BUBBLES AND BOTTOMS: May 2019

Bubbles and Bottoms 27 May 2019

This being the first weekly instead of monthly edition, i thought i`d start off with some bottoms instead of bubbles, just to keep the positivity going.

Looking at tax receipts, personal current taxes have been steadily on the rise, while taxes on corporate income really seem to have hit rock bottom. Considering that this chart is not measured in percentages, but in Billions of Dollars received, it`s difficult to argue that this will go down to an even lower level than it already is.

Another bottom can be seen in Gold and Silver mining stocks, especially when compared to Utility stocks. This chart shows a perfect double top, which would indicate that mining stocks could increase threefold in 8 months if they follow the previous path!

Going back to my specialty, bubbles, i saw this great chart from Doug Short, showing that the Conference Board Leading Economic Index peaks, on average, 12-13 months before an official recession is announced. What is this leading economic index precisely? it`s an index of indexes, consisting of 10 key variables. Examples are: unemployment rate, unemployment claims, building permits, consumer sentiment index and many others. The fact that this index is still peaking, means that most likely we won`t be ending up in a recession soon (at least a year from now) and if we follow the path of the late 80`s or 90`s, we can be peaking for a much longer period of time.

The market is also not showing any fear, despite December`s pullback. On average, there are 3 times per year when the market pulls back 5% or more. So far this year, we had none.

The last image that i will show you is that of tech IPO`s over the past 3 quarters. You can find the valuation, the revenue and the losses that were made by each company. If you would put all these companies together, you would have 25 Billion in revenue, with 6 Billion in losses.
Not surprisingly, of these 15 companies, only 2 of them make a profit.

I hope you enjoyed this bite-sized newsletter! A big shout-out as usual to all the amazing people who are making these charts and giving them away for free on twitter. Our lives wouldn`t be the same without you, and your contributions are priceless!

Thank you for reading, and don`t forget to stay positive!

Robbert-John Sjollema

The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.

April/May 2019 - Introduction -

April has been a month of new record highs on most indexes. The S&P 500 IT sector valuation is now nearing a 20 P/E ratio, while being at 14 in the last week of December 2018. Complacency can be seen all over the place, and fundamentals are looking increasingly worrying.

Earnings growth slows to the lowest level since Q1 2016, global trade volumes are falling at their fastest pace in a decade, U.S. wholesale inventory is at its highest level since 2009 (don`t believe it when Trumps says this is good for the economy, it shows that there`s just more supply than demand, simple as that). 81.4% of borrowers who refinance their mortgage, take out cash off their homes (last time it was this high, it was late 2007 at the dawn of the global financial crisis). And last but not least: Germany`s factory orders have now declined at its fastest pace since the global financial crisis and is down by a massive 8.4%.

Fundamentals say that a worldwide recession is around the corner, while most markets in the developed world act like nothing is happening, and we are just at the start of a decades long economic miracle.

While Mr. Market is never wrong, it can stay irrational much longer than anyone expects. I expect it to catch up to reality sooner than later, and no central bank that can do anything against it (unless we`d consider a hyperinflation scenario, where the markets can go up by thousands of dollars, but its real value actually declines).

I will show you a lot of charts that will indicate a decline in various sectors, in different countries around the world, together with the market`s irrational response to it. As you might have expected, the most irrational sector is once again the tech sector, which is behaving like it`s 1999 all over again.

This will be the last monthly newsletter, after which I will switch to a weekly edition. This is necessary to stay up to date to the latest developments, as they move incredibly quickly. Over the past 2 months i`ve seen myself rewriting the entire newsletter, just because the narrative has completely changed within a matter of weeks.

Enjoy the ride, and don`t forget to stay positive after reading this newsletter, this too shall pass!

Robbert-John Sjollema

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The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in this publication is that of the publisher and is subject to change without notice. The information in this publication may become outdated and there is no obligation to update any such information.

April/May 2019 - Bubbles and bottoms for consumers -

Ray Dalio has come up with a great presentation about why capitalism should be “reinvented”, as it seems to make the rich richer, and the poor poorer. His chart below shows that the income share of the top 1% richest people, in relation to the income share of the bottom 90%, is hovering around its highest point since the great depression in 1929. The bottom of the chart is reached in 1971.

If you`re a bit familiar with my newsletters, you know that this is when the gold standard got abolished, and the world started to get addicted to debt. If you put two and two together, you`d likely come to the conclusion that less debt creation means less wealth disparity, for whichever reason that might be. Perhaps it`s because when you`re rich, it`s easier to get cheap loans, which can make you even more rich.

Now i`d like to play the devil`s advocate here. Despite the fact that there`s a massive wealth disparity, it also seems like the worldwide poverty rate has never been lower than today. So perhaps a big income disparity is not all that bad? Perhaps that top 1% of richest people create a lot of jobs, which in turn stimulates the economy. Perhaps equality is not something we should strive for, as equality always comes with mediocracy. Communism is the greatest example of this.

Perhaps we shouldn`t strive for equality, and perhaps we shouldn`t blame the 1% for all that is wrong with the world, but perhaps we should look at why this 1% had opportunities that others didn`t, and fix the issue from the source.

People think there is a shortcut to becoming part of the 1%, and that is real estate. It has been a piggy bank for generations on end, simply because populations and productivity kept on growing. We all know what happened during the great financial crisis; people`s homes had sky high valuations, and they started using their property as an ATM machine. Why wait to cash in on the different between the purchase value and the actual value, if you can already take out some money during your mortgage refinancing? Great idea if the housing prices keep on rising!

Unfortunately, nobody has learned their lesson from the 2008 crisis and property bubble, and we are now at a rate of more than 81% of people who take out cash of their homes during their mortgage refinancing. That is at the same level as late 2007. I don`t think I have to explain to you how this story will end, and I guess I don`t have to tell you that all these “responsible homeowners” will not be part of the 1% anytime soon.

90% of my charts are always about the U.S. markets. This is mostly because it`s the largest market in the world, and a good indicator of how the rest of the world is doing. The second largest economy in the world also has its own problems though, and both consumers as well as businesses and the government itself is to blame.

Below you can see the outstanding credit card balances as a percentage of GDP for various countries at various times in history. As you can see, the mainland Chinese are quite good at raking up debt on their credit cards, even at a larger scale than the U.S.!

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April/May 2019 - Bubbles and bottoms for companies -

Corporate debt. It is the type of debt that has gone up the most over the past decade, compared to household, government and financial sector debt. As i`ve said before, the next financial crisis won`t be starting at banks. Banks have been bullied by every single government since the great financial crisis, and this is practically the only industry that has managed to deleverage over the past years. If one wants to find the catalyst of the next great crisis, look no further than private and listed companies all over the world.

Zooming in on this picture, one can see that Chinese nonfinancial corporate debt has been the biggest cause of the worldwide corporate debt growth. It has gone from roughly 3 Trillion in 2007, to more than 20 Trillion in late 2018!

In the U.S. it`s not much different though, with Russell 2000 companies increasing their debt fivefold in a decade.

When it comes to companies who are about to be listed on the stock market, the story might even be worse, as the majority of them are not even profitable yet. The Lyft IPO that went terribly wrong last month, was infamous for having the largest annual loss before going public. Ever.

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April/May 2019 - Bubbles and bottoms for stock markets -

Record debt means record valuations on stock markets, as long as the debt can be paid back. What can stop this debt payback? An increase in interest rates or a decline in demand.

Since the decline in the markets from October until December, markets have rebounded and found new all time highs. Just to put in perspective how fast this rally was, and how much the price increased: it took 80 trading days to let the Nasdaq 100 or NDX decline 23%, while it took only 73 trading days to go up 29%. Over the past 3 weeks it increased another 4%.

The Nasdaq has been up 15 weeks out of the past 17, which last happened at the peak of the 2000 bubble. Complacency galore.

There`s massive overconfidence in the Nasdaq 100, being close to extreme levels. Overconfidence in other markets, currencies and commodities don`t even come close.

The largest chunk of the rally comes from the tech sector, which is quite unsurprising. While not even being close to levels last seen in 2000, the tech sector is still outperforming the S&P 500 and is now the strongest since 2001.

The tech sector is fuelled by new IPO`s, since most of the newly listed companies are in the tech sector. This year will become the 4^th time that cumulative IPO value will hit the 100 Billion mark. The last 3 times this happened were in 2000, 2008 and 2015.

The flipside of this is that cumulative flows to tech funds have crashed since the peak in late 2018, and are now almost negative. This is bad news for all tech companies who are about to get listed. One can think of Pinterest, Slack, Robinhood and WeWork.

Investors are becoming more confident after the December dip, with the bull-bear spread now reaching October 2018 levels. What does it take for investors to run towards the exit again, just like they did in December?

Dumb money is also more confident than they have been in a long time. Since 2010 to be precise. The dumb Money indicator include the equity-only put/call ratio, the flow into and out of the Rydex series of index mutual funds, and small speculators in equity index futures contracts.

The reason why many investors are becoming so optimistic again, is because there haven`t been any large declines for a while. On average, it takes 48 days to have a 3% sell-off in a day. Currently we`re at 69 days, which is practically 50% higher than average.

“It is far more common for people to allow ego to stand in the way of learning.”

- Ray Dalio -

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April/May 2019 - Bubbles and bottoms for governments -

Worldwide, economies are slowing down at a pace last seen since 2009. The global purchasing managers index, which is a good indicator of economic health for the manufacturing and services industries, has shown the longest losing streak in at least 20 years, surpassing the declines seen in 2008 and 2009.

This comes together with a massive and steep decline in global trade, mimicking the declines in 2008.

Zooming in on Asia, one can see that export volumes have plunged to levels, you guessed it by now, last seen in 2008.

China`s industrial profits have declined last month by 14%, which was the largest decline since 2009.

This is despite a multi decade high in Chinese consumer confidence, which should boost domestic consumption. Unfortunately for China, domestic consumption is still a much smaller part of the economy than for example in the U.S.

Meanwhile in Europe it`s all looking bleak as well, with Germany`s manufacturing orders going down 8.4%. This has now surpassed the declines from 2012, when we were in the middle of the European banking crisis.

In the U.K. it`s a whole different story, and on the surface you would think that their economy is booming. You can see the massive outlier in U.K. factory output compared to its European peers. But once you start to realize that this is all due to stockpiling because of the Brexit uncertainty, one can imagine that this fast rise will collapse just as fast, whether or not an actual Brexit will take place.

London house prices are going down at the fastest rate in more than a decade, likely due to the fact that much of the London property is being used for speculation by the Arabs and Chinese, who don`t use the property as their primary dwelling.

Debt to GDP levels in Europe have increased in all countries since 2008, but you can see that there are actually only two countries who managed to come very close to their pre-recession levels. Germany is practically back at the same level, while the Netherlands is declining rapidly since 2014.

What do these two countries have in common? They are the two largest exporters in the EU zone.

Germany`s exports account for 24.2% of total EU exports, while the tiny Netherlands account for 11.2%. Why have the two largest export nations shown the most positive developments in debt to GDP levels? Reason number 1 is the low Euro. If Germany and the Netherlands would still have their own currencies, it would be at much higher levels in comparison to, for example, the US Dollar. But because the Euro is basically a collection of 19 differently performing economies, the bottom performing economies pull down the value of the Euro and create a massive advantage for the EU`s export nations. The opposite is true as well; if the bottom performing economies in the EU would have their own currency, it would be at lower levels to the US Dollar than the Euro currently is.

This is the main reason why countries like Greece and Portugal are continuously underperforming and need continuous bailouts. In my opinion, countries like Germany and the Netherlands are more than happy to bail these countries out, because on the bottom line there`s still an economic gain.

Now, here`s the real issue with the EU, which is hardly spoken about: despite having a united currency, the EU does not have united EU bonds. Each EU member pays different interest rates on their bonds, and you guessed it; the bottom performing economies pay the highest interest rates.

If there would be European bonds, or Eurobonds, with an interest rate that is based on the average performance of all EU members, just as the Euro is valued, there would be a much better balance in the EU`s economic system, where the best performing economies benefit from a low currency, but have to pay higher interest rates, and the least performing economies benefit from lower interest rates, but have to endure a higher currency. But guess who the biggest opponents are to Eurobonds? You guessed it…

In my opinion, this is the biggest kept secret about the EU, with the Netherlands and Germany being the biggest beneficiary. They literally have their cake and eat it too; an artificially low currency with low interest rates!

Meanwhile, the U.S. is reaching the record of 120 months of economic expansion, that was set in the mid 90`s. Back then, the economic expansion happened with much higher GDP growth, but nonetheless it`s very impressive, and a great example of what Quantitative Easing can do for a country. The biggest problem right now is that consumers, businesses and even the government itself is becoming addicted and dependent on this constant inflow of “cheap money”, and there doesn`t seem to be a way out of this spiral.

“If you’re not failing, you’re not pushing your limits, and if you’re not pushing your limits, you’re not maximizing your potential”

- Ray Dalio -

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April/May 2019 - Summary -

This 8^th and final monthly newsletter shows that the cracks are finally appearing in economies around the world, and that these cracks can cause massive financial instability, which will most likely be much larger than during the 2008 crisis. I`ve said it many times, but i`ll say it again: the 2008 crisis wasn`t fixed, it was patched. It couldn`t be fixed, because the underlying problems are just too big, and the economic suffering that we`d all have to endure to really fix it, would cause massive poverty all over the globe.

Hence the governments chose to “keep the music playing”, and create artificial wealth by printing more and more money, while the value of this money kept on going down. To top that off, most of the wealth ended up in the hands of the small percentage of people who own stocks.

Now that the U.S. – China trade war is shaping up, we should prepare ourselves for massive declines in stock market value, massive layoffs, and prices that keep on rising. The word for this is stagflation, which is still my number one outcome of this whole debacle that we are in right now.

From now on I will write shorter, weekly newsletters that will be available through the website www.bubblesbottoms.com, or the good old twitter. If you haven`t done so, do follow me on Twitter at @bubblesbottoms, which is where I post all the charts that are added into the newsletter. Practically none of these charts are mine, they are made by the great individuals who run the financial twitter or “fintwit” community, and whose insights make me smarter every day. The only thing I do is compile this information, share their insights and mix it with my own opinion.

A special mention goes to the $TSLAQ community, which has given amazing insights into the workings of Tesla as a business. I started following many of the people in this community in July, when Elon Musk worked on a submarine for the Thai cave rescue, and suddenly called one of the divers a “pedo guy”. Two months later he got interviewed by Joe Rogan and smoked weed in front of millions of viewers. This irrational behaviour has intrigued me, and the $TSLAQ community has shown that not only he, but also his company has deeper secrets than what the mainstream media shows. From excess inventory to the thickness of car paint, from the “whompy wheels” to the tens of videos with failures in autonomous driving, the community has taught me a lot about a person and a company that I admired a lot in the past!

To me Elon Musk is one of the poster childs of cheap credit; big promises, small delivery.

Thank you for reading, and don`t forget to stay positive!

Robbert-John Sjollema

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