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The “Least Loved” Bull Market Becomes Euphoric

June 11, 2014

After nearly six years of unprecedented intervention by the world’s top central banks, the world’s financial markets are hopelessly broken. What used to be accepted as market gospel and guided investors’ decisions in the marketplace, before the 2008 financial crisis, - no longer seems to apply in today’s marketplace. Wall Street is no longer the bastion of free and open markets, where the prices of bonds and stocks are determined by the collective judgment of millions of investors. Instead, market prices are determined by a handful of political appointees, called central bankers, who pull the levers and intervene from behind the scenes, in an effort to influence the direction of the markets.

Playing by the older and more traditional set of rules of investing (prior to 2008) has caused many astute investors to miss out on some of the biggest gains in Wall Street’s history. The “Least Loved” Bull market is now 63-months old, and it’s the fourth longest money minting rally in history. It’s still running on steroids, with the S&P500 index having nearly tripled from its Great Recession nadir, and is now zeroing in on the once unthinkable 2,000-level. The Dow Jones Industrials are clawing their way higher, and are within spitting distance of the psychological 17,000-level. The faithful Buy-and-Hold – and dollar cost averaging investor, is enjoying the ride, having cast aside the frightful memories of six years ago.

Strangely though, even as the US-stock market indexes soar to new stratospheric heights, the trading volume in the most actively traded exchange traded fund – based on the S&P500 index, (ticker symbol; SPY) has plunged by roughly -60% compared with a year ago. Investors are more content to let their Bullish bets ride rather than to add to their exposure to the market. Who is the biggest buyer in the marketplace today, with an unrelenting bid, that buys on all dips? The answer is: Corporate America. Amid such thin market conditions, the S&P500 companies can buoy the market, with a few big blocks of buybacks. And further dispelling investors’ fear of heights, there’s the safety net of the secretive “Plunge Protection Team” (PPT) that rescues the index funds when risky bets go sour. 

The aging Bull market on Wall Street is dubbed the “Least Loved” Bull, because it’s been accompanied by the weakest economic recovery from a recession since the 1930’s. Since the recovery officially began in June 2009, the US-economy has been crawling ahead at an anemic +2% growth rate, or less than half the vigor of the typical rebound from a recession since 1946. The rapidly expanding wealth on Wall Street, mostly flowing to the Richest-10% of US-households, hasn’t trickled down to the average household – take home pay of $839 a week in April ’14, was only +$20 higher than in January 2008, when adjusted for inflation.

What skeptics of the “Least Loved” Bull market have failed to realize over the past 5-years is that the Federal Reserve has turned the stock market upside down, making bad economic news a reason to buy stocks, and good economic news a reason to sell them. The distortion keeps the real value of assets obscure and stuck in the “Twilight Zone.” The answer to this bizarre market behavior is simple: the stock market is being ruled by the Fed, not by fundamentals. In simple terms, what matters to the stock market is the easy money from the Fed, not the performance of the companies whose stocks they are buying and selling.

Indeed, the Bank of International Settlements (BIS) warned a year ago, on June 6th, 2013, “the equity markets are under the spell of monetary easing policies that have enabled market participants to “tune out signs of a global growth slowdown.” Investors are able to shrug off weak economic data and instead, continue to bid stock prices higher, “amid the prospect of further central bank stimulus. Abundant liquidity and low volatility fostered an environment favoring risk-taking and carry trade activity,” the BIS observed.

As recently as May 20th, 2014, Philly Fed chief Charles Plosser lamented, “It’s the Fed’s fault that the markets are ignoring the fundamentals.” “Since the onset of the financial crisis, central banks have become highly interventionist in their efforts to manipulate asset prices and financial markets in general, as they attempt to fine-tune economic outcomes. This approach has continued well past the end of the financial crisis. While the motivations may be noble, we have created an environment in which “it is all about the Fed.” Market participants focus on how the central bank may tweak its policy, and central bankers have become too desirous of managing prices in the financial world,” he said. 

“I do not see this as a healthy symbiotic relationship for the long term. If financial market participants believe that their success depends primarily on the next decisions of monetary policymakers rather than on economic fundamentals, our capital markets will not deliver the economic benefits they are capable of providing (ie; accurate price discovery). And if central banks do not limit their interventionist strategies and focus on returning to more normal policymaking aimed at promoting price stability and long-term growth, then they will simply encourage the financial markets to ignore fundamentals and to focus instead on the next actions of the central bank,” Mr Plosser said.

It’s all about the Fed – During the tenure of the Bernanke Fed – the US-central bank shifted its focus from central banking to central planning, from smoothing the business cycle to micro-managing the markets and financial engineering.  The trading desk that controls the formerly free capital markets is situated on the ninth floor of 33 Liberty Street, also known as the home New York Fed. From a glass-enclosed conference room situated next to a small cluster of trading desks the uber-secretive “Plunge Protection Team” (PPT) controls the money flows that determine the daily fate of credit, equity and virtually all other markets, that have now been hijacked by the central planners at the White House and the US Treasury. As the number of shares traded each day in stock market dwindles to a six year low, the PPT has become an even more influential price setter in the stock market. The PPT concentrates its firepower in the Dow Jones Industrials futures market, which in turn, can move the S&P-500 index several points, with trading volumes as pathetically low as they are today.

The biggest winners in the financial markets last year were traders that respected the old axiom, “Don’t Fight the Fed.” They rode the QE gravy train, and kept their bets focused on the increasing size of the Fed’s portfolio of bonds. Under the cloak of “Infinity QE” – the Fed injected $1.5-trillion into the coffers of its agents on Wall Street, which in turn, was funneled into the stock market, and inflated the market value of NYSE and Nasdaq listed stocks by $6.5-trillion to a record $25-trillion today. Since the Fed fist launched QE in Sept ’08, the central bank has increased its portfolio of bonds by $3.45-trillion, while the value of US-listed shares has increased $15-trillion. In other words, for every $1 of QE, the Fed increased the wealth of shareholders by $4.35. The Fed’s propaganda artists say the QE injections didn’t fuel market bubbles, because the monies were bottled up at the Fed itself, in special reserves accounts, which have captured most of the QE monies.

However, the chart above tells a different tale. It shows a +87% degree of correlation between the growing size of the Fed’s bond portfolio and the increasing value of the S&P-500 index. There has a been few periodic pullbacks in the S&P-500 index along the way to the 2,000-level, but they were all very brief, and only served as better buying opportunities for Bullish traders that kept their focus squarely on the size of the Fed’s portfolio. Last year, every bit of news that did not fit the Bullish narrative was downplayed and soon forgotten.

Even after racking up a stellar +28% gain for all of 2013, the biggest annual gain in 16-years, the “Least Loved” Bull market was easily able to shrug-off news of a -1% contraction in the US-economy in Q’1 of 2014. Proving for the umpteenth time that a weak economy does NOT translate into a weaker stock market, when all the smoke had cleared, the S&P-500 index ended the first quarter with a +1.2% gain, despite the lousy economy. The old adage, “Sell in May and Go Away,” was tossed into the trash heap and the “Least Loved” Bull continued to show its agility as it climbed to new stratospheric highs.

“Least Loved” Bull market running on 2 Cylinders, - Corporate America, - flush with $2-trillion of cash stashed away in their US-banking accounts, has decided there’s nothing more attractive than itself. So, the S&P-500 companies are spending big bucks to buy back their own shares. Last year, they plowed about 80% of their profits into the hands of shareholders, through buybacks and dividend payments. Over the past 3 ½ years, the number of shares of stock available to be bought or sold on the US-stock exchanges has dwindled by -10%. Shareholders like buybacks because they automatically increase earnings per share (EPS). And most often, though not always, a higher EPS leads to rising stock prices. It’s also made it more treacherous for short sellers to maintain bearish bets.

Some notable examples are; Northrup Grumman (ticker NOC), the military contractor expects to reduce its shares outstanding by -25% by the end of 2015, with buybacks. Last year, Home Depot (ticker HD), announced a $17-billion buyback program, that will remove -18% of the shares outstanding at current prices. On June 9th, Home Depot issued $2-billion in five and 30-year bonds, with the intention to use the monies to buy-back shares. The demand for HD’s debt exceeded the supply by a ratio of more than 3-to-1.  Shares of FedEx (FDX) the operator of the world’s largest cargo airline, - soared to above $140 /share, after it authorized a buyback plan equivalent to -10% of its shares outstanding.

The powerful impact of Corporate QE can be seen with the outsized performance of the Power-Shares Buyback Achievers fund (ticker; PKW) compared with the benchmark S&P-500 index. PKW buys shares of companies that have already purchased at least 5% of their shares outstanding over the past 12 months. The goal is to avoid companies whose buybacks go solely toward offsetting stock option grants and don’t shrink the share count. Since January 1st, 2009, PKW has increased in market value by +176%, compared to a gain of +113% for the S&P-500 index fund, ticker: SPY. Analysts estimate that 40% of the increase in the earnings per share of S&P-500 companies in the past 12-months was due to the “financial engineering” of corporate treasurers. In other words, corporate buybacks has scared the daylights out of short sellers - and is conceivably responsible for about one third of the stellar gains of the “Least Loved” Bull market. 

Financial Engineering at Apple - Everyone knows Apple Inc (AAPL) employs many of the best high-tech engineers in the world. But who knew some were also on the financial-engineering side? In a deal that was greeted so eagerly by salivating investors hungry for a piece of Apple’s debt pie, the Cupertino, California- based iPhone maker issued $12 billion of bonds on April 29th, designed to reward shareholders with a leveraged buyback of shares. The world’s most valuable technology company has $151-billion in cash, but only $18-billion of that stash is readily available in the US - meaning Apple needed to issue additional debt to help fund its $130-billion shareholder capital return plan.

The resurgence of Apple’s stock has as much to do with financial engineering as the company’s technological wizardry. For years, AAPL has shifted billions in profits out of the US and into affiliates based in Ireland, where it negotiated a tax rate of less than 2%. Its offshore entities have paid little or no tax in recent years, on $40-billion of earnings generated outside the US.  Luca Maestri, - Apple’s chief financial officer, explained on the latest earnings call, “To repatriate our foreign cash under current US-tax law, we would incur significant tax consequences and we don’t believe this would be in the best interest of our shareholders.”

The sharp rebound in AAPL’s share price to near its all-time high has a lot to do with the wizardry of Carl Icahn who has repeatedly argued that AAPL’s shares were undervalued, and Icahn did provide a blow-by-blow update on Twitter of every new investment he’s made in the company since June ‘13, when he first disclosed his buying spree in AAPL.

On October 1st, 2013, Icahn said in a tweet that he had pushed Apple CEO Tim Cook for a $150 billion share buyback, “Had a cordial dinner with Tim last night. Pushed hard for a $150-billion buyback. We decided to continue dialogue in about three weeks,” Icahn tweeted.  In a CNBC interview, Icahn emphasized how strongly he felt about an increased buyback. “It’s a no-brainer and it makes no sense for this company with their multiple being so low not to do a major buyback. And there’s another reason that I mention, that I think might go forgotten, the fact that you can borrow money so cheaply today. I don’t think we are going to see this again,” Icahn said on CNBC’s “Halftime Report.”


“They have a golden opportunity to go borrow money. With Apple trading at about $482 per share, a repurchase of this kind would mean buying more than 300-million shares. Apple currently only has about 900 million shares outstanding, so a buyback of this size would be a reduction of more than one-third,” Mr Icahn explained. On April 23rd, 2014, Apple put Icahn’s advice into motion, it issued $12-billion of debt, boosted its dividend +8%, and said it would spend an additional $30-billion to buy back shares, taking to $130-billion the total amount it plans to spend on repurchases and dividends by the end of 2015.

Even before the ramped up buybacks, Apple had already reduced the amount of its floating shares by -8.5% to 860-million shares, and by shrinking the float, helped to catapult AAPL’s share price to $665 today, (pre-split basis) up from as low as $390 in April ’13. 

AAPL’s most brilliant maneuver was voting to authorize a 7-for-1 stock split. Since the split was announced in late April, Apple's stock has climbed +25%, creating more than $100-billion in shareholder wealth while the benchmark S&P-500 index edged up +4%. The lower price also clears the way for AAPL to be included among the 30 stocks in the Dow Jones Industrial average. Meanwhile, the mastermind of AAPL’s resurgence, – Carl Icahn, the “King of Wall Street” can celebrate since his hedge fund (IEP) is holding 7.5-million shares of AAPL.

Even as stock prices continue to spiral higher, the S&P-500 companies are trying to keep pace by raising their dividend payouts. 421 of the S&P blue-chips are expected to pay a combined $348-billion of dividends this year. That equals a dividend yield of 2.3%, or about 30-basis points less than the yield on the US Treasury’s 10-year note. 

Dow Blue-Chips Unfazed by Shakeout in Small Caps, Nasdaq high flyers, - There hasn’t been a correction of -10% in the benchmark S&P-500 index for 34-months. Historically, a correction rocks the market about 18-months apart, on average. Yet there was a stealth correction within the US-stock market from the beginning of March through the middle of May that went undetected by the unsuspecting US-public. For instance, the small-cap Russell-2,000 index recently tumbled -10% from its all-time highs, skidding to the 1,100-level. Other segments of the high flying Nasdaq index, such as the social media, bio-tech, and internet retailers stocks were hit even harder, plunging -20% or more. Even Nasdaq kingpins such as Amazon, (AMZN) lost more than a quarter of its market value from its peak levels, and the heavyweight champion Google (GOOGL) stumbled -15% from its highs. As of May 17th, roughly one-third of all US-listed stocks were trading -20% or more below their 52-week highs, (a bear market), with the average Russell-2,000 member down -24%!

At its peak levels in early March, the Russell-2,000 index was priced at a whopping 103-times its 12-month Trailing earnings. Historically, its P/E has averaged 35-time earnings. If there is a bubble to be found anywhere in the marketplace, the most obvious place to look is the Russell-2,000 index, which is home to two thirds of all listed US-companies. It’s a homegrown collection of companies that earn about 85% of their revenue within the US’s borders, and is often seen as a proxy for the US-economy. The sudden -10% correction through the middle of May shaved the Russell-2,000 index’s trailing P/E ratio to 73-times.

Typically, when small-caps get in trouble, a sell-off in the big names is next.  However, on May 7th, the new Fed chief Janet Yellen sought to prevent the large cap S&P-500 Oligarchs from suffering the same fate, by assuring Wall Street traders in testimony before Congress that “valuations for the broad stock market remain within historical norms. Overall, broad metrics don’t suggest we are in obviously bubble territory,” she said. And with those magical words, Yellen put a floor under the Dow Jones Industrials at the 16,350-level. As the Dow Industrials and Transports quickly regained their footing and climbed to new heights, the small–caps breathed a sigh of relief. The Russell-2,000 index built a base of support at the 1,100-level, and recovered most of its recent losses to close at the 1,165-level today. When the PPT does intervene in the stock index futures market, it concentrates its firepower in the Dow Industrials contract, where it can get the biggest bang for its buck.

Fear Gauge at 7-year Low, Euphoria sets in, - Nowadays, the higher the S&P-500 index climbs, the less investors seem to worry. Thanks to the hallucinogenic effects of the Fed’s QE-injections, corporate QE (buybacks), and Mergers & Acquisitions, risk is no longer priced into anything. Everyone has been brainwashed to interpret and spin all economic news as Bullish for the stock market. There is no need to hedge and no need to lighten up on positions carrying huge paper profits. It’s enough to just sit back and enjoy the fireworks. As such, the trading volume on the US-stock exchanges has shriveled up. For example, in the week ended June 6th, only 353-million shares traded in S&P-500 index fund (ticker; SPY) that’s -62% less than a year ago. In the previous week, only 279-shares traded.

When the S&P-500 index hit an all-time high on May 23rd, only 24 of its 500-members reached new 52-week highs. That’s the lowest participation in a year. Since 1990, there have been four other times when the SPX set a 52-week high with fewer than 10% of its members peaking and the overall volume trailing the average. In 3-of-4 occasions, the SPX fell at least -5% in the next two or three months. When volume and breadth are weak, and stock indexes surge, it’s often served as a warning sign that has preceded losses in the past.

However, what used to be true in the past is no longer relevant in the hallucinogenic world of QE, and the Zero Interest Rate Policy (ZIRP). The Fed has made sure that markets are a one-way bet, risks are eliminated, and by stimulating investors’ animal spirits – the omnipotent Fed can create a virtuous cycle that will support economic expansion.

The sharp drop in the number of shares changing hands is not necessarily a sign of danger, because a certain amount of money will buy fewer shares the higher the stock price goes. Most companies have chosen no to split their shares, despite the higher prices. As such, corporate buybacks would lose some of their potency, since treasurers can buy fewer shares as prices become more expensive, through their own rigging activities. But for now, most traders are reluctant to jump off the Fed’s QE-gravy train, and the safety net of buybacks.

Serene Sense of Tranquility among Buy-and-Hold Investors, On March 4th, Warren Buffett told CNBC that investors should not to pay much attention to short-term moves. “Most investors are blinded by the markets’ gyrations and spend far too much time trying to form macro opinions or listen to market predictions, rather than investing simply and prudently for the long-term. Games are won by players who focus on the playing field, not by those whose eyes are glued to the scoreboard,” Buffet said. And there is no need for investing expertise. Buffett recommends a low-cost S&P-500 index fund for nonprofessionals. “Forming macro opinions or listening to the macro or market predictions of others is a waste of time,” he adds. His bottom line fundamental advice: “Ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.” (In other words, just Buy-and-Hold, and relax).

After 5-years of monetary sedation, traders don’t see the need to buy ultra-cheap insurance against the possibility of a nasty market correction. The CBOE Volatility Index (VIX), also known as fear gauge, can be bought as a hedge against falling markets. Yet the VIX plunged to its lowest level in 7-years last week, reflecting the lack of fear of even the slightest pullback. Instead, investors on Wall Street are mesmerized by the Fed and are comfortable living in a calm and predictable universe, where there is no fear of turbulence. In the past, contrarians used to view such complacency as a major warning sign of a bubble top.

Outlook:  The “Least Loved” Bull market is still running on steroids, even at 63-months old. The median lifetime of the Top-12 Bull markets is 55-months. So it’s lasted 8-months beyond its mid-life. A -10% correction hasn’t happened for the past 34-months, far beyond the average of 18-months between corrections. Yet it looks as though the S&P500 index has entered the Euphoria stage, - the fourth and final phase of the Bull market. It wouldn’t be surprising to see the Madness of Crowds, - where frustrated investors jump off the sidelines to buy equities, alongside the indiscriminate buyers, (ie; corporate treasurers), in what’s called a “Melt-Up.” The Euphoria stage could see the S&P500 index surge another +5% to +10% higher from today’s close of 1,950. Even as the Fed winds down its QE injection scheme by October, its comrades at the Bank of Japan and the European Central Bank will be running the printing presses in its absence, and keeping the liquor flowing for the late night partiers.


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