October 2018 Newsletter: "The Time Has Come the Walrus Said"

The New Playbook I've Talked About is Here


Dear Subscriber,

What and Why the Correction Happened—The Real Story
Look--I could give you the simple stock market mechanics  answer for “why and what happened in the last 48 hours”:
1) The market for growth stocks ran out of new marginal buyers (meaning index money and stock buyback money that are price insensitive stock buyer who uses market not price-limit order to buy stocks) and boom—
2) we had a marginal buyers strike where index fund redemptions and 86% of the corporate buybacks buyers were not in the market due to their “pre-earnings blackout periods” and BOOM BOOM!
3) We had more market sell orders than marginal buyer buy orders starting last week and the stock markets peaked. Then
4) the price momentum buyers quickly turned into market order sellers with the breaking of 20-50 day moving price momentum averages and then a self-fulfilling cascade of profit taking algo/black boxes kicked in and boom—
5) the biggest winning stocks swooshed down 10-20% on profit-taking following the stock market’s new red-headed stepchild Facebook down 20% into the shitter.
Or I could hypothesize that the rolling over in demand and stock prices for commodity semiconductors especially memory chips in June signaled a 2018 peak in the 3-year semiconductor cycle (that we identified 60 days late but still made a killing in). Since we live in a digital-not-analog world, this is the equivalent of seeing car engine sales roll over or housing starts rolling over in the analog world (which by-the-way—car sales peaked in late 2017 and housing starts HAVE peaked and are rolling over thanks to 7 year high car financing rates and mortgages and, in housings case, not enough construction labor).

OR I could just reiterate the most obvious macroeconomic facts of life:
1) If you pour $1.5 trillion of borrowed money into the US economy at the 7-8th inning of an economic expansion, it' materially inflationary and like pouring gasoline on a low-grade forest fire
2)  10-25% Tariffs with our 3 largest trading partners are materially inflationary and like pouring gasoline on low-grade inflation
3)  Adding $1 trillion a year in Federal debt to a $20 trillion economy with $22 trillion of Federal Debt/$35 trillion of Fed/State/Local government debt and 6% LOWER Federal Tax collections in 2018 (ex-one time repatriation taxes) is like pouring gasoline on Federal creditworthiness and future interest rates
4) After 10 years and $15 trillion in central bank intervention, you have to build some firepower for the Fed to fight the next recession because the government can't borrow another few $trillion on top of the $trillion it already borrows every year without creating a negative death spiral feedback loop of high borrowing costs/interest payments that in turn go to 20% of the Federal Budget
5) Oh yea...trees don't grow to the sky and bull markets need 10%+ corrections to remain healthy bull markets.  
But to REALLY understand the nature of equities value creation and destruction, you have to understand the power of the new macroeconomic and monetary policy transformations and commercial/industrial transformations that have begun in earnest with the arrival of 3% 10-year bonds going to 4% or higher.  

Yes with the S&P 500 at a three-month low and the Shanghai Composite sitting on a 22 percent loss for the year, investors are now steadying themselves for the upcoming third-quarter earnings season. JPMorgan Chase & Co., Citigroup Inc. and Wells Fargo & Co. kick it off for U.S. banks on Friday. But even if Q3 earnings pull off a strong quarter (that is already baked into stocks--it's the forward guidance that really counts), you and I have to take a stroll down "How the Stock Market Works" lane and get ready for the final leg of the US expansion and bullish stock market. 
The ONE Stock Market Lesson You HAVE to Know in 2018—and Forever More!
On a day-to-day or week-to-week basis the market for stocks is a mechanical machine that runs on just two emotions—greed aka the fear-of-missing-out on big profits (FOMO) or fear-of-losing big money (FOLM). Those emotions are translated into sectors of the market that buyers deem to have the right macro and microeconomics mix that make them most likely to deliver the highest profits. That selection behavior (remember the stock market is analogous to a beauty contest and our job is to understand what the “judges” aka institutional money managers find most beautiful) has been algorithmitized into individual microeconomic “factors” (aka quantitative analysis) and loaded into stock buying and selling computers. About 90% of stock buying and selling in NYSE/NASDAQ stock market is now computerized black box buying and selling according to the latest data.  
Key Point: Transformity Investing is in the business of “Quantamentals™” stock market investing. Our job is to reverse engineer and own what the COMPUTER ALGORITHMS tell the institutional money managers what sectors they want to own and what stocks within that sector. I call Transformity Investing a “quantamental” stock market investing strategy (quantitative + fundamental sector and stock picking) because that is what we do: we mix macro and micro-economic quantitative factors into investable themes and pick the stocks that own the most valuable intellectual property or resources that enable that sector to transform and become 5x-10-20X more valuable during a bull market. 
OUR 800% outperformance (55.3 annual) over the 7% annual return from stocks (since 1989) comes from OUR quantamentals philosophy about what stocks at what time in the monetary/business cycle will be the most attractive to secular growth investors i.e., investors who want to get RICH buying the secular transformative companies and sectors vs. the value investors who want to buy $1 for 50 cents or lower.
Value investing has underperformed growth from 1990-2000 (call that Internet 1.0 transformation decade), 2003-2008 (call that the Wireless Internet 2.0 transformation decade) and from 2008-2018 (let’s call that the Internet 3.0 business digitalization decade when wireless broadband became ubiquitous worldwide and business and consumer processes had to transform to being digitized, "AI-ified“ "appified” and cloudified.)
IN those time periods we have had other major transformational events—infrastructure was transformed into securitized MLPs (which we made 100%+ profits in 2012-2014), fracking of hydrocarbons became practical and natural gas became the dominant feedstock of hydrocarbon-based energy (another area of big profits) and of course individual companies transformed their business structure or models and gained 10X+ new value based on those transformations (our investment in Newtek Business Capital NEWT is a great example of profiting from corporate transformation).
But ALL of our quantamental sector and stock picking starts with the Federal Reserve’s monetary policy because to have bull and bear markets for stocks in the first place—especially growth stocks—the foundational demand driver is the alternative to stocks—risk-free bonds. For instance, stocks have returned 7% a year (including dividends) since 1989. Because the bond market has been in a 36-year bull market, 10-year bonds have returned about 9% rolled over for the last 36 years (when 10-year coupon rates dropped from 16% to 1.25% in 2012—bond prices go UP in value as interest rates go down and vice versa).
Key point: Given the action of bond prices (yields exploding up, bond prices down 10% in 2018) we can say with about 98% certainty the greatest bull market for bonds in history is over.  THAT is part of a monetary transformation and risk/reward inflection point will have a significant impact on the market for stocks and what kinds of stocks until the next recession (still 2020 IMHO since the real economy lag for Fed rates hikes is 10-12 months).
The Monetary Transformation of 2019
Our bullishness of stocks in 2009 started with the global central bank emergency actions to reduce the short-term yields of Federal Funds (and money-market and bond rates) to enough to make their after-inflation returns zero or negative returns. They made zero-risk “cash and bonds trash” and made equities and other income generating risk assets significantly more attractive. The banks via “quantitative easing” became the marginal buyer for treasury bonds (and in Europe corporate bonds as well) and stocks and particularity growth stocks were made the most beautiful girl at the stock market beauty contest and irresistible vs. guaranteed after inflation losses in “risk free” bonds and paper.
Key point: The reason why secular transformational growth stocks go UP 5X-10X-50X-1200X in value versus value stocks is their future earnings growth and profit margin duration. Institutional investors make a 3-5 year forecast and then discount that forecast by 2 or 5 year bond rates (to expected inflation proxy). WHEN those rates are zero or negative, the discount turns into a premium multiplier that acts as a turbo charger to long “duration” earning growth values—instead of discounting those earnings those earnings get a premium! That is why we did so well with Apple and Salesforce.com and fracked natural gas and energy stocks into rising nat gas and sweet crude prices 2009-2014 (and why we SOLD energy when Saudi Arabia declared war on US hydrocarbon frackers in October 2014 and ended to secular energy price wave).
This is ALSO why we have crushed the market by 810% since 2013—we have monetary winds at our back and an Internet 3.0 digital transformation wind occurring that was and still is growing 20-60% annually worldwide—led almost 90% by US technology companies. Frankly IF you understood basic monetary policy, macro-economics and the topline-earnings growth inflection of the Internet 3.0 age post-crisis, it’s been a license to print money.
Key point: In a 2%ish growing economy, buying 20%ish or 10X faster growing profitable (or soon profitable) companies with FREE MONEY was a no-brainer. But with >3% GDP growth (above 10-year trend), that kind of growth by definition RAISES inflation and that raises interest rates—they are tied at the hip. Incurring 10-25% input cost tariffs is inflationary--Mr. Trump must have skipped his Econ 101 classes at U of P—accelerating GDP without accelerating labor productivity means accelerating inflation ALL of which means tightening Fed monetary policy! Throwing $1.5 trillion of borrowed money into a 2.5% GDP and $20 trillion economy WILL absolutely raise GDP growth rates one percent or so a year for 2-3 years or more (assuming $1 trillion of that money used for stock buy backs EPS grows too and $500 billion goes into capital investment).
But—if that 40% higher rate of GDP growth comes NOT from organic demand or higher rates of labor productivity but from injecting $1.5 trillion of tax cuts back into the US economy (and we borrowed 100% of that money to inject into our economy and now borrow another $1 trillion a year to fund our entitlement payments negative cash flow) at some point Federal borrowing costs will HAVE to go higher, too (too much supply drops the value of anything--when bonds go down in price they go UP in interest rate).

Key point: That combo WILL eventually create a negative economic inflection point that starts a negative economic feedback loop (i.e., as credit quality goes down with higher debt payments not matched by higher tax collections—credit ratings go down and cost of borrowing money goes up).  
Really KEY point: THAT oncoming economic train wreck reality needs to be priced into risk assets and bonds over the next year.  That train wreck does NOT happen today for numerous reasons—but the bigger the bubble blows the more powerful the negative result when it pops.
Don't miss this point: In the here and now—IF you reverse the monetary tailwinds driving growth stocks and turn them into headwinds, and you now discount hyper-growth companies (those that are growing 3-5 years out at 5-15+ times the overall GDP growth rate) at 3-4% per year versus zero or at a premium, the present value of those extraordinary earnings is 2-3X LESS than if we discounted them at 1.25% 5year or with no discount at all (in fact a .5 premium).
It's just math--you get it now?  All these forces were building up-- it's just the Fed Chairman to say that he was raising rates even WITH these negative data points that pushed the panic button. There is more. This shift in the core monetary world from the free money of the US Federal Reserve + higherrisk free bond yields vs. Euro/Japan makes the US dollar worth more than the other major currencies too (i.e., you buy the dollar with cheaper currencies and get a much higher interest payment in the stronger dollar--it's a two-for benefit UNTIL the dollar starts to go down in value and other countries raise their rates) The strengthening US dollar vs. Euro/RMB/Pound ALSO hurts future value of US earnings made in currencies that converts to US dollars at a discount. The strong US dollar ALSO has to, at the margin, cost US based companies some sales revenue simply because competitive solutions or parts are cheaper when paid for in other currencies.
The expansionary monetary policy works because it is by definition and positive feedback loop. Conversely, monetary tightening (removing dollars from the economy and rising cost of money) works to slow inflation because it is a negative economic feedback loop. What we have here now is a witches’ brew of a value destructing feedback loop for growth stocks that now HAS TO GET priced into secular growth stocks in real-time. IT WILL OVERSHOOT—these corrections ALWAYS DO (and we have a simple plan to make some SICK profits on that bounce back—more on that plan in a moment).
But when you add in rising 1) short-term and long-term rates and suddenly the specter of 4% yielding 10-year bonds in the 7th-8th inning of a record 10 year business expansion and 2) inflation rising tariffs and fiscal stimulus and all of a sudden BONDS start to look MORE attractive to institutional investors (who use their money to pay pensions or endowments obligations) and to the $2 trillion in sovereign wealth funds who now control 8-11% of the total equity and 5-6% of the $100 trillion global debt market.
IN SHORT—there is now a strong case being built to switch horses to the bond-proxy, high dividend “value growth stocks” that are also in big sector transformations IF this 3% 10-year rate is going to 4% (which means bonds will take another 10-15% hit in value).  That of course is AFTER we get what I think will be BIG oversold bounce in hyper-growth stocks with their hyper-growth story still intact (more on our get richer quick plan).
The reality of this week is the economic bill has come due for 10 years of free money. The game of chicken is over and the bond market and hyper-growth investors blinked. Negative real interest rates (real means after inflation is deducted) should be called what they are—a credit subsidy. They caused a boom and mania in American housing 2001-2006 that crashed. They have done the same thing 2008-2018 as we have talked about for years and taken advantage of for 5 years. As the Wall Street Journal Editor Page rightly stated today
“Negative real interest rates in 2001-2016 that produced a credit subsidy that fed a commodity boom and housing mania that eventually became a panic and crash. Former Fed chairs Ben Bernanke and Alan Greenspan to this day blame everyone else—“global imbalances”—but they should reread Charles Kindleberger: “The cycle of manias and panics results from the pro-cyclical changes in the supply of credit.”
BTW--you should read Kindleberger too, He is one of my favorite economists because he never considered himself an economist—he was a physicist and understood gravity. He built upon the work of Hyman Minsky who was a proponent of what he called the “financial instability hypothesis,” which posited that financial markets are inherently unstable. Periods of financial booms are followed by busts, and governmental intervention can delay but not eliminate crises. Minsky’s work received a great deal of attention during the global financial crisis aka "A Minsky Moment" (see here and here; for a summary of Minsky’s work, see Why Minsky Matters).
Kindleberger provided a more detailed description of the stages of a financial crisis. To him, the period preceding a crisis begins with a “displacement,” a shock to the system. When a displacement improves the profitability of at least one sector of an economy, firms and individuals will seek to take advantage of this opportunity like a moth to a flame. The resulting magnetic demand for financial assets leads to an increase in their prices. Positive feedback loops in risk asset markets lead to more investments and financial speculation, and a period of “euphoria,” or mania develops (think Vancouver BC real estate, private Internet 3.0 tech stocks like Uber or WeWork, SF/Seattle real estate, Manhatten/Miami/Hamptons real estate, Modern and Classic Expressionist and Abstract artists like Picasso or Renoir or my frigging rare wine/whiskey portfolio that has outperformed EVERYTHING).
At some point, however, insiders begin to take profits and withdraw from the markets. Once market participants realize that prices have peaked, flight from the markets becomes widespread. As prices plummet, a period of “revulsion” or panic ensues. Those who had financed their positions in the market by borrowing on the promise of guaranteed no-brainer profits on the purchased assets become liquidated and insolvent (like me buying $5M of real estate in 2005!) Panic ends when prices fall so far that some traders are tempted to come back into the market, or trading is limited by the authorities, or a lender of last resort intervenes to halt the decline.
S&P 666 in March 2009 ring a bell? Las Vegas/Phoenix real estate in March 2009 ring a bell?
This is especially true in the current monetary cycle because of the Fed’s post-2008 ministrations. The risk assets include equities that have had an extraordinary run since 2009 even as the real economy grew only moderately until 2017. THISis the disconnect that HAS to be taken out of the system. It’s the same reason that the housing bubble blew up—the revenue from rent could not begin to cover the mortgage even with 30-40% down (PS a financial bubble is when the upswing in prices exceed two standard deviations of price range OR the income from the asset does not cover the cost to own the asset.)
My pal Russ Mould, investment director for AJ Bell, suggests Americans look in the mirror for the biggest clue of all. Russ points to recent U.S. Census Bureau data that shows 10 years after the crisis, median U.S. household income is finally back at 2007 levels—at $61,372. That’s in contrast to U.S. household net worth, which recently crossed the $100 trillion mark for the first time, nearly 50% higher than at the cyclical high of a decade ago. Now understand just 1% of the population owns 90% of that wealth increase--the top 15% of American households own 96% of the wealth increases. 
The pace of household net worth vs. incomes isn’t sustainable, warns Mould, in a recent note to his clients. “The difference [between the two numbers] is likely to be accounted for by the surge in the value of financial and other assets — equities, bonds, property and frankly everything from vintage cars to art to wine to baseball cards — and this is one warning that at some stage another collapse in financial markets will sweep around the globe.”
I’m not saying that is today—but financial gravity has not disappeared—it was just suspended by $15 trillion of world Central Bank intervention to suppress its downward gravitational pull. We HAVE been playing a game of chicken with the bond market ever since the Fed started its slow reduction in monetary stimulus and raised Fed Fund rates above the inflation rate. The increased interest cost IS biting. Auto sales down--stocks hitting lows. Home buyers cant get affordable new homes...and people in existing homes can't sell and get a nice place for the same money. Housing stocks are in a bear market. Semiconductor demand peaked in June--semis are in a bear market. THOSE are the three best leading indicators for our economy. 
Really key point:  Since corporate tax reform and deregulation reversed Barack Obama’s policies, the real economy has surged and is now growing at close to 4%. The Fed is lifting rates in response and belatedly (if slowly) winding down its bond buying. Bond yields are now rising in response to this faster growth, and traditionally that has meant that stock prices will fall.
The question that no one can answer with certainty is whether the correction in asset prices will be longer and deeper because the Fed’s financial repression was so extended. An honest assessment has to be that no one knows but if 2002-2006 was a lesson--we just expanded their 4-year ultra-strong monetary stimulus plan to 9 years of even more powerful stimulus. We have never seen the kind of central bank experiment that Mr. Bernanke began and that Europe and Japan followed. It’s certainly possible that as long bond rates rise, capital will flow out of certain risk assets and back to a more normal pattern of investment allocation and risk.
This week the market is FINALLY starting to price in a 350% rise in 10-year rates (30-year loan in 2009—I.25%. Today? 5%!). But wait—there is more! We have OTHER material risks ahead:

  1. If Democrats take Congress (House and Senate) in November and reverse corporate tax reform, a recession is all but certain. BUT the $1.5 trillion is already spent and priced into stocks. Unfortunately (as mentioned) that money is NOT creating a spike in labor productivity that curtails inflation OR adds to Federal tax collections. IRS reports a 6% y-over-year DECREASE in tax collections for Q2. That money bought back $1 trillion of stock at elevated values--oops! 

  2. If Mr. Trump’s trade war escalates, a recession is not necessarily imminent in and of itself. But it become another .35-.5% drag on GDP and since the stock market goes bear (20%+ drop 4-6 months) ahead of GDP recession, and if we have an evaporation of $10 trillion or so of market wealth (out of our $100 trillion private hoard of wealth) that will surely exacerbate the rate of the rate of GDP decline.

  3. And most of all—IF Chairman Powell now reverses his “we will likely go beyond the monetary neutral rate because the economy is so strong” market message and even SMELLS like he is responding the Mr. Trump calling the Fed “crazy” –then the Federal Reserve credibility is SHOT and ALL HELL breaks loose. Therefore we can only surmisethat the Fed is even MORE determined to do its duty to hold inflation to a 2% ish rate.

So—thanks to Mr. Trump, the Fed is NOW cornered and HAS TO raise rates and may go back to the language of “data dependence” too. Since the data is GOING to be inflationary, that data gets us to 4% 10-year too—and 6% mortgages—and 9% car loans. In short, a good old Fed led recession where demand, at the margin, drops and GDP goes negative.
Trumps $20 trillion tweets could be a $40 trillion tweet if we wipe out real estate values again (like I said already happening in the high end) So in conclusion, here is where we are today.
The Hawkish Fed: The Punch Bowl Has Been Removed
After years of seemingly unquestioned central bank support — including the so-called “Fed Put” aka the market’s trust that the Greenspan/Bernanke/Yellen Fed Chairman had a button on their desk to buy index funds/pump money into a plunging stock market to “save” stock values— that put is gone. Stock and bond markets are in the process of transitioning away from a world where major Central Bank liquidity injections underpin asset prices and moving toward a “you’re on your own” greater role for macro and micro economic fundamentals. Almost by definition, this is a volatile process: Mental picture: Think of a plane changing engines while flying at a high altitude.
Outsized US economic growth vs. the rest of the advanced world economic weakness is complicating this liquidity-to-fundamentals market transition. In addition, the Federal Reserve is well ahead of the rest of the world in normalizing monetary policy, after ending quantitative easing, hiking interest rates eight times, publishing the timetable for reducing its balance sheet, and signaling further rate increases for both this year and next.
Key Point: Economists call this economic phenomenon “divergence.” But the real question is whether other countries will eventually converge with the U.S. in achieving higher growth or whether the U.S. will be pulled down. Since 23% of the US Economy is exporting our stuff, services and media to the rest of the world, at the margin IF our export demand is falling, our GDP is falling too.
I am NOT betting on global growth convergence. The World Bank just downgraded world GDP. Trade tensions are adding to the uncertainties about the market transition. Specifically, it’s not yet clear how long it will take China to realize that the least bad alternative for its development is to pursue the same path that other countries (South Korea, Mexicoand Canada) ultimately followed — that is, make concessions to the U.S. It also isn’t clear what concessions would satisfy the Trump administration.

Like I said in August newsletter: the conventional wisdom from my fellow economists and money managers was as SOON as Canada/Mexico was done the White House would get after China to declare victory before the mid-terms. NOW it's obvious China is being made in a reality show villain to be blamed for lost revenues, canceled contracts, and higher prices. And as of today, the Fed is now a villain too and antagonist in Trumpian Reality Show where there must be at least two or more villains to attack and fight to keep up the ratings for the 33% of Americans who love the drama (and have no friggin ideas or understanding of what I am sharing with you in this newsletter edition). 

Maybe Mr. Trump will surprise us IF the market meltdown ruins his "I love the stock market" narrative?  Wanna bet on it?
Feel a little shaky? I have said for 2 years we have been in a game of musical chairs that the corporate tax cut extended. But ALL forms of government palliative care for economic growth eventually run out of juice. Again somehow at Wharton, the POTUS missed the day that taught “GDP growth is a function of the growth of #population and employed workers X hourly wages paid x output of labor.” The United States population growth and household demand are growing slower because there are 16,000 Americans who turn 65 or 79 every day till 2030 and only 10,000 Millennials turn 21 per day until 2030. The numbers don’t add up.  
The Equities Illuminati Pyramid Touched the Sun
It has been common knowledge for a while that the stock market has been driven higher by an “elite cabal” of high-flying but alsohigh quality companies. The “Equities Illuminati” as I call them includes Apple, Amazon, Netflix, AMD, Nvidia, Microsoft, Google, Visa, and Mastercard, which have accounted for about 52% or half of S&P 500's gains since the stock market's correction in early February, according to data compiled by Goldman. In the market we call this “narrow breadth.”
This disproportionate contribution to index gains has been frequently cited as a bearish signal — one that highlights a troubling lack of breadth in the market. The idea is simple: when a select handful of companies are doing the heavy lifting in the market, it can often mask underlying weakness.
Vincent Deluard, a macro strategist I follow, notes that record highs for stocks during periods of low breadth have historically occurred near the end of bull markets. He cites the market collapses in 2000 and 2007 as the most contemporary examples.


Deluard also surmises that the FAANG Group — consisting of Facebook, Apple, Amazon, Netflix, and Alphabet — has broken down. As of today, he is dead right--and he sent me this forecast two weeks ago! Deluard's bearish call says "Much of this year's action suggests a rate-driven correction is nearing," he said in a recent client note. "The next few weeks could be a perfect storm for the U.S. equity market."
Well, he sure got THAT right—he published this call three weeks ago too!
Deluard doesn't stop there. He also identifies six other headwinds he expected to combine to put serious pressure on stocks. Hence his forecast that a correction could befall stocks in a matter of weeks (which did!)
1) Seasonality— The last weeks of September and the first weeks of October have historically been the worst periods for stocks.
2) Post-earnings buyback blackout periods— Buybacks have been a crucial driver of share appreciation throughout the bull market, but companies are entering a stretch where they won't be able to conduct them.
3) The stock market is a future earnings discounting mechanism. Tougher year-over-year earnings growth comparisons— US stocks have been enjoying incredible profit growth over the past several 2018 quarters with earnings growth climb into 20% y-over-year setting a precedent that will be tough to beat.
4) Headline risk—The Italian budget (October 15), and the US midterm election (November 6).
5) Monetary tightening from the European Central Bank— The bank's 30-billion-euro injections are likely to be cut in half at the end of the month before ending altogether in December.
6) Treasury issuance will keep pressuring yields— at the margin, this will attract capital from the stock and corporate bond markets as zero-risk of 4% ish yield as weighed against a 2020 recession. BUT...this massive issuance is going to want higher rates--purely supply and demand. 
7) I’ll also add Mueller risk—I am now advised by multiple DC sources that the next indictment from the Office of the Special Prosecutor will be Donald Trump Jr. and possible the other brother Eric. This will shock the markets in the short term as one or both of the kids could roll over on Dad.

So...where is the White Knight to rescue the floundering 

Earnings & Stock BuyBacks to the Rescue!

Almost all major U.S. companies entered their stock buyback “blackout” period, which removed a steady—and I think way underappreciated— a market lifting factor that has been buttressing equity values especially post-cash repatriation Corporate tax cut. PS only about $200 billion of cash has been actually repatriated according to latest data—but US cash of >$1 trillion will be spent in 2018 according to Goldman Sachs research and data. According to Goldman Sachs, companies spent $384 billion on buybacks in the first half of the growth, an amount that represents growth of 48% from the prior year.

FYI--The term “blackout” period refers to how most companies and corporate insiders are prohibited from repurchasing their own shares in the 30 trading days before the release of their quarterly results. As I have said for some time, it is obvious that the big tech companies buying back their own stock have been providing a major floor to equity prices. “Buybacks provide a tremendous amount of support to the market, and with blackout season coming, we won’t have that added measure of support,” said Scott Glasser, the co-chief investment officer of ClearBridge Investments, which has about $140 billion in assets.

Glasser spoke at last week’s Legg Mason Investment Forum and said equities were “overdue for a correction,” and that the blackout period could add to the odds of one occurring. Way to go Scott ... you and Vince are my new heroes.  So here is the deal: according to Goldman’s data, 18% of the companies in the S&P 500 index are currently in their blackout period. This rose to 86% in stock buyback black out by Oct. 5.  When did this market meltdown start? October 5th--that is not a coindidence. 

“Since 2000, S&P 500 returns have been comparable in blackout and non-blackout periods, but realized volatility has been nearly 1 point higher in blackout periods than when a majority of firms are free to repurchase stock (14.4 versus 13.6),” the investment bank wrote in a note to clients. The blackout issue was cited as being a contributing factor to selloffs in early February. At the time, Goldman wrote that blackout issue was “likely intensifying the decline” in the major averages, which resulted in corrections—or 10% declines from a peak—for both the Dow Jones Industrial Average DJIA, -0.35%  and the S&P 500.  My new guru Vince Deluard calculated that stocks that were in a blackout period during the worst of that selloff underperformed the market by 150 basis points or 1.5%.

Roughly 8% of a total year’s buyback spending is done in October, Goldman wrote. Why does this matter? Longtime subscribers know I talk a lot about the “marginal buyer” of stocks, options, and securities or any active market/limit bid market. The marginal buyer is the market bid in the market—the price insensitive bid. There are individuals for sure that use market/price insensitive bids but the big movers are passive index funds that have to reposition share count daily, short sellers closing out short positions (stock they borrowed and have to return) BUT the big marginal buyer since corporate tax reform are the tech stocks (especially FAAM giants) are the 20 $100+ billion market cap tech stocks.


Action to Take: HOLD TIGHT and look for our email! Tomorrow's futures look up--like today. If they are met with selling and the bottom of today holds, we are set for a MASSIVE bounce back in the stocks that got crushed the most--Micron, Nvidia, AMD, Netflix and more. I assume that traders will want to be flat going into the weekend--that last hour should be a good time to pick up some out-of-money call options with 200-500% upside. WE WILL buy some late October and January Call options to take advantage. 

Have a great night!

PRO NewslettersTobin Smith