Quote of the Day: Good Samaritan duty

There is a long tradition in the common law that refuses to recognize a legal duty to help strangers in emergency situations: the so-called Good Samaritan duty. It is not because the common law judges were heartless and did not recognize moral duties. It is because they recognized that state compulsion or legal liability should be used sparingly. They also recognized a whole host of practical problems in enforcing Good Samaritan duties.

Not to recognize a distinction between the moral obligations of individuals and the role of the state is an error of profound consequences.

This is from New York University Associate Professor Mario Rizzo at the comment section of his article on Free Market Moralism, published at the NYU’s Think Markets Blog

A Rejoinder on Cuervo’s (non) response on my Philippine Property Bubble article

My article expounding on the possibility of an inflection point on the Philippine real industry, particularly Cracks in the Philippine Property Bubbles has elicited an industry response. 

I would like to thank Cuerve Property Advisors for citing my article as example of the property boom contrarians.

However, the Cuervo article seems to have sidestepped on the issues or the risks that I have raised. They mostly regurgitated on the 'positive' angles of the article I earlier questioned.  

(hat tip to my libertarian colleague Lemuel Goltiao)

Cuervo did not answer the following:

1. Has there has been an existing imbalance between demand and supply in the property sector?

The supply side which I questioned reported an average of 30% growth annualized for condominiums since 2005.

But how about demand?

A. Domestic Demand

In the second quarter, Philippine statistical economic growth was reported at 7.5% (constant prices).

Household demand or the HIFE was at 6.6% constant prices, where housing (along with water, electricity and etc) expenditures grew by 5.9%, according to the National Statistical Coordination Board.

For the sake of Occam Razor’s parsimony of logic rule, 30% (supply) minus 7.5% (demand) translates to 22.5% surplus. Yet not all consumer demand is about real estate as the table above shows.

B. BPO. The BPO industry grew by 18% in 2012 (but has averaged 46% since 2006 mostly due to what I see as the low base effect changes or from Wikipedia.org, the “tendency of a small absolute change from a low initial amount to be translated into a large percentage change”).

The Industry targets a near doubling of revenues at $25 billion in 2016 from $13 billion in 2012 or an average growth of 48% or cagr of 17.76%. There are only about 800,000 (777,000) people employed in the industry

However there are impediments to such aggressive growth target.

There haven’t been enough qualified employees, the Cebu BPO industry Blog notes that “According to the Business Processing Association of the Philippines (BPAP), out of every 100 applicants to call centers in Cebu and other cities, 95 of them are turned down. The companies just can’t find the right people for the number of jobs offered.”

Further there has been growing obstacles on labor regulation, notes China Daily Asia,

There were also concerns related to investment incentives and the legal and regulatory framework.

For instance, some foreign investors are surprised that employees cannot simply be let go, and that termination of employment needs to follow a particular procedure, otherwise the dismissal could be considered unlawful,” the law firm wrote. “Other new companies offer significant compensation packages at the very start of operations, not realizing that they may not be able to scale these back later on because of the local legal regime’s principle of non-diminution of benefits.

While I think BPOs will continue to grow strongly my impression is that the pace of growth will decelerate.

So if I simplistically refer to 2012 growth at 18%, real estate demand from BPO will not be enough. To the contrary BPO demand will translate to also a deficit of 12% (30%-18%). 

And even if we use the 46% benchmark, considering that the BPO is a small (but rapidly growing) industry yet, the 16% surplus will unlikely cover the deficits from the rest.

Yet benefits from the growth in the BPO industry won’t be all about real estate spending.

C. Remittance. Remittances reportedly grew at 7.4% in August. 

The World Bank in my earlier article notes remittance trend may slow due to “Stricter Implementation of the migrant workers’ bill of rights; -Political uncertainties in host countries; and -The slowdown in the advanced economies” which the Cuervo article seem to have overlooked.

Remittance growth trends have been on a decline since 2010 as shown by the World Bank Chart.

So again in simplistic deduction, demand from remittances represented by the 7.4% growth will also translate to a deficit (22.6%). Again not all of remittances will be directed to real estate.

The focus on remittances as main drivers of real estate (17-18% of total demand as assessed by a top property firm) seems misplaced. I have dealt with this here. Whatever happened to the 82-83%?

D. Foreign Demand. The global economy grew by 3% in 2012. IMF expects growth to further slip this year to 2.9% and 3.16% for 2014. 

The problem is the global economy has been materially slowing as shown above.

In addition, foreign demand for properties, whether for investment or for use, are subject to competition within the region.

Foreign demand is also subject to price and yield changes or the law of economics

And one should notice that BPO, remittances and foreign demand for local properties are sensitive to changes in the conditions of the global economy. Notes the World Bank from their (p.39) PHILIPPINE ECONOMIC UPDATE May 2013

However, the sources of growth can also become the sources of risk. A real estate sector driven by OFW sales and BPO leasing is vulnerable to shocks in the global economy. The low interest rate regime is also a source of risk. As lenders and developers compete for higher yields, lending requirements may be relaxed beyond prudent levels.

(bold mine) 

So it would be misguided to look at domestic developments in exclusion of external developments. The domestic economy has been materially entwined with the global economy. So even domestic demand is likewise sensitive to exogenous forces.

E. Informal Economy. Cuervo didn’t even tap the informal economy which the ILO estimates that between 40-80% of Philippine employment. [As a side note, the reason for the wide estimates is that the informal sectors are invisible to government statistical data] 

However, the Philippine Department of Labor and Employment estimates 41.1% of the Philippine labor force as informal, as of 2011

While the informal sector may not be buyers of high end projects, they are potential buyers of the middle to low cost housing. The informal economy also includes the 30-40% informal channel for remittance flows.

But these sectors are highly vulnerable to price inflation (whether food, energy or rents). Rent is a key component of poor and non-poor household spending as of 2003.

2. The company didn’t explain of the possible risks from potential oversupply and the risks of overleveraging of the industry. They seem to only assume that like stocks, property prices are headed only in one direction; up up and away.

3. They didn’t address how higher property prices will affect consumer affordability, disposable income and consequently demand.

4. The company also failed to explain how rising property prices will affect competitiveness, productivity and profitability of the general industries (including BPOs) when input costs led by rents go up.

At the end of the day the Cuervo analyst delivers the most important gist of their defense…which the late investing guru Sir John Templeton calls as the “four deadliest words in investing”:

As an experienced Appraiser, Real Estate Broker and Consultant, my opinion is now different.

This time is different.

US Stock Markets: UP UP and Away!

There is only one direction for stock markets in the US or elsewhere. That is UP UP and AWAY!

Good news equals rising stock markets. Bad news also equals rising stock markets.

Bad news is good news, from Bloomberg

Speculation slower growth in hiring will extend Federal Reserve stimulus lifted U.S. stocks and pushed the annual advance in the Standard & Poor’s 500 Index within a percentage point of the best yearly gain in a decade.

The S&P 500 rallied as much as 0.8 percent today, boosted by speculation the Fed will delay curtailing its monetary stimulus after payrolls in the U.S. climbed by less than forecast in September, indicating the economy had little momentum leading up to the 16-day shutdown of the federal government. The jobless rate fell to an almost five-year low.

Bad news is good news because of the chronic addiction to debt-inducing stimulus.

Record S&P 500

Record small cap Russell 2000

Up, up and away extrapolates to a parabolic climb for both the S&P and Russell 2000

US PE ratios as discussed last weekend. From the Wall Street Journal:

Skyrocketing P over E. Shrinking dividend yields. 

So how can things ever go wrong?

As the great Ludwig von Mises warned:

For the naive mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's Treasury Department! The government, professors tell us, "can raise all the money it needs by printing it."  Taxes for revenue, announced a chairman of the Federal Reserve Bank of New York, are "obsolete."  How wonderful! And how malicious and misanthropic are those stubborn supporters of outdated economic orthodoxy who ask governments to balance their budgets by covering all expenditures out of tax revenue!

Regime Uncertainty: Why a French Economic Recovery is a Mirage

I recently pointed how France serves a critical example of the many parallel universes—or detachment between asset prices and economic reality—operating today, as consequence from the politicization of the markets.

Yet the mainstream rationalizes (or misrepresents) such dynamics as ‘economic growth recovery’.

While government statistics may show ‘growth’, real world developments in France suggests otherwise.

From this excellent article by Telegraph’s Anne Elizabeth Moutet (hat tip LewRockwell.com) [bold mine]

A poll on the front page of last Tuesday’s Le Monde, that bible of the French Left-leaning Establishment (think a simultaneously boring and hectoring Guardian), translated into stark figures the winter of François Hollande’s discontent.

More than 70 per cent of the French feel taxes are “excessive”, and 80 per cent believe the president’s economic policy is “misguided” and “inefficient”. This goes far beyond the tax exiles such as Gérard Depardieu, members of the Peugeot family or Chanel’s owners. Worse, after decades of living in one of the most redistributive systems in western Europe, 54 per cent of the French believe that taxes – of which there have been 84 new ones in the past two years, rising from 42 per cent of GDP in 2009 to 46.3 per cent this year – now widen social inequalities instead of reducing them.

Three  observations here:  

One, taxes have begun to affect the public’s confidence level and opinion of policies. 

Second, taxes induce social inequalities rather than reducing them, which goes contrary to the outcome conceived by populist politics of 'social justice' redistribution. 

And third, the increasingly repressive  tax regime has forced many capitalist out of France or has turned them into ‘tax exiles’.

Why French politicians resort to increasingly repressive taxes? The article continues

By 2014, France’s public expenditure will overtake Denmark’s to become the world’s highest: 57 per cent of GDP. In effect, just to keep in the same place, like a hamster on a wheel, and ensure that the European Central Bank in Frankfurt isn’t too unhappy with us, Hollande now needs cash. Technocrats, MPs and ministers have been instructed to find every euro they can rake in – in deferred benefits, cancelled tax credits, extra levies. As they ignore the notion of making some serious cuts (mooted at regular intervals by the IMF, the OECD and even France’s own Cour des Comptes), the result can be messy.

The answer is that the French government has been growing immensely far faster than the real economy. 

And instead of promoting productive enterprises, the government has resorted to bigger confiscation of the resources from the private sector.

So the political class (parasites) benefits at the expense of their shrinking (private sector) hosts who are now pushing back.

And taxes influence people’s incentives and the corollary, people’s action. The article again gives a lucid example

Take last year’s famous 75 per cent supertax, on individuals earning over one million euros a month. This has still not been implemented. First, it got struck down by France’s Constitutional Council on a technicality. Leaks suggested the rate would fall to 66 per cent. They were confirmed, then denied. Hollande eventually vowed that the tax would be paid by the targeted individuals’ employers, for daring to offer such “obscenely” high salaries. This has just been approved by the National Assembly, and must still pass the Senate. So far, it is only supposed to apply to 2013 and 2014 income, but no one knows if the bill will be prolonged, killed or transformed.

What we do know is that this non-existent (so far) tax has been the clincher that sent hundreds, possibly thousands of French citizens abroad: not just “the rich”, whom Hollande, during his victorious campaign, said he personally “disliked”, and who now are pushing up house prices in South Kensington and fighting bitterly over the Lycée Charles de Gaulle’s 1,200 new places; but also the ambitious young, who feel that their own country will turn on them the minute they achieve any measure of personal success…

“It’s not only that people don’t like to be treated like criminals just because they’re successful,” says a French banker friend who has recently moved to London. “But this uncertainty in every aspect of the tax system means it is impossible to do business: you don’t know what your future costs are, or your customer’s. You can’t buy, you can’t sell, you can’t hire, you can’t fire.”

This is a wonderful example of what Austrian economist Robert Higgs calls as the regime uncertainty or [bold mine]

a form of uncertainty related to the public’s—especially the private investors’—confidence in the future security of private property rights, which can be impaired by future regulatory changes (e.g., Dodd-Frank and Obamacare regulations), court decisions, administrative twists and turns, tax increases in various forms (e.g., Obamacare penalties enforced through the income-tax system), monetary-policy changes that threaten the dollar’s purchasing power and distort the allocation of credit, and personnel changes in the government’s corps of executives, judges, and assorted capos.

The likely effects of 84 new taxes and more coming plus a battery of regulations are...

First, these promotes insecurity of the French property rights regime “don’t like treated like criminals”, 

Second, such obscures economic calculation “you don’t know what your future costs are, or your customer’s” and 

Finally the same policies obstructs or impedes on the economic coordination process “You can’t buy, you can’t sell, you can’t hire, you can’t fire”

With an environment like this, real economic activities will shrivel as political consumption lords over private sector production. 

Diminishing real output means lesser taxes, bigger deficits (as above) and increasing reliance on more debt to fund current political spending programs

French government debt has now reached 93.5% of the statistical gdp according to countryeconomy.com. I suspect that this could be larger as statistical economy tends to inflate output.

So again while French politicians and their cronies benefits, the rest of the nation suffers—thus the wider incidence of inequality (as consequence of political inequality)

There will be a point where creditors will come to question on the quality of French debts, which I believe should be sooner than later. 

So no matter the recent 'sanguine' reaction by the French stock-bond market or how government statistics say “growth”, unless the French government realizes that economic growth emanates from productive enterprises, and not from confiscation, the French economy will remain in stagnation if not in depression.

Even ECB president Mario Draghi recently admitted of the limitations of central bank interventions. As quoted by Reuters:(bold mine)

The ECB has done as much as it can to stabilise markets and support the economy. Now governments and parliaments need to do all they can to raise growth potential.

Monetary policy cannot create real economic growth. If growth is stalling because the economy is not producing enough or because firms have lost competitiveness, this is beyond the power of the central bank to fix.

Well said.

China’s Property Bubbles Intensifies

So the ‘silent stimulus’ recently implemented by the Chinese government (including the hiding, editing censoring of statistics) aimed at attaining statistical growth goals has only been further inflating property bubbles. 

China’s credit fueled property bubbles may have entered a blowoff phase, notes the Bloomberg:

Home prices in China’s four major cities rose the most since January 2011 last month, raising concerns that a lack of new property curbs is allowing a bubble to form.

New home prices climbed in 69 of the 70 cities the government tracked in September from a year earlier, led by 20 percent increases in the southern business hubs of Shenzhen and Guangzhou, the National Bureau of Statistics said in a statement today. Prices in Beijing rose 16 percent and advanced 17 percent in Shanghai, the biggest gains since the government changed its methodology for the home data in 2011.

Premier Li Keqiang has come up with no additional measures to rein in property prices since his predecessor Wen Jiabao stepped up a three-year campaign in March to cool the housing market, ordering the central bank to raise down-payment requirements for second mortgages in cities with excessive cost gains. Some Chinese cities are facing increasing pressure to meet annual home-price targets they set earlier this year and to cap gains at the growth rate of local disposable incomes.

Bubbles are a function of inflationism, and in China’s case, compounded by financial repression, viz keeping capital markets underdeveloped or limiting options for the citizenry to invest their savings in order for the government to tacitly capture them.

Previous property curbs has failed and will continue to fail because of the political incentives driving China’s politics.

Political careers of local government officials have been mainly dependent on the goals set by the national government. Thus, for local government to meet such statistical ‘growth’ targets, they resort to circumventing these regulatory hurdles by using local government financing units (LGFU) through the private sector, who partly bankroll these property projects via the shadow banking industry.The national government has accused many local governments of statistical manipulation. Yet if the LGUs indulge in them why not the national government?

Add to these the barrage of stimulus employed unannounced by the national government.

More signs of credit expansion fueling China’s bubbles, from the same article…

Domestic loans to developers jumped 50 percent last month from a year earlier, according to Shanghai-based advisory firm CEBM Group, which calculated government data.

A residential land parcel in Beijing sold at a record price 73,000 yuan ($11,980) per square meter (10.76 square feet) on Sept. 4, according to Centaline Property Agency Ltd. Sun Hung Kai Properties Ltd. (16), Hong Kong’s biggest developer by market value, bought a site in Shanghai for 21.8 billion yuan in an auction the next day, a record price in that city, Centaline said.

“Developers have been able to access cheaper liquidity, which financed their land acquisitions,” ANZ’s Liu said. “Homebuyers dashed into the market fearing that home prices will rise further given the high land prices.”

For the fifth month in a row, the eastern city of Wenzhou was the only one to post a decline, with prices dropping 1.7 percent from last year.

Existing home prices rose 18 percent in Beijing last month from a year earlier, leading the gains, followed by a 14 percent increase in Shenzhen and 12 percent in Shanghai, according to the data.

The Chinese government recently surpassed their statistical objective growth threshold of 7.5% with a 7.8% 'growth' for the third quarter. 

Curiously the pace of growth in the broad sector has been nearly ‘identical’ to their reference points.

This from another Bloomberg article 

Gross domestic product rose 7.8 percent in the July-September period from a year earlier, the National Bureau of Statistics said today in Beijing, matching the median estimate in a Bloomberg News survey. Industrial production advanced in September by 10.2 percent, in line with projections, while retail sales gained 13.3 percent…

Industrial output growth compared with August’s 10.4 percent.Retail sales compared with a median estimate of 13.5 percent expansion and 13.4 percent in August.

Fixed-asset investment excluding rural households, a key force behind growth, grew 20.2 percent in the first nine months of the year, compared with the median estimate of 20.3 percent from analysts and a 20.3 percent pace in the January-August period

Let see: Industrial output 10.2 vis-à-vis 10.4. Retail 13.5 relative to 13.4. Fixed asset 20.2 against 20.2. Given the booming and highly volatile property sector, in my view, I’d smell something fishy with the seemingly placid numbers which assumes that general economy has been growing at steady pace.

Yet more credit inspired statistical economic growth from Financial Times: 

A surge in lending by banks and other financial institutions at the start of this year is one of the main explanations for the upturn in Chinese growth. Total social financing – China’s widest measure of credit – rose 52 per cent year-on-year in the first five months of 2013, an astonishingly fast pace.

So whether in the US, Japan, Europe or China or elsewhere, governments have been pushing debts to their critical limits in order to attain temporal statistical growth. 

Along with the momentum or yield chasing inspired private sector, governments have been funneling resources into speculative-capital consuming activities.

Yet every action has a consequence. Spurious or artificial growth financed by unsustainable will eventually face a day of reckoning. The $64 gazillion question is: when?

And another thing… as China’s bubbles intensify, Hong Kong and Singapore’s luxury rental market has shown signs of a slowdown: are these signs of a reprieve before the next leg up or are these initial signs of a coming reversal?

Ray Kurzweil: Bridge to Bridge System Towards an Everlasting Life

Futurist Ray Kurzweil of the Singularity fame and now a director of Google says that immortality may be near

From Daily Mail (hat tip EPJ)

Google engineering director and futurist Ray Kurzweil believes we are close to realizing everlasting life and is dead-set on getting us there.

The inventor and noted author believes the key to such a scientific breakthrough is a system of 'bridges' that enable the body to move from strength to strength over time.

The youthful 65-year-old currently takes 150 supplements a day, which he argues if the first bridge.

The idea is to build enough bridges to ensure the body holds out long enough for life-lengthening technology to come into its own.

He has likened the biology of the body to computer software and believes we are all 'out of date'.

In an interview with Canadian magazine Maclean's, Kurzweil says he hopes the supplements will keep him healthy enough to reach the 'nanotech revolution'.

'I can never say, “I’ve done it, I’ve lived forever,” because it’s never forever,' he said.

'We’re really talking about being on a path that will get us to the next point.

'Bridge one: Stay as healthy as possible with diet and exercise and current medicine.

'The goal is to get to bridge two.

'Bridge two (is) the biotechnology revolution, where we can reprogram biology away from disease.

'And that is not the end-all either.

'Bridge three is to go beyond biology, to the nanotechnology revolution.

'At that point we can have little robots, sometimes called nanobots, that augment your immune system.

'We can create an immune system that recognizes all disease, and if a new disease emerged, it could be reprogrammed to deal with new pathogens.'

Such robots, according to Kurzweil, will help fight diseases, improve health and allow people to remain active for longer.

Read the rest here.

In my view, if Mr. Kurzweil is right, then the coming generation will benefit from this.

US Fed’s Coming Centennial Anniversary of Failures and Inflationism

The US Federal Reserve will be observing its 100 years of existence in December 23, 2013. Unfortunately it has been 100 years of volatility, turbulence and boom bust cycles.

Sovereign Man’s Simon Black enumerates the failures of the FED

As we’re coming up on the 100th anniversary of the establishment of Federal Reserve, one thing has become abundantly clear– these guys are horrible at their jobs.

According to the popular lie, the Federal Reserve was supposed to have been established to smooth out the economic cycle, thus preventing booms, busts, recessions, and depressions.

It hasn’t really worked out that way.

In the 100 years prior to the establishment of the Federal Reserve, there were 18 distinct recessions or depressions:

1815, 1822, 1825, 1828, 1833, 1836, 1839, 1845, 1847, 1853, 1860, 1865, 1869, 1873, 1887, 1890, 1899, and 1902.

Since the establishment of the Federal Reserve, there have been 18 recessions or depressions:

1918, 1920, 1923, 1926, 1929, 1937, 1945, 1949, 1953, 1958, 1960, 1969, 1973, 1980, 1981, 1990, 2001, 2008.

So in other words, the economy experienced just as many recessions with the ‘expert’ management of the Federal Reserve as without it.

And this doesn’t even begin to capture all the absurd panics (the S&L scare), bailouts (Long-Term Capital Management), and ridiculous asset bubbles that they’ve created.

I’d like to add that since the introduction of the FED, the US dollar’s purchasing power has immensely shrunk.

Based on the US Department of Labor’s CPI Inflation calculator, as of this writing, $100 in 1913 is worth only $4.23 today! The US dollar has lost over 95% of its purchasing power since the Fed’s birth! What an accomplishment by the FED.

Explore more infographics like this one on the web's largest information design community - Visually.

Here is a chart of the US dollar courtesy of visual.ly

Even John Maynard Keynes knew of the insidious effects of monetary debasement on societies.  

From Chapter VI, Europe after the Treaty from “The Economic Consequences of the Peace” [1920] (source The Online Library of Liberty) [italics original; bold mine]

Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery. [very much the yield chasing phenomenon today--Benson]

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

The Fed certainly did get one thing right: they have been unwaveringly abiding by Lenin’s prescriptions towards the undoing of a capitalist society for 100 years. And expect more to come.

Phisix: US Debt Ceiling Deal and UNTaper Spurs a Global Melt UP

Melt Up!

Melt UP!

Suddenly stock markets metastasize into a frenetic melt-up mode.

In the US, the S&P 500, the S&P 400 Mid-caps and the small cap Russell 2000 set new record highs. 

The German Dax and the French CAC also carved fresh landmark highs. 

In Asia, Australia’s S&P ASX, and India’s Sensex shared a similar feat. Ironically just a few months back the Indian economy seemed as staring into the abyss—to borrow from German Philosopher Friedrich Nietzsche[1]. How confidence changes overnight

And knocking at the door of historic highs are New Zealand Exchange 50 Gross, South Korea’s KOSPI, Taiwan’s TWSE, Hong Kong’s Hang Seng, and Malaysia’s KLSE

Media explains the melt up as a function of the debt ceiling deal and extended US Federal Reserve ‘credit easing’ stimulus. From Bloomberg, “U.S. stocks rose, sending the Standard & Poor’s 500 Index to a record, as speculation grew that the Federal Reserve will maintain the pace of stimulus after Congress ended the budget standoff.”[2]

Thus the common denominator in explaining the melt-up has been the market’s worship of debt expressed via the orgy of the speculative hunt for yields in the asset markets, particularly the stock markets.

Will the global melt-up influence the Phisix, the likely answer is yes. But….

How the FED Alters the Priorities of US Corporations

Goldman Sach's chief US equity strategist, David Kostin has been quoted as attributing the current US stock market surge on P/E multiple expansion, “The S&P 500 has returned 22% YTD driven almost entirely by P/E multiple expansion rather than higher earnings.”[3]

 

This means record US stocks has hardly been about earnings growth but of the aggressive bidding up of the equities.

More signs of the yield chasing frenzy.

In addition, as pointed out above by Blackstone Group’s Byron Wien[4], S&P 500’s net income has been on a decline since 2010. This decline has been accompanied by a slowing of earning per share growth (y-o-y).

Yet, the modest gains in the growth rate of the S&P’s EPS have mainly been bolstered by share buybacks. 

And as previously pointed out[5], a substantial portion of corporate share buybacks has been financed by bonds which remains a present dynamic[6]. 

In other words, the FED’s easy money policies, including the “UNTaper” have been prompting many publicly listed companies to shore up or ‘squeeze’ earnings growth via debt-financed corporate buybacks meant to raise prices of their underlying stocks.

Share buybacks has essentially substituted the capital or investment based expansion or the organic earnings growth paradigm. Said differently, publicly listed corporations have joined the herd in the feverish speculation on stocks rather than investing in the real economy.

This also means that the yield chasing mentality has infected the corporate board rooms, where corporate models appear to have been reconfigured to focus on the immediate attainment of higher share prices. 

And a recent research paper has underscored such changes. Stern School of Business John Asker, Harvard’s Joan Farre-Mensa and Stern School of Business Alexander Ljungqvist finds[7], (bold mine)

Listed firms invest substantially less and are less responsive to changes in investment opportunities compared to matched private firms, even during the recent financial crisis. These differences do not reflect observable economic differences between public and private firms (such as lifecycle differences) and instead appear to be driven by a propensity for public firms to suffer greater agency costs. Evidence showing that investment behavior diverges most strongly in industries in which stock prices are particularly sensitive to current earnings suggests public firms may suffer from managerial myopia.

So short-termism, mainly brought about by the Fed’s policies, has afflicted many of the publicly listed firm’s priorities. Many executive officers and shareowners have presently elected to use the unsustainable speculative financing model of boosting earnings that yields temporal benefits for them.

This essentially defies Ben Graham’s 1^st rule of margin of safety where companies should stick to what they know or ‘know your business’ and to avoid to making ““business profits” out of securities—that is, returns in excess of normal and dividend income” as I showed last week[8].

Yet all these will depend on the persistence of easy money regime, the suppression of the bond vigilantes and the sustainability of debt financed buyback model.

So while most publicly listed US companies have yet to immerse themselves into Ponzi financing, sustained easy money policies have been motivating them towards such direction.

A Dot.com Bubble Déjà vu? Google as Symptom?

The scrapping for yields has impelled many to jump on the IPO bandwagon despite poor track record of newly listed companies. 

According to the Wall Street Journal, 19 out of 28 or 68% of the technology issues which debuted this year has been unprofitable over the last fiscal year or during the past 12 months, which has been the highest percentage since 2007 and 2001. Yet punters wildly piled on them.

The same article notes of intensifying signs of mania “The excitement over companies’ potential rather than their present results is the latest sign in the stock markets of a rising tolerance for risk. The U.S. IPO market, often seen as a gauge of risk appetite because the stocks don’t have a track record, is on pace to produce the most deals since 2007, according to Dealogic”[9]

And Art Cashin UBS Financial Services director of floor operations at a recent CNBC interview expressed worries over a remake of the dotcom bubble, “The way people are treating technology companies, it's starting to feel a bit too much like 1999 and 2000”[10]

1999, 2000 and 2007 signifies as the zenith of the dotcom (1999-2000) bubble and the US housing bubble (2007)

Has Google been leading the way?

Google’s [GOOG] stock breached past the US$ 1,000 levels (particularly $1,011.41) with a breath-taking 13.8% gap up spike last Friday.

At market cap of over $335 billion, Google surpassed Microsoft [MSFT] and is now the third largest company after Apple [APPL] and Exxon Mobile [XOM][11].

Since Google is a member of the S&P 500[12], Friday’s quantum leap materially contributed to the new record of the major S&P bellwether (SPX). 

And as shown in the same chart, the S&P 400 mid cap and the small cap Russell 2000 flew to the firmament last week.

Three of the 5 largest S&P companies are from the information technology. In addition, technology comprises the largest sectoral weighting at 17.7% on the S&P, followed closely by financials 16.5%, and from a distance, Healthcare 13.2%, consumer discretionary 12.3% and the others. 

Should the technology mania persist, this will be reflected on the relative strength of sector, as well as, through a bigger share of the same sector in the S&P 500’s sectoral weighting.

Surprise 3rd quarter revenue growth of 23% from advertising part of which came from the mobile platform and Wall Street “emotion” has been attributed to Google’s spectacular price spike.

This Yahoo article[13] says that part of adrenaline rush on Google’s share prices has been to due low exposure on stocks by institutional investors (bold mine)

Google is higher today because it reported strong numbers, but it's not a 10% better company today than it was 24 hours ago. Wall Street is in a manic phase at the moment. For all the terrific things about Google's third-quarter, the best thing about the report was that it came on a day when institutional investors are feeling like they have far too little exposure to stocks. The average hedge fund was up less than 10% through September and there weren't many people expecting this race to new highs on the S&P500 (^GSPC) on the heels of debt ceiling debacle.

In short, more signs of frantic yield chasing.

Google’s reported 3rd quarter earnings of $10.74 per share[14], which came ahead of consensus estimates of $10.34.

While I am a fan of Google’s products, I hardly see value in Google’s stocks. 

Yahoo data[15] shows that Google has a trailing PE (ttm or trailing twelve months intraday) at 27.52, forward PE (fye or fiscal year end: December 2014) at 19.42, Price/book (mrq or most recent quarter) 3.75 and enterprise multiple of enterprise/ebitda (ttm or trailing twelve months) at 16.14.

The above multiples exhibit how richly priced GOOG has been

The same applies to the general stock market

Based on the prospects of continued declining earnings growth rate and based on the trailing PE[16], as of Friday’s close, the Dow Industrials has a ratio of 17.24, from last year’s 14.47, the S&P 500 at 18.32 from 17.03 a year ago and the Nasdaq 100 at 20.88 from last year’s 15.24. 

Most shockingly, the small cap Russell 2000 has a PE ratio of 86.58 from 32.69 a year ago! The Russell PE ratio more than doubled this year. Wow.

While I have not encountered GOOG resorting to share buybacks yet, GOOG’s increasing recourse to debt to finance[17] her operations has hardly been an attraction.

What perhaps may justify GOOG’s current prices is the prospect of success from its upcoming products such as the driverless cars, Google Glass and the cloud based planning applications called the “Genie” targeted at the construction industry[18].

But this would be audacious speculation.

And overconfidence has become a dominant feature.

Aside from stock market bulls brazenly hectoring and scoffing at the bears, market participants have been conditioned to see stock markets as a one way street.

For instance, record stocks which brought about the biggest single-day decline in U.S. equity volatility since 2011 rewarded the bullish option traders who aggressively doubled down on bets that the bull market in stocks would survive the default deadline[19].

The consensus has been hardwired to see any stock market decline as opportunity to “double down”.

For the bulls, risks have vanished. The stock market’s only designated direction seems up, up and away.

Yet the bullish consensus seems oblivious to the reality of the deepening dependence the stock market (and even housing) has been to the Fed’s credit easing measures. They are ignoring the fact that corporate business models have been evolving towards speculation, rather than to productive investments. Expanding price multiples, declining net income and EPS growth rate, increasing dependence on buybacks and debt financing for speculation are symptoms of such transition.

Aside from corporations, the convictions of bullish market participants are being reinforced by evidences of more aggressive actions.

While I don’t expect the FED to take the proverbial punch bowl away, everything depends on the actions of the bond vigilantes. For now, the bond vigilantes have been in a retreat. The hiatus by the bond vigilantes provides room for the bulls to magnify on their advances. Question is for how long?

If QE 3.0 in September of 2012 pushed backed the bond vigilantes for only 3 months, will the euphoric effects of the UNtaper, Yellen as Fed Chairwoman, debt ceiling deal last longer?

The French Disconnect

As I pointed out above, the UNtaper-debt ceiling deal has incited many markets to a melt-up mode which media rationalizes as “recovery”.

The French stock market, which is also at record highs, serves as an example.

The CAC 40 has been rising since the last quarter of 2011. Yet during 2012-2013, as the CAC rose, the French economy vacillated in and out of negative growth rates or recessions. While economic growth statistics reveal of a recent recovery, sustainability of the recovery is unclear.

French industrial production was down 1.6% in August[20], Unemployment rate is at the highest level since 1998 at 10.9% at the second quarter[21]. August loans to the private sector have been trending downwards since May[22]. Fitch downgraded France last July[23]. [note to the aficionados of credit rating agencies, French downgrade coincided with higher stocks]

Yet the CAC continues to trek to new highs. What gives?

Notes on the Debt Ceiling Deal

Furloughed Federal employees will receive a back pay[24]. This means government shutdown for furloughed employees extrapolates to a paid vacation.

The bi-partisan horse trading resulted to insertions of various goodies (Pork) for politicians. This includes $174,000 death benefit for Sen. Frank Lautenberg’s widow[25]

The US treasury will be authorized to suspend the debt ceiling as I earlier posted[26]. A limitless borrowing window will be extended until February 7, 2014[27].

This marks the second time when the debt ceiling has been unilaterally suspended. The first occurred this year from February 4, 2013 to May 18, 2013[28].

What seems as an increasing frequency of the suspension of the debt ceiling (twice this year) may presage a permanent one.

A day past the US debt ceiling deal, US debt soared by a record $328 billion. This has shattered the previous high of $238 billion set two years ago as the US government reportedly replenished its stock of “extraordinary measures” used to keep debt from going past he mandated level[29]. This brings US debt to $17.075 trillion Thursday.

Two days after, US debt further expanded by $7 billion to $17,082,571,268,248.24[30].

Debt levels growing at a rate far faster than the rate of economic growth is simply unsustainable.

Since 2008, US Federal has grown past $ 7 trillion whereas the economy grew by nearly $1 trillion[31].

There is always a consequence to every action, so will the above.

Yet this is what equity market praises.

---

[1] Friedrich Nietzsche CHAPTER IV: APOPHTHEGMS AND INTERLUDES Beyond Good and Evil, p 107 planetpdf.com

[2] Bloomberg.com S&P 500 Surges to Record on Fed Bets After Debt Deal, October 18, 2013

[3] Zero Hedge Goldman: Entire S&P Move Higher Is Due To Multiple Expansion; Shiller P/E Says 30% Overvalued So... Buy

[4] Business Insider Net Income is Actually Declining even as Earnings Rise, Wall Street's Brightest Minds Reveal THE MOST IMPORTANT CHARTS IN THE WORLD, October 9, 2013

[5] See Phisix: Rising Systemic Debt Erodes the Margin of Safety October 14, 2013

[6] Reuters.com Bond-backed stock buybacks remain in vogue September 6, 2013

[7] John Asker, Joan Farre-Mensa and Alexander Ljungqvist Corporate Investment and Stock Market Listing: A Puzzle? April 22, 2013 Social Science Research Network

[8] See Phisix: Rising Systemic Debt Erodes the Margin of Safety October 14, 2013

[9] The Wall Street Journal Market Pulse In Latest IPOs, Profits Aren’t the Point October 11, 2013

[10] CNBC.com Cashin: Tech valuations remind me of dot-com bubble October 17, 2013

[11] FoxNews.com Boom: Google Zooms 13% to a Record High; Market Cap Tops $335B October 18, 2013

[12] S&P Dow Jones McGraw Hill Financial S&P 500 Indices Fact Sheet

[13] Jeffe Macke Is Google Worth $1,000 a Share? Yahoo.com October 18, 2013

[14] Google Investor Relations Google Inc. Announces Third Quarter 2013 Results

[15] Yahoo Finance, Google Inc. (GOOG) Key Statistics

[16] The Wall Street Journal Market Data Center US Stocks

[17] 4-traders.com Google Inc (GOOG)

[18] Businessinsider.com Google's Secret Project 'Genie' Could Transform The Construction Industry October 18, 2013

[19] Bloomberg.com VIX 21% Tumble Means Shorts on Volatility Double Money October 17, 2013

[20] Tradingeconomics.com FRANCE INDUSTRIAL PRODUCTION

[21] Tradingeconomics.com FRANCE UNEMPLOYMENT RATE

[22] Tradingeconomics.com FRANCE LOANS TO PRIVATE SECTOR

[23] Bloomberg.com France Loses Top Credit Rating as Fitch Cites Lack of Growth July 13, 2013

[24] Fox News.com Senate budget deal provides back pay for furloughed federal workers October 16, 2013

[25] Abcnews.com $174,000 to a Senator’s Widow and Other Surprises in the Fiscal Compromise Bill October 16, 2013

[26] See Quote of the Day: There is now No Limit in government borrowing October 18, 2013

[27] US Congress H.R.2775 - Continuing Appropriations Act, 2014

[28] The Foundry Debt Ceiling with $300 Billion in New Debt, Heritage Foundation, May 19, 2003

[29] Washington post U.S. debt jumps a record $328 billion — tops $17 trillion for first time October 18, 2013

[30] Brilling.com U.S. NATIONAL DEBT CLOCK

[31] Lance Roberts The Long Game Of Hiking The Debt Ceiling STA Wealth October 11, 2013