Bad News Bulls Ignore Falling Confidence While Stock Market Bubble Inflates

by The Curmudgeon

The CURMUDGEON wonders why the main stream media either ignores or diminishes bad news about the real economy.  For example, few journalists picked up Friday's announcement that U.S. consumer confidence hit a 10 month low in October.  The Thomson Reuters/University of Michigan final consumer sentiment index decreased to 73.2, the weakest this year, from 77.5 in September. The median estimate in a Bloomberg survey called for a decline to 75 compared with a preliminary reading of 75.2.


The U.S. government’s partial closing prompted Americans to turn more pessimistic about the economy, whose recovery continues to be uneven. Disappointing gains in employment and the prospect of a protracted budget battle into 2014 raises the risk that consumer spending will cool as the holiday-shopping season approaches.


Buried on page B6 of Thursday's print WSJ is a piece titled:  Federal Woes Faze Business Owners.  Small-business owner confidence in the economy fell to a nine-month low in October, according to a survey by Vistage International Inc. and The Wall Street Journal.  Of 692 business owners surveyed online between Oct. 7 and Oct. 16, 36% said they felt the economy was improving, down from 47% in September. Just 21% said they expect conditions to pick up in the year ahead, down from 30%, according to the survey, which was conducted before Congress reached an agreement on Oct. 17 to reopen federal offices. The survey was limited to firms with less than $20 million in annual revenue.


Another area where there's lack of confidence is the job market.  Many unemployed workers drop out of the labor force, which has led to a near 33 year low in the labor participation rate. At 63.2%, it has been in a steady decline since 2008, which is unprecedented in any "economic recovery."

Floyd Norris' Saturday NY Times column focused on the long-term unemployed:

"More than a quarter of the unemployed workers in the United States say they have been out of work for at least a year, and that does not count those who have given up looking, since they are no longer counted as unemployed. That is down from nearly a third at the peak of the recession, but far higher than it had ever been before the recession that began in 2007."


Norris' numbers understate the problem.  The October 22nd BLS Employment report states: "The long-term unemployed accounted for 36.9% of the unemployed."


We now revisit several themes raised in last week's comprehensive assessment of a seemingly unstoppable and never ending bull market in U.S. equities:


1.  The U.S. $ as the world's reserve currency: 

In its lead weekend edition editorial, the Financial Times (subscription required) wrote:

"Washington’s flirtation with a voluntary default has shaken confidence in American political institutions. There may be no immediate rival to the dollar as the world’s reserve currency. Markets are more preoccupied by prospects of a delay to the Federal Reserve’s tapering plans. But as John Kerry, US secretary of state, said this week, the world is now monitoring the US to see when it will recover its senses. It cannot afford to make a habit of political recklessness."


"Neither the Chinese renminbi nor the euro are in a position to supplant the US dollar, which still accounts for more than 60 percent of global reserves. But governments and private investors are far more alert to possible alternatives than before. History is littered with solid objects – and risk-less assets – that have melted into thin air."


From an October 20th NY Times Op-Ed - American Debt, Chinese Anxiety: 

"China has been encouraging the invoicing of trade in renminbi, with some success (albeit starting from very low levels). In addition, China is loosening restrictions on renminbi-related financial transactions, with an eye to increasing the Chinese currency’s role in international finance. Eventually, this will mean a reduced demand for the dollar."

The CURMUDGEON continues to believe the US $ is a wild card that could precipitate a huge selloff in both stocks and bonds if it were to decline much from its current level (DXY closed at 79.21 on Friday).

2.  U.S. stock market rise is based on perceptions and momentum, rather than earnings growth or valuations:

In a Saturday's FT article titled U.S. Equities Ride Wave of Easy Money, Michael McKenzie wrote:

"Since May 2012, there has been no pullback of more than 10 percent in the S&P 500.  Another stunning illustration of bullish momentum is how the S&P 500 has remained above its 200-day moving average since last November and currently sits 8 percent above this key measure of long-term price trends. 

In terms of momentum versus fundamentals, there is no contest. “We look at valuation and momentum and the most dominant measure is momentum,” says Jack Ablin, chief investment officer at Harris Private Bank.  “Once you get more than 5-10 percent above the moving average and stay there, the subsequent 12-month return is another 10 percent.” 

For all the Fed’s support, there are concerns that the surfeit of liquidity will end badly if the economy does not accelerate and justify the market’s lofty valuations. And for all the cheering     over record S&P 500 profits and expectations of the same in 2014, stalling sales growth is a big concern. Either companies keep cutting costs or sales must pick up to keep generating higher profits."

Directly adjacent to the above FT article is a terrific companion piece by McKenzie titled: QE froth is great for asset prices, less so for the real world:

"This week provided a vivid illustration of poor economic news being cheered as investors pushed the S&P 500 to a record peak. The rationale behind bad news representing a bonus for the market is the bet that the moderating pace of US job creation means the Federal Reserve is in no position to start withdrawing its hefty stimulus.   In a very short time, investors have become confident that any tapering of the Fed’s $85bn in monthly bond purchases is a story for next spring and not this year."

"It illustrates how money printing has been great for asset prices, and less so for the broader economy as the S&P 500 has climbed nearly 30 percent since it bottomed last November."    

Michael Hartnett’s team at Bank of America Merrill Lynch estimated this week that central banks worldwide have boosted liquidity by roughly $9tn since equities bottomed in 2009. In that time, they say global market capitalization has risen $35tn while the global economy has expanded only $14tn.   “We believe the longer it takes for liquidity to feed through to economic growth, the greater the risk is that liquidity could cause excess valuations in financial assets,” wrote Mr. Hartnett. 

"Already we are seeing debt in private equity leveraged buyouts equal 5.3 times earnings before interest, taxes, depreciation and amortization, just shy of 2007’s figure of 6 times ebitda."


Jim Sarni, managing principal at Payden & Rygel, says: “Intuitively, the Fed knows they need to get out of QE but they’re not ready. The end of QE will not happen until there is a wider recognition that QE is distorting asset prices.” 

Should markets keep rising, with Treasury, mortgage and corporate bond yields returning towards their lows of this spring, the Fed runs the risk of repeating previous policy errors that led to the dotcom bust and mortgage market crash.

Richard Gilhooly, strategist at TD Securities, warns: “(The Fed) stepping aside until March of next year, or later, is a certain recipe for overvalued asset markets that will cause more problems when they adjust to economic reality at some point down the road.”   


Jesse Columbo has a very definitive view of the market in his recent Forbes article: Why Stocks Are Undoubtedly Experiencing a Massive Bubble


He writes, "The global economic recovery is actually what I call a “Bubblecovery” or a bubble-driven economic recovery that is driven by inflating post-2009 bubbles in China, emerging markets, Australia, Canada, Northern and Western European housing, U.S. housing, U.S. healthcare, U.S. higher education, global bonds, and tech (Web 2.0 and social media)."

3.  There's a bigger bubble in social media and selected stocks (e.g. Tesla) that's reminiscent of the late 1990s DOTCOM/Optical networking boom (and eventual bust).

From the WSJ October 24th print edition:  Pinterest's Latest Valuation: $3.8B


For a company with almost no revenue, Pinterest Inc. sure is valuable.  The popular site for “pinning” collections of online images said Wednesday it raised $225 million from Fidelity Investments and other investors in a round of financing valuing it at $3.8 billion. The latest round brought Pinterest’s total fundraising to $564 million since it was launched in 2010.

Asked why a $3.8 billion valuation is justified for a company that doesn’t yet generate meaningful revenue, Pinterest investor Rick Heitzmann described the site as a place where people discover what they love, and want to buy many of the things they discover.


Here's an even better on-line blog post: Why Pinterest makes no money but is now worth $3.8 billion  

"Although the company has recently started exploring promoted pins, the co-founder Ben Silbermann went out of his way to tell users that Pinterest wasn’t making money from the ads. In the blog post announcing the move he said, “Nobody’s paying for anything yet—we want to see how things go and, more than anything, hear what you think.”  So Pinterest has an infant monetization strategy, no revenue, and yet a $3.8 billion valuation. We shouldn't be surprised."


Yet Pinterest isn't the only social media company with no sales and a sky high valuation.  Instagram made no money but got a $500 million valuation before being bought for over $1B by Facebook.   Let's now look at a couple of social media superstars for a sanity check (or not).


Twitter was said to have a "modest" valuation of $11B, according to many analysts.  The company had revenue of $317M in 2012, the calendar year that preceded its filing this coming Thursday.   But it LOST nearly $80M last year!  What’s particularly alarming is that Twitter has been losing money at an accelerating rate over the past couple of quarters for which it reported these figures. But, what the heck, why worry?


This year's darling of social media stocks is LinkedIn (LNKD)- a one trick pony that owns the "professional" social networking market  But is it worth a $27B market cap?  The stock is up 130.22% in the last 12 months and 113.67% YTD as you can see from this chart: 

Closing Comment:

The sky high valuations of social media private companies seem like a repeat of the massive Dotcom/Internet/Optical network BUBBLE of late 1990s-2000!  Evidently, no lessons were learned from that blow-out!

Victor Sperandeo wrote in an email: "It does not surprise me that Pinterest does not earn money .... in the late 90's DotCom stocks sold at 100's times sales. I guess I have been taught these ridiculous things happen.  The market is 100 % manipulated by the federal government's bogus economic numbers- like a 1.5% CPI YOY (who's kidding whom?).  That allows the Fed’s QE's to continue and causes valuations like Pinterest."


Till next time........................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.