteries will bring a 30% to 40% improvement in energy density with considerably more safety. Toyota & the Germans will have them in production by 2025.”

Mark Speigel, Stanphyl Capital

Lithium Mining, Still in a Bear Channel, Why?
Optimists say, with the help of a Biden White House, by 2030 close to 100% of SAAR will be in the electric vehicle space. With a battery mileage range of 1000-1200, the bulls say the ICE (Internal Combustion Engine) will be nearly obsolete. But, if this is the case looking forward, why aren’t large lithium miners a lot higher? During 2017’s electric vehicle excitement phase, when investors were piling into anything and everything EV, Albemarle was near $150 a share vs. the $78 today.  As one of the largest lithium producers on earth, Albemarle is uniquely positioned and a far more attractive value relative to Tesla. In 2015, ALB finished its $6.4B takeover of Rockwood Holdings (one of the Big 4 lithium producers globally), the company is an anchor tenant in the lithium space. The Street expects Albemarle to capture a LARGE share of global lithium-demand growth over the next several years. An oversupplied market risk in 2020 has been the question mark. Some analysts point to the negative impact of the coronavirus on electric-vehicle demand. The company slowed the pace of its lithium expansion to help balance the market while it continues to consolidate its position in catalysts.

*Lithium is the key component of batteries in electrically-powered vehicles and other battery-powered applications. Rockwood’s lithium-based compounds are used in a variety of high growth applications, including base chemicals for numerous industries, drug intermediates, elastomers for car tires and rubber soles, lithium batteries, thermoplastic materials, and high-performance greases. Rockwood has lithium production facilities in the United States, Chile, Germany and Taiwan.

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

As of 8:30 AM ET, July 21, 2020

Metals Last 30 Days

Month over Month

Silver +18.4%
Copper +11.4%
Palladium +9.4%
Platinum +5.7%
Zinc +5.2%
Gold +4.9%
Nickel +3.8%
Aluminum +3.5%
Tin +2.3%
Cobalt -1.5%

Bloomberg data.

A client in our institutional Bloomberg chat, shared with permission:

July 17: “Since mid-May, the Bloomberg Dollar Index is almost 5% lower. This week the bid for long-dated TIPS (Treasury inflation-protected securities) has been very strong, telling indeed. Demand was so fierce, yields plunged down to -30bps. In April, we saw TIPS outflows, now capital is flowing in, large. Clearly, the market is pricing in the early genesis of inflation or stagflation.”

July 13: “We have looked at the S&P in EUR (Euro currency). I would love to see it in gold. I bet it doesn’t look nearly as hot in gold equivalent. Gold is a powerful global currency, especially right now!”

Unloved Silver is Finding Some Friends
On July 21, 2020, Silver surged 6% before 9am. Keep in mind silver’s all-time high is over $50, while today gold is very close to its 2011 perch. Silver has some large scale catching up to do. We went to a full, “high conviction” silver position for clients in late March 2020.

US Dollar is 5% Lower Since Mid-May
We have recently lightened gold but maintained a full 3/3 position in silver SLV and 2/3 XME materials and metals. We MUST NEVER forget how many investors globally are crowded into U.S. equities.  When a stock’s performance in gold starts to look unattractive, U.S. equities will lose some portion of their global investor-base. So many things can be said about the chart below but we think what it really does is cancel out the Fed effect. Meaning, the Fed has caused the inflation of both stocks and gold – higher asset prices for sure.  So, if you price stocks to gold – the Fed’s ($3T of balance sheet expansion) effect on the stock market more than disappears.

Commodities Year to Date

Lumber +37%
Uranium +30%
Iron Ore +29%
Gold +19%
Silver +8%
Copper +4%
Wheat -4%
Corn -13%
Bloomberg Commodities Index -18%
Oil -35%

Bloomberg data

So far in 2020, hard commodities (metals) are doing much better than their soft, ags (agricultural) brother.  Investors are building up silver positions – prices head for a sixth straight weekly advance, the longest stretch in more than three years. Further gains are likely, with demand from investors and industrial users led by China, while supplies are constrained due to the coronavirus pandemic. Futures traded on Comex in New York touched the highest since 2016 this week, and exchange-traded funds backed by the metal are on course for the 12th week of net inflows, per Bloomberg.

July 13: Silver Making a Colossal Move, Major Breakout
Lots of new paper wealth on the planet is looking for a hard asset hedge. During the week ending July 10th, another $1B flowed into gold and silver ETFs. Silver is a very small pond relative to the near $40T in US paper assets. 

Shocking and Shocking

The most shocking moment of this shocking chart is that it quite recently made a big new low. It wasn’t a token new low. It was much much lower than the previous lows.

Just Wow
We agree it looks much more natural. We think the price of the S&P in dollars is the ultimate Fed head-fake.  The entire 2018 move has been canceled. It is really a revelatory chart. It’s super important! U.S. stocks in gold terms are trading at late 2017 level if my eye doth not misread, one ugly equity rally indeed. Poor foundation, in two words.

Colossal Inflows

In the first half of 2020, Gold-backed ETFs closed with a record $40B of net inflows. In June, gold ETFs added nearly 110 tonnes, this brought global holdings to all-time highs of nearly 3700 tonnes.

Capital Looking for a Hedge
With over $35T in paper-promises; U.S. Treasuries $15T, U.S. Corporate Bonds $11T, Big Tech Stocks $7T, and U.S. Municipal Bonds $4T – all that new wealth is crowded in financial assets – looking for a real, hard asset (hedge) alternative. At some point, when the promissory note pool becomes too large, more and more capital starts to look for a hard asset (copper) hedge, WE ARE THERE.

July 10th’s PPI Inflation

June Producer Prices: fell -0.2% m/m vs. +0.4% est. & in prior month; core fell -0.3% vs. +0.1% est. & -0.1% prior… y/y -0.8% vs. -0.2% est. (unchanged); & y/y core (chart) +0.1% vs. +0.4% est. & +0.3% prior. With Liz Ann Sonders on the PPI Inflation data.

Don’t miss our next trade idea. Get on the Bear Traps Report Today, click here

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

Follow the Money

So far in 2020, investment-grade bond issuance is approaching $1.3 trillion, that’s more than double the $595 billion IG debt issuance pace at this time last year.  In the history of U.S. capital markets, four of the top six best IG new supply months are found in 2020, with April being the mother-load, up close to $300 billion.

Credit Risk, Who’s Funded?
As you can see above, credit risk is driving equity prices. Well funded sectors (blue Goldman strong balance sheet) have performed well since the market highs of June 10th, while under-funded balance sheets are falling behind. Likewise, the S&P Equal Weight equity index is down almost 10% over the last month. Everyone knows – a few, well-funded companies inside the S&P 500 are running the show with hundreds of other companies left behind.

The Eye-Opener

Here’s an eye-opener. Below we take a look at the BB and higher credit quality new issues – year to date by sector. That’s right, YTD debt sales in 2020 vs the FULL YEAR 2019, the data is telling:

1) Financial $427 billion vs $546 billion (increase in deposits, record money market fund inflows, equal lowered funding needs);

2) Consumer non-cyclical $175 billion vs $228 billion (cash flows steady, COVID19 favors staples)

3) Consumer cyclical $153 billion vs $108 billion (levering up, get it while you can);

4) Communication $117  billion vs $87 billion (deals, 5G expansion funded for now);

5) Energy $116 billion vs $133 billion (companies disappearing, capex (drilling) imploding vs. 2017 levels);

6) Industrials $113 billion vs $98 billion (again, get the money while you can);

7) Technology close to $110 billion vs $68 billion (explosive inequality, monopolistic advantages all funded by the Fed, continue the debt build);

8) Utilities $75 billion vs $100 billion;

9) Basic Materials $36 billion vs $48 billion (There are 10,000 fewer holes (metals and mining) on earth being dug today than a decade ago. From a CAPEX overdose to starvation, NO supply!

The Bloomberg Financial Conditions Index is now at the mid-point of the February 2020 range, yet IG issuance clearly is set for issuance records unforeseen back then. A one-week all-time issuance high was set in April at $110 billion.

The cause is well known: a near-infinite Central Bank bid allows IG companies to raise as much money as they can dream of despite poor economic conditions. Meanwhile, after multiple fiscal stimulus rounds, the White House is pushing for another $1 trillion before the August recess.

Debt markets may have found an equilibrium point. Treasury just had a record 3-year issuance of $46 billion, up-sized by $2 billion, and a full $8 billion above the norm that has held since December 2018. At 0.19%, it is the richest on record. The cover was 2.44, lower than last month’s 2.55, and a touch below the average 2.45 of recent times. So we have now the first sign of some investors on the sidelines.

Second-quarter earnings are soon, with S&P earnings forecasted down 30%. Earnings may not be quite that bad, but cash flow to interest ratios are set to deteriorate markedly. It will be interesting to see if this quarter’s earnings season “puts a lid on it.”

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please.

“A democracy cannot exist as a permanent form of government. It can only exist until the majority discovers it can vote itself largess out of the public treasury. After that, the majority always votes for the candidate promising the most benefits with the result the democracy collapses because of the loose fiscal policy ensuing, always to be followed by a dictatorship, then a monarchy.”

Alexis de Tocqueville, 1841

The Life Cycle of a Democracy*

1. Bondage to spiritual faith
2. Spiritual faith to great courage
3. Courage to liberty
4. Liberty to abundance
5. Abundance to complacency
6. Complacency to apathy
7. Apathy to dependence
8. Dependence back into bondage

Alexander Tytler, 1787

*See the latest developments in Venezuela, Argentina, Greece, and Puerto Rico – all in stages 7-8.

A Bullish Set up for Commodities and Emerging Markets

A disenfranchised population rises in revolt against the establishment ruling class, demanding equal rights after having been subjugated more than two hundred years before, after fighting side by side with the elites in a series of wars leaving the country the wealthiest and most powerful country in the history of the world. Four years of war built on massive debts leaves over five percent of the male population killed. A prophecy of the immediate future? No. A description of ancient Rome’s  Social War of 91 BC to 87 BC. Over the last 2200 years, democracies have a very consistent pattern of self-destruction. Can it happen here and now? Yes. Can it be averted? Yes. And by the most mundane of all things: employing millions of citizens to fix and modernize America’s crumbling infrastructure, both the old fashioned bridge, tunnels and roads, and the modern final push to lay down fiber optic cable for 100% of the country, a common vision, purpose, and effort to fill the hearts and minds of all Americans with the dignity and pride of a job well done for the benefit of all. But will it happen? Let’s explore.

America’s Broken Bridges

Total: 614,000
Over 50 Years Old: 42%
Structurally Deficient: 14%

American Society of Civil Engineers. Look for a large infrastructure renaissance in the 12-18 months to come. Levered-up social experiments bathing is colossal debt financing are coming down the pike.

The U.S. Unemployment Surge
Since January, we have experienced over $4 trillion of deficit spending and $3T of balance sheet expansion from the Federal Reserve. Will the U.S. continue to borrow more, to print more, to stimulate more? A disastrous 11% unemployment number was greeted as a positive surprise. One thing is very clear, a long term sustainable solution is needed to replace the jobs that are NOT coming back.

“You realize of course, that in order to be eligible for forgiveness of PPP loans, employers HAD to rehire employees by June 30, 2020. After that, if funds provided by CARES have been used for payroll and eligible expenses, the employers have no restriction on future layoffs.”

– John Hussman

Large Hole to Fill
The latest bill passed by the Democrat-controlled House of Representatives concocts a $3 trillion infrastructure bill spending that represents a jump towards a Green New Deal, and unabashedly so. The Republican-controlled Senate knows not what to do: on the one hand, it doesn’t want an infrastructure bill it deems not truly an infrastructure bill, but on the other hand, rejecting what is touted as jobs creating legislation makes for bad optics politically. One would hope that some sort of infrastructure bill slithers out of the Senate before August recess. Assuming a compromise bill is signed in September, then what? Why, more trillions of dollars to state and local governments whose coffers have been emptied by lockdowns. Of course.

When it comes to Washington policy, we highly recommend setting up a call with our associates at ACG Analytics. Email tatiana@thebeartrapsreport.com if interested. There has never been a more important time to discuss the political impact on sector rotation in the United States.

The Coming Fiscal Cliff

It’s a scary few words, but all it means is there’s a large amount of fiscal love about to expire, but it sure can be replaced. A robust infrastructure spending agenda is an important option, far more sustainable than sending Americans cash. Some form of an extension of federal unemployment insurance will surely pass in the next piece of legislation. However, the $600 per week “plus up” will not be renewed. Why? Because 70% of recipients now are paid more money NOT to work than the “back to work” option. Usually, there is no federal unemployment pay. Every state has its own parameters for unemployment disbursements. However, currently, we also have a COVID virus inspired federal unemployment payment scheme. This has had a profound effect on the US economy.

Consumer Credit

Over the last 3 months, US consumers have paid down a colossal $106 billion in credit card debt, bring the total outstanding credit card debt below $1 trillion. Indicatively, the first time total credit card debt hit $1 trillion was back in December 2007, which means that the deleveraging of the past 3 months has sent the US credit card balances to a 13 year low. – ZH

So Far, Delinquencies are in Check
Big credit expansion from the Federal Reserve and a colossal fiscal boost has significantly reduced credit card delinquencies and increased car purchases. Those two phenomena will reverse once the $600 a week safety net vanishes after July 31st. We expect Congress to extend the PPP program for small businesses, but in a more focused format that supports only the hardest-hit businesses. Extending the full $600 per week in Pandemic Unemployment Compensation (PUC) is highly controversial and will NOT last past July.

Unsustainable Cash Burn

Close to 70% of the U.S. annual budget is already entitlements and interest expense, so laying-out current $600 per week for the roughly 20 million Americans is NOT sustainable. The colossal outlay for those NOT working adds up to $48B a month or $576B a year for the U.S. Government. To put that in perspective, the Defense Budget is $721B this year, and the interest on all of the U.S. Government’s debt is nearly $400B this year (and that’s only the case if the Fed is able to arrest long term interest costs on the U.S. debt obligations). This is clearly an unsustainable unemployment benefit pay-out, but a cliff drop to no benefits could be disastrous. If you take it away, yes you force people back into the labor force, but you also drag down near-term consumption. This is the reason why the Administration is considering ‘bonuses’ to get people to go back to work. The question is what has a stronger effect – Less money in people’s pockets in Q3/Q4 or increased confidence of future income from increased employment? This is another major selling point for infrastructure. 

A Must Pass Fiscal Boost for Infrastructure

In brief, and ironically, household income increased in the second quarter as the economy collapsed, and household income will decline as the economy recovers in the third quarter.  There will be another bill of over $1 trillion, if only because Senate Republicans know it’s a MUST PASS bill heading into November’s election. They simply have to deliver.  As a result, some unemployment benefits will likely be extended to year-end and selected states will be backstopped financially.

As to infrastructure, this has been discussed for well nigh three years now. The House bill insists on broadband for all and Green New Deal lite, while the White House wants classic bridges, tunnels, and roads plus optic fiber everywhere. The whole recipe is a colossal tailwind for construction stocks and a couple of high tech heavyweights. Meanwhile, the Senate is conflicted about more fiscal love and doesn’t know what to do. Timing: perhaps a September signing, right in the middle of the presidential campaign. But any sign that the U.S. economy is potentially strong enough to withdraw fiscal and monetary support, you will see the mother of all taper tantrums. Stock will collapse.

Our High Conviction Call from Early April Here Below
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Green New Deal Posing as Infrastructure

The House measure surreptitiously has over $1 trillion of environmental justice programs which are seemingly unrelated to classic infrastructure. A green wolf in infrastructure clothing won’t be embraced by the Republican Senate. But there is another risk: many Republican Senators vowed NOT to raise taxes. The question for them is: how to pay for $1 trillion of infrastructure without raising taxes. The pie is only so big, they argue, but a gas tax is the most likely with a focus on heavy users like Amazon. The answer is new infrastructure grows the pie and so pays for itself over time. As detailed in a previous missive of ours on infrastructure: the improved efficiency of interstate commerce and commute to work times will stimulate the economy enough to generate more tax revenue. Infrastructure should pay for itself in ten years or less. The Department of Transportation is due to release its proposal soon, which we suspect will make exactly that point, which in turn will provide Senate Republicans with exactly the political cover they need.

Political risks to a delay are high and real. Nearly 40% of still employed make less than $40,000 a year. If unemployment remains high, the Democrats may sweep in November.

Normally, infrastructure bills take a long time to hammer together as they are as contentious as they are complicated. One would usually assume it can’t be done quickly. However, the vibrant threat of political extinction is a powerful prod to Republicans to pass infrastructure legislation.

Yet Democrats face their own risks. Why would they hand Trump a major victory before the election? Democrats want to say to their constituents that they passed an environmental bill masquerading as an infrastructure bill. So political risks cut both ways since if Senate Republicans pass their own massive infrastructure bill only to have it rejected by the House, that will be used as a campaign weapon Republicans will use against Democrats. What’s good for the goose is good for the gander. Current betting odds have Democrats doing well come November. But now they have the memory of pain. Polls looked good for Dems the last presidential election cycle. Obviously, they haven’t forgotten.

Biden’s True Love, the Rails

But let us assume no infrastructure bill is passed before election day, and Biden wins. What then? Well, while all of Biden’s policy papers are written by others. Per ACG Analytics in Washington Biden has a long track record of promoting transportation. A train station is named in honor of him. The “Joseph R. Biden, Jr. Railroad Station”, also known as Wilmington station, is one of Amtrak’s busiest stops, serving nine Amtrak trains as it is part of the Northeast Corridor. Further, Dems won’t give up on some kind of Green New Deal, and the Green New Deal, for all its sociological ramifications, has to have a major transportation component, particularly under a Biden stewardship.

Surging Second Wave Risk Assures Colossal Infrastructure Spending

What would tip the balance in favor of an early infrastructure bill? Worse Covid-19 numbers coupled with a marked slowdown in opening up the economy. The worse the economic news is in the weeks ahead, the more likely an infrastructure bill is in the near term before year-end. Over $8 trillion of U.S. GDP resides in troubled states. The Texas governor, for one, has publicly expressed concern.  We note, in passing, that Europe seems to be emerging from lockdowns in a less sloppy manner than is the USA. Their equity markets and the Euro, seemingly, as a result, are performing better than ours.

Copper and Baltic Dry Index are Telling Us Something
With large fiscal plans coming out of China, the U.S., and the UK, the global commodity complex has caught a bid. Above all, with over $30T in hiding-out in U.S. Treasuries, U.S. Corporate Bonds, and U.S. Big Tech stock certificates, all that PAPER wealth needs an inflation hedge in REAL tangible assets, now MORE than EVER. Bullish commodities.

Populism’s Next Act Will Demand a Colossal Fiscal Response

We’re face to face with the meta-macroeconomic background of Central Banks providing the groundwork for the rise of populism. For over a decade, central banks have done all the heavy lifting, and now its time to pay the piper. The link isn’t direct. The causal relation isn’t proximate. However, QE is the ground cause behind populism’s rage. By inflating financial assets, wealth inequality has gone through the roof. Fact. Central Bankers’ protestations to the contrary. This has not gone unnoticed by the huddled masses. The concentration of capital, if carried to excess, leads to revolution. Lost in the discussion of this topic is this simple observation: the USA is the only country in the world that has more guns than people, at 120 guns per 100 people, as per the Small Arms Survey conducted in 2017. No other country comes close. If a minority crushes a well-armed majority, the price will be quite high, as history teaches. Social upheavals have been around for as long as we have historical records. The Social War in ancient Rome, for example, lasted from 91BC to 87BC and centered on tribes and cities conquered by Rome 200 years priorly. These peoples were not enfranchised even though they had fought shoulder to shoulder with Romans in the creation of their empire. They believed they should be treated as equals. The Roman Senate disagreed. A devastating civil war ensued, which Rome ultimately won. However, after its victory, the Roman Senate didn’t want to go through another Social War, so the demands for equal citizenship were finally granted. 50,000 Roman men of fighting age fell in the conflict, out of an adult man population of less than 900,000. A similar ratio of men killed for the USA today would number ten million dead. We note that according to the latest polling data, fully a third of Americans believe a Civil War is in the offing. Inequality’s explosion over the last decade nearly guarantees a meaningful infrastructure plan solution.

The Battle for the US Senate

The GOP took 18 Senate seats back in the 2010, 2014, and 2018 elections, a mean reversion shift to the Dems is more than overdue. While the Republicans seem split between those in the Senate who don’t want excess spending, vs. those such as the White House who embraces excess spending, it should be noted that a Democratic sweep would probably lead to but a narrow Senate majority for the Dems and some of the newly anointed will have won narrow victories themselves from States with large conservative populaces.  So Republicans will most likely be left with a modicum of leverage. The betting odds for a Democratic takeover of the Senate has increased from 32% to 52%, a remarkable change. The Republicans feel pressure at the state level as well, where more Republican states will have to allow legalized gaming and legal recreational cannabis use to financially survive. States are thirsting for new creative revenue solutions.

One unknown is the accuracy of presidential polling. Presidential polls have become notoriously unreliable. Given that few people will admit they are Trump supporters, it is hard to gauge his real support. And even the betting odds are suspect since they report dollars wagered, but Trump supporters make smaller bets because they have less money to wager. So on a numerosity basis, the betting odds are closer. One can say with confidence, however, that directionally Trump’s reelection chances have worsened since the beginning of the year. However, if “only” 35% of the population are die-hard Trump supporters, it is hard to see how ignoring them after a Democratic “landslide” would “heal” the country. But the Democrats plan to not merely ignore Trump voters but to destroy them for the simple reason that progressives utterly despise and disdain them. This is hardly a secret. It should be noted that geographically liberals are in highly concentrated positions with their backs to the water, a fact that would have delighted Augustus Caesar had he found himself in similar circumstances to conservatives today. Geography is destiny, even in a civil war. So: The King is dead! Long live the King! Or as the Who put it in “Won’t Get Fooled Again”: “Meet the new boss. Same as the old boss.” Politics is about power, not justice.

The initial and essential purpose of the lockdown was to flatten the curve so as not to have the hospital system overwhelmed. The result is over forty hospitals have gone bankrupt or have shut down entirely. So while the prospects of an infrastructure bill lifts materials stocks, no one is talking about building new hospitals.

But there is hope. There is hope indeed for a new bipartisan consensus has emerged: China is bad and big tech is bad. One can debate about which political party will address these two issues with greater vigor, but both will cooperate with each other in a fundamental supply chain reconfiguration, and new regulations on and split up of big tech. It is thus conceivable that upcoming legislation on infrastructure will be followed by further significant legislation on more than one front and supported by both parties and the majority of the American people. Generationally, it seems inevitable that more eco-friendly laws will be passed. And there is broad consensus across the electorate that every single citizen, without exception, should be equal under the law. All of these speak to a greater populism that might well unify the country, not divide it. And infrastructure build-out, of both the old and the new, may well lead the way.

When it comes to Washington policy, we highly recommend setting up a call with our associates at ACG Analytics. Email tatiana@thebeartrapsreport.com if interested. There has never been a more important time to discuss the political impact on sector rotation in the United States.

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

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Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only. 

Zig Ziglar once said, “you can get anything in life you want if you just help enough other people get what they want.” It’s the little things in life that are often the big things and keep us all going. Let’s focus on the right direction.

“So on the subway home, a homeless guy was asking for money. Young. Mid-twenties. Physically fit but a little off his rocker. Usually, I am annoyed by that type of thing and was about to shake my head, but at the last second, I gave him a $20. He was so happy, naturally. As he walked away he said to himself, “What a good guy!” And for a moment, I felt kind of good. Of course, that faded quickly, but I realized that it was among the top ten nicest things that someone said to me in a month. I really didn’t know what the lesson was other than it is nice when someone says something nice to you. I didn’t expect it. I guess it was the sincerity, enthusiasm, and certainty in his voice when he said it, as much if not more than what he said. Then he sat down a few seats away all excited and called someone on his cell phone. It was his daughter and he asked her to tell mommy he would be home soon because he got money for dinner much more quickly than he thought. So there is a lesson way beyond my vanity there.”

Herb Lust