It seems civil unrest is picking up in every part of the world as we speak, with a rising minority tired of corruption and pro-wealthy tax laws that look after only the top 1% of the population. It is worrying that the world is showing signs of cracking as this disparity grows -- the people cannot and will not contain their anger and repression any longer, whether it be religious, political or social.
As we battle with this geopolitical backdrop, we have a financial system managed by the Fed, ECB, Bank of England and Bank of Japan that has become entirely useless in its purpose of fixing the problem, only propagating it by simply throwing more money at it, making matters worse and making the wealth inequality gap even wider. Did they not learn from their mistakes the first time around?
After decade-long expansion of the Fed growing their balance sheet by around $3 trillion dollars and lowering rates all the way down to 1.5%, today after a year of trying to "normalize" the system, the Fed is considering yet again embarking on Quantitative Easing (oops sorry, Not-QE) by buying short-term Treasury bills and extending their repo open market operations until 2020. If that does not signal a broken system, I'm not sure what does.
Economic data across the globe is showing signs of a serious slowdown, in some parts even deflation. Yet the S&P 500 is sticking to its all-time highs of 3000. When one looks at the chart of cumulative U.S. equity fund flows, it has been on a severe decline since 2018, when the slowdown first emerged.
What gives? If one were to track U.S. corporate buybacks from 2009 onwards, the trend is shocking. Buybacks in 2009 averaged about $137 billion, steadily increasing every year to reach $585 billion by 2017, $810 billion in 2018, and $795 billion through he first half of 2019! That is about $5 trillion in all since 2009.
This has got to be the biggest financial scandal of the decade. The Fed keeps printing money, easing interest rates, allowing the companies to borrow even more money at cheaper rates only to use that money to buy back their own shares. With a lowered share count, they manage to boost their Earnings Per Share (EPS) number even though earnings deteriorate. This is arbitrage on a whole new level.
Don't be fooled by the high S&P 500 index as underneath the surface, sectors outside of technology, which has contributed to the majority of gains in this index anyway, are suffering and will continue to do so.
October has been a busy month with trade talks, Brexit deal potential, and the Fed FOMC meeting. The former two events have come and gone with no progress and perhaps none for years to come. The market is gripping onto this 3000 level in hopes of a Fed about to announce even lower rates and more Quantitive Easing policy measures. Hope can only last so long until the reality bites one in the rear end.
Third quarter 2019 earnings have started, with 70 companies reported so far and around 80% of them beating earnings. Clean beats vs. accounting beats are yet to be argued. Netflix NFLX is a great example, as it beat its top-line EPS, causing the stock to rally 10%, but after further studying the numbers, it showed net cash burn higher and poor subscriber growth and outlook guidance. EPS beats are becoming meaningless these days.
Monday morning, South Korea's exports were reported down 19% in the first 20 days of October alone. South Korea is a benchmark for world earnings and growth as it shows the trend and state of global trade and demand. Japan's September exports were down 5.2% year over year vs. an expectation of 3.7% decline, with exports to China down 6.7% and to U.S. down 7.9%.
Despite OPEC and Russia cuts -- and to their detriment -- the price of oil is still below $60/bbl Brent, with the Aramco IPO getting delayed even further. Energy oil majors will start reporting earnings soon to show significant quarter-on-quarter decline. The big majors are cheap, with high free cash flow yields, but as we know cheap can always get cheaper with lack of earnings upgrades. Copper has stayed muted below $5800/tonne and the miners, after rallying on Fed cutting rates and U.S./China trade deal optimism, have given back some of their recent gains.
The Fed is up next. If their dovishness fails to impress the markets, there are a multitude of arguments that can take the markets down. Stay tuned.