Tipping Point

For most traders and investors in U.S. stocks and bonds, the following questions appear to be relevant and central to immediate and longer term trading and investment decisions:

1. Will the ongoing investigation by Special Counsel Robert Mueller into Russian meddling in the 2016 U.S. Elections ever have an impact on U.S. financial asset prices? If yes, then when?

2. Are there more indictments forthcoming in Mueller's Russian investigation? If yes, then when? And will these indictments impact financial asset prices?

3. Headlines in the media this past weekend indicate that Commerce Secretary Wilbur Ross may be connected to the Kremlin and/or Russian financial interests. Does this matter to traders and investors in U.S. stocks? If yes, then when?

4. At the end of the day (defined as 18 months or less), will President Trump be implicated by Mueller's office in the Russian investigation? Could President Trump be implicated in "crimes and/or misdemeanors" unrelated to the Russian investigation (but uncovered by Mueller's office)? Could President Trump be swept up in the nationwide sexual harassment and assault investigations that have been triggered by the alleged Harvey Weinstein scandals? Is it possible to indict a sitting U.S. President (i.e. Paula Jones vs President William Clinton)?

5. If President Trump is impeached or forced to resign, will Vice President Mike Pence become President (and then pardon Mr. Trump)? Or is it possible that any potential impeachment process might also include Vice President Pence?

6. If the Democratic Party wins back the House of Representatives (and maybe even the Senate) in next year's November 2018 elections, and if President Trump is still in office, will the Democratic controlled House of Representatives then vote to impeach President Trump (and maybe even VP Pence)?

7. If President Trump and Vice President Pence are both impeached beginning in January 2019 and if they are then both found guilty by the Senate, does that mean House Majority Leader Nancy Pelosi would then become President? 

8. If pressure on the Trump Administration continues to escalate in connection with the Russian investigation, how will this affect the Republicans' efforts at Tax Reform (tax cuts, no real reform)? Does the fact that France now wants to raise the corporate tax rate to 45% from the current level of 33% work against the U.S. Republican Party's push right now to lower the U.S. corporate tax rate to 20% from 35%?

9. Are the Democrats in Congress strong enough to force a "shutdown" of the U.S. Government in upcoming budget negotiations as scheduled in December 2017? If so, how will this impact U.S. financial asset prices?

10. According to reports from CNBC and the New York Times, NY Federal Reserve President William Dudley may announce his early retirement in a speech this coming week. William Dudley was a strong advocate for Chair Janet Yellen to be re-appointed. If Dudley retires, the Federal Reserve Board would then need five new members in addition to the newly appointed Chairman (Jerome Powell). Will these upcoming changes in the Federal Reserve Board impact U.S. financial asset prices? If so, when and how?

11. Until now, investors in U.S. stocks and bonds have ignored hawkish monetary policy comments and rhetoric from almost every U.S. Federal Reserve official over the last several months. However, a careful review of the latest weekly financial report from the U.S. Federal Reserve (weekly reports are released late Thursday each week) reveals that the Fed's balance sheet actually showed a $6 billion reduction in assets in the month of October just ended. Chairman Yellen announced to the financial markets that the Fed would, in fact, begin to reduce its balance sheet by $10 billion per month this quarter, and then scale up these reductions by $10 billion per quarter over the next year. Will this so-called "quantitative tightening" have any impact on U.S. financial asset prices? If so, when?

12. According to this weekend's press reports, major arrests have been made in Saudi Arabia that include Prince Alwaleed Bin Talal, a prominent member of the Royal Family and a wealthy investor (worth about $20 billion) with large stakes in many U.S. equities. There are also reports of the death of another Saudi Prince and a large group of Saudi generals in a downed helicopter on the Saudi/Yemen border. And to add insult to injury, (Iran-backed) Yemen now appears to have actually fired one or more missiles into Saudi Arabia which targeted the King Khalid International Airport in the Capital of Riyadh. According to a statement from the Saudi coalition carried by the state-run Saudi Press Agency, the missile that targeted Riyadh has been called "a direct military aggression" by Iran against Saudi Arabia, that "could rise to be considered an act of war." Is there a risk of war or major confrontation between Iran and Saudi Arabia? If so, will the United States get involved? And does this matter at all to traders and investors in U.S. stocks and bonds?
13. Is China’s financial system significantly more vulnerable now due to its extremely high leverage? Incredibly, People's Bank of China (PBOC) Governor Zhou Xiaochuan actually offered this warning in a report released this past weekend! “Hidden, complex, sudden, contagious and hazardous” risks are accumulating in China’s financial system. These remarks, published on the Central Bank’s website on Saturday, are the latest in a series of warnings from the People’s Bank of China chief on the potential vulnerabilities to the financial system in light of elevated leverage. Will China's President Xi Jinping actually reign in dangerous leverage in China's economy (especially in the highly leveraged "shadow banking system")? And how will global markets respond if China's economy slows dramatically? The August 2015 melt down in U.S. stock prices was precipitated by an overnight collapse in China's financial markets!
14. Spain is preparing to arrest all the key members of the separatist Catalonia's governing cabinet. Extradition efforts from Belgium appear to be successful and arrests are expected early this week. Madrid's ruling class has now scheduled a "snap" election on December 21st with respect to Catalonia's recent attempt at independence. It looks to me like this snap election may backfire on Madrid and actually legitimize Catalonia's independence effort. If the secessionist vote wins in December, are there financial consequences to Spain and the European Union in general which may not have been considered by global investors?

15. There are credible reports that the North Korean government is preparing to launch another missile when President Trump visits our Asian allies over the next 10 days. If this happens while President Trump is in Japan, China, or South Korea, what will be the U.S. response (if any)? Does this matter at all to U.S. financial asset prices? Is any potential confrontation with North Korea priced into U.S. stock prices?

Is there a TIPPING POINT when bearish news and equity valuation concerns actually begin to matter for here in the United States? And if so, what is the downside risk to investors in U.S. stocks (and bonds)? When will the current winning strategy of "buying every dip" turn disastrous (if ever) for traders and investors?

Several major U.S. stock market indexes posted all-time highs this past Friday, November 3rd. Records seemed to be broken on a daily basis with respect to the current stock market advance which began in March 2009. There have been only 5 trading days in the last year when the S&P 500 Index has lost more than 1% in a single day, and there have been no days when the SPX lost more than 2%. This "Teflon Market" has been immune to every potential bearish news cycle and every potential valuation concern. Momentum investors have overwhelmed value investors, and historically reliable "contrary" indicators have been worthless for any bearish traders who have dared to step in front of this northbound train.

Does it matter that Amazon's largest shareholder just sold $1.1 billion worth of his Amazon stock holdings? This is the 2nd sale of a $1 billion worth of Amazon stock by Jeff Bezos this year. His last sale was in May 2017. Will Amazon ever make any real money? Will NetFlix ever make any real money? Will Tesla ever make any real money? Is it possible that profits are NOT the real objective for Jeff Bezos and Elon Musk? Are they both just closet consumer advocates (in the extreme) who never really intend to make money in their highly regarded corporations? If so, when will investors wake up to the mounting evidence supporting this view here? Is it true that Amazon has been quietly discounting third party vendor items on its website by as much as 10% over the last two weeks in order to effectively compete with giants like Walmart and other major retailers this holiday season? And the discounts won't stop at 10%! Can Apple really sell enough $1,000 phones to meet it bold and optimistic 4th quarter financial forecasts as reported last Friday? And if consumers actually buy Apple's projected number of $1,000 phones, will consumers have any discretionary income remaining to buy anything else?

Lots of questions! All pointing to only one conclusion!! The U.S. stock market is poised on the precipice of a major decline!!

The TIPPING POINT is now!

The following two charts have been posted here courtesy of research from Dr. John Hussman, Chief Investment Officer of the Hussman Funds and President of the Hussman Investment Trust. Both charts speak for themselves. 

Amazon - Is Disruption Worth More Than Profits?

In his latest quarterly letter to investors dated October 24th, Greenlight Capital's very successful well-known veteran hedge fund manager David Einhorn wrote the following:

"Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value," he wrote. "What if equity value has nothing to do with current or future profits and instead is derived from a company's ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?"

"Our view is that just because Amazon can disrupt somebody else's profit stream, it doesn't mean that Amazon earns that profit stream. For the moment, the market doesn't agree," he wrote. 

Einhorn's conclusion would prove to be an understatement!

Late Thursday (after the NY market closed), October 26th,  Amazon released its latest quarterly earnings report.  It reported revenue of $43.7 billion as compared to a consensus Wall Street estimate of $42.0 billion, and Amazon reported "adjusted" earnings of $0.52/share versus a consensus estimate of $0.02/share. Investors immediately piled into Amazon's stock, and Friday's 13.22% gain in Amazon's stock price is a clear testament to Einhorn's theory that value may have nothing to do with current or future profits, but may instead be derived more from a company's ability to be disruptive!

In the fine print of Amazon's earnings report, the Company reported $4.58 billion in revenue from it AWS cloud services division which translated into $1.17 billion in operating income from this division. It may be noteworthy that AWS accounts for approximately 10% of Amazon's total revenue and ALL of the Company's profit. In fact, without this $1.17 billion in net income from AWS, Amazon actually LOST $823 million for this latest quarter in all of the rest of its divisions combined!

Amazon's cloud services division currently has 30% of the cloud services market, but competitors are making up ground extremely fast. Microsoft's growth in this sector has beaten Amazon's growth for 8 quarters in a row. Microsoft is now the second largest player in this space with 14% of the total market. Other major competitors include giants like Google, IBM, Alibaba, and Oracle.

Investors now value Amazon at 278 times trailing twelve month earnings! Investors expect Amazon's "earnings" to double over the next twelve months to about $8.00/share (this looks optimistic, at best), which would then translate into a forward price/earnings ratio of about 138 times if we used Friday's closing stock price of $1,100.95/share! This compares to a forward P/E ratio of about 20x for the major market indexes.

Amazon has at least 130 major corporate competitors, mostly in low margin businesses. While all these companies attempt to adjust to Amazon's disruptive (and predatory) low price strategies, it's unclear when (or IF) Amazon will EVER earn substantial profits. Amazon's current "profit engine" is clearly its cloud services division, but given the substantial corporate names now competing aggressively in this space, investors should probably NOT count on the same kind of revenue growth or profit growth in quarters immediately ahead (or EVER) from this key division!

With respect to the broader market last week, despite record all-time highs posted this past Friday in the Nasdaq Composite Index and the S&P 500 Index, the average Nasdaq listed stock actually fell every day last week except on Friday. Even with Friday's big gain, the average Nasdaq stock still lost 0.90% on the week. On the New York Stock Exchange, the average listed stock declined 0.51% on the week!

In my computer trading system, despite record highs in the Nasdaq Composite Index AND the S&P 500 Index:

Weekly chart sell signals were officially triggered at Friday's close in the following stocks: BA, BSX, FIVE, GM, HPQ, MMC, MTH, PCH, PFE, RTN, and UTX.

Monthly chart sell signals were triggered last week in the following stocks: BIIB, BK, BMY, CVX, EBAY, GD, LMT, MMC, RTN, TWX, and UN.

Caveat Emptor: There is something terribly wrong inside the U.S. stock market, and a major correction looks highly probable on the near-term horizon!

The week ahead may prove to be among the more interesting weeks of this entire year. Here are just a few potential triggers of increased volatility:

1. Special counsel Robert Mueller's office is expected to announce its first indictments in its ongoing investigation of Russia's meddling in the November 2016 U.S. Elections (probably Monday, October 30th).

2. Congress is expected to release its first draft of potential tax reform (probably midweek - November 1st. A 1,000 pages of tax cuts (no real tax reform) and hardly any spending cuts is forecast. Current deductions for mortgage interest and State & Local taxes will probably be maintained, which would then violate the $1.5 trillion deficit cap that was agreed to in the budget reconciliation agreement).

3. President Trump is expected to announce his choice for Chairman of the Federal Reserve (unknown date, but probably towards the end of the week - the WSJ is reporting that Jerome Powell will be Trump's pick, but I continue to believe there is a chance that President Trump will choose John Taylor who would be Trump's "own guy" as opposed to an Obama holdover in Powell)

4. The Federal Open Market Committee meets to discuss monetary policy (statement expected on Wednesday, November 1st - no interest rate hike is forecast, but the closing statement will likely be hawkish and indicate that a December interest rate hike is likely along with ongoing regular monthly draw-downs of the Fed's balance sheet as per the schedule already released)

5. The Labor Department will release its latest monthly employment report  for October 2017 (this release is expected Friday morning, November 3rd).