ETFs CFDs Bucket Shops and 1929

The worldwide number of Exchange Traded Funds (ETFs) has soared 20-fold in 15 years and their assets in the US alone has increased even more, by 30 times to $4.4 trillion.  Moreover, keep in mind that these are 2019 numbers, they certainly higher today.

Take a guess what was the most popular retail product for “investors” in the years leading up to the Great Crash of 1929? Yessiree Bob, exchange traded funds - they called them Trusts back then.  And guess what?,  just like today they made speculating on margin even more leveraged than regulations allowed because Trusts leveraged their portfolios and then the buyer could again margin the Trust shares on his own account.  So, securities margin was set at 50% (2x leverage) and the investor could ramp that up to 4x  (Some people erroneously believe that margin requirements were as low as 10%  and that’s what accelerated the crash, but that’s not so).

Today, we have 2X and 3X S&P 500 or NASDAQ 100 index tracker ETFs that go up (and of course down)  double and triple as much as the underlying index. Put that baby on 50% margin and... guess what? Your effective leverage is 6X. If you’re not worried about what that means in a sudden market break...you should be. I mean... seriously, we’re talking trillions of dollars here and those products are 100% retail.

Next subject is Contracts For Difference (CFDs).  You (but not if you’re in the US) can go into your favorite electronic trading platform and buy a CFD on just about any stock or index They are NOT stocks themselves, they are agreements between you and the broker that they will credit/debit your account with the difference between the stock prices shown on the regular exchange at the time of sale and purchase, respectively.  I say it again, you are not investing, you are merely betting on a move, up or down. And again, guess what? Because CFDs are not securities they are not bound by margin regulations and, in fact, they are typically margined as low as 2%, ie you leverage 50 times. Yes, fifty.

Ever heard of bucket shops? That’s exactly what they did back in the 1920s. Only thing is, they posed as legitimate stockbrokers because such CFDs were illegal and they often got raided by the police.  But today... OMG they’re legit!! Outside the US, anyway. 

So, dear reader, and particularly if you are an old reader, we’re back to the lunatic alphabet soup era. Back in 2007-08 it was subprimes, bonds, tranches and credit derivatives ABS, CMO, CDS etc etc. Today, it’s stocks, funds, ETFs, CFDs and huge leverage.

There’s nothing new under the Sun, it seems.  Loonie valuations for “new technologies”(it was radio in the 1920s), lots and lots of small speculators, easy money, high leverage - it all looks awfully similar to 1929.  

Scared yet?  I think we should all be...

 

Smoke And Mirrors, Literally

 RLX Technologies, a Chinese vaping company just did an IPO to raise $1.4 billion. That’s a lot of money for smoke, but that’s not all: it listed on the NYSE and on the first day of trading its shares jumped 133% from $12 to $28 giving RLX a market cap of $44 billion.  That’s 1,900 times annual earnings... for smoke...to be clear: that’s one thousand nine hundred times. Oh, and a mere 97 times revenue.

Does every man, woman and child on Earth vape?? I guess they must!!

You know, Tulipmania was sane by this measure...

If You “Get It”, Get To Work

A day before Mr. Biden’s inauguration I posted on my personal FB page that the US is “mindlessly hurtling towards civil war” and a friend called me “a bit dramatic”. But, Mr. Biden in his speech called for an end to the “uncivil war” in America.  As he said, “I get it”. Question is, what does he get? What must he, his administration and both Houses now controlled by Democrats do to prevent a “real” civil war?

In yesterday’s post I presented jobs data to point out the declining fortunes of America’s once mighty middle class.  Today, I present data from a Pew study on income and wealth inequality. As usual, pictures are worth thousands of words - after all, I did study engineering (smile).

First up, the income gap between upper and middle class households is rising and, even more importantly, the middle class share of aggregate national income has plunged while that of the higher ups has soared. As an Army field officer would say, the center is not holding..

Next, the wealth gap  has widened enormously from 28% in 1983 to 62% today.

This is not about the rich getting richer and the poor poorer. Sure, that’s always bad, but not nearly as consequential and dangerous for the very existence of the American Empire as the middle class getting whacked, while the rich get incredibly richer.  It results in a paycheck to paycheck subsistence/existence, addiction to online pass times, poor health, anger and depression. The rich become trillionaires (!!) jetting to Aspen, Dubai and Zermatt, while the so-called middle class stays at home with Netflix and Twitter.  That’s definitely not “fair” and certainly not the American Dream. 

Who is to blame? Wouldn’t you know it, Americans blame it on losing their jobs to China (what I pointed out yesterday) and a tax system that favors the rich. 

And who do Americans expect to fix these inequalities? The Federal government and big corporations.

Bottom line, Mr. Biden has his work cut out for him.  Americans don’t want handouts, but good jobs and a fair tax system that makes corporations and the wealthy pay more in taxes.  The next few days and weeks will show us if Mr. Biden truly “gets it” and starts to rebuild the American middle class.

The Annihilation Of The American Middle Class

 As Mr. Biden assumes office, the question remains: what produced Trumpism? Why does a huge 34% of all Americans still approve of Donald Trump, even after all his antics, his abject failure to handle COVID, the Capitol raid and two Impeachments? Is it just a passing personality cult or is it something much deeper and more serious? IMHO, it’s the latter.

Gallup Poll

I believe Trump has touched a nerve with tens of millions of angry middle class Americans who have seen their relative living standards deteriorate sharply over the past 40 years. He is a symptom, not the cause of the deep American divide. Unlike most, I see this schism as almost entirely socio-economic (who has how much) instead of cultural-political (who believes what).  Let me put it this way: if your belly is full you don’t storm the Bastille (or the Capitol), not really.

Let’s look at some numbers.

Manufacturing employment in the US topped out in 1980 at nearly 20 million workers, accounting for 27% of all private sector employees.  It has since receded to just 12 million, a mere 9.3% of the private sector.  That’s a precipitous 66% drop in just one generation!

The Middle Class Train Has Derailed

The unionized factory floor served as the prosperity locomotive for America’s postwar baby-boom middle class. It has now derailed, its passengers left to find other means to get ahead in life. (Yes, productivity has risen sharply but that mostly means higher profits for the corporations, not much higher wages).

What has taken manufacturing’s place? One very big sector is Hospitality and Leisure (restaurants, bars, hotels, theaters, etc).  Since 1980 employment there has increased from 6.8 to 17 million (pre-COVID), or from 9% to 13% of all private employees. But that’s not all...

The Rise Of The Burger Flipper 

Factory jobs were (and still are) much better paid and have better benefits.  They pay on average $29/hr vs $17/hr in hospitality and offer much better benefits (eg 84% of them have an employer sponsored pension plan vs. 33% in hospitality).

Here’s another statistic: in 2000 16% of factory workers were represented by a union vs. 4% in hospitality.  Today, those numbers are 9% and 3.5%, respectively.  Manufacturing employees have lost a lot of bargaining power whereas hospitality ones never had any to begin with.

In sum, the jobs that replaced factory positions are really, really bad. The American Dream road that lead straight from high school to assembly line is no more. Even a Bachelor degree is no longer a ticket to a relatively comfortable lifestyle, as seen in the next charts from a study by the Congressional Research Service.

I recently read someplace that even American professionals (lawyers, engineers, accountants, etc) nowadays consider themselves relatively “poor” or “unprivileged”, which just goes to show how far the middle class has been squeezed.

In sum, Trump felt and unashamedly exploited a real social problem that has been brewing for decades.  Someone has to solve it, and soon, because he certainly didn’t...

Heat Maps

Another two charts today, first one again courtesy of Yardeni Research.

The stockmarket Bull/Bear ratio is a good sentiment indicator.  Notice how it has become almost entirely red (over 3 times more bulls than bears) in the last 6 out of 7 years.  The 2015-16 pause must be attributed to the highly unusual Presidential election period which resulted in Trump who then proceeded to slash corporate taxes to the lowest level in 80 years.

And here's another stripe chart from the World Meteorological Organization...

I'm troubled to find the two oddly correlated - do you?

 

Two Charts

 I really like Yardeni Research for its in-depth economic analysis.  You will find the link at the right margin.  Here are two charts I find interesting.

The first one is the yield spread between high yield (aka junk) bonds and Treasurys.  It is a very good indicator of risk appetite and it is currently back to near all time lows, ie risk appetite is very high.

The next chart goes a long way to explain the American middle class malaise.  Manufacturing has been stagnant for 20 years - well-paid jobs on the assembly line are becoming ever scarcer as the population grows.  In my opinion, that’s the source of Trumpism, MAGA and, conversely, the awesome rise of China.

The Real Deal Bubble

Lets talk bubbles.

For one, a bubble is not "real" until after the fact, i.e. after it has burst. It then becomes so obvious that people shake their heads in disbelief at their blindness.  The Emperor's New Clothes, the tale by Hans Christian Andersen, is a perfect example of mass suspension of disbelief.  Yet, the signs are there to see beforehand, obvious to anyone who is willing to see with his very own eyes instead through the viewpoint of mass, crowd hysteria.

Why would a single tulip bulb sell for as much as a house? Why would anyone, including the genius Sir Isaac Newton, participate and be fleeced in the South Seas madness?  Why would anyone believe that subprime loans could be sliced, diced and tranched into AAA bonds, which were then used for credit derivatives, which were in turn turned into more AAA bonds?  Cutting cow apples into small pieces doesn't turn them into gold, does it? Duh...

Excess -  in and by itself - is not a very good indicator of bubbles, however.  The one element that is, however, is a screaming imbalance between present fact and projected future.  For example, back in the Credit Crisis of 2006-08 many mortgage lenders, brokers, etc were already failing and/or reporting big increases in non-performing loans (fact), yet markets were ignoring the news and kept on making new highs, projecting a rosy future forever.

So, what about today? What is the present imbalance?  In my humble opinion, it's the obvious decline of the United Sates as a stable, superpower Empire (fact) contrasted to the stratospheric level of stocks and near zero interest rates for bonds (projected future).  This imbalance is so major, of such historic proportions that it goes unreported and under-analyzed by most media.  I mean, yes, the Capitol stormed by the "unwashed masses" was in every front page, but it was mostly brushed off as an extremist event.  To that I say... remember the Bastille or, more recently, the Berlin Wall. 

                                                                     End Of Empire

Another fact that markets continue to ignore is global warming and climate change.  The absolutely necessary changes in our Permagrowth model will impact the level AND makeup of economic activity.  Business cannot go on as usual, consumers cannot go on buying $1 t-shirts or (more importantly) paying $1,000+ for yet another, newer edition of a smartphone, tablet, whatever.  Transforming our society and economy to a Sustainable Model will create new businesses BUT... the overall direction will be towards less of everything. Think of Greta Thunberg as the child who pointed to the Emperor and said.."but, he's naked!!". If you don't like Greta, remember Al Gore and his Inconvenient Truth, which is now becoming A Clear and Present Catastrophe.

End Of Permagrowth

Therefore, two very, very large "facts" are pointing to one direction while markets are obliviously whooshing towards another.  And that, friends, is The Real Deal Bubble.

Best Wishes For A Gappy New Year ;)

 Charting is a really arcane type of market analysis and, for the most part, pretty useless as a predictive tool.  At best, it should be attempted using a very, very thick pen (thick mouse pointer these days).  Still, there is ONE basic principle that has proven pretty accurate over many years - in my experience, anyhow: gaps get filled.

To this end, here is a daily chart of  Dow Jones Industrials.  The gaps that have been formed on the upside are at 28500, 23700, 21400, 19100 and remain unfilled (blue arrows).  The red arrows show gaps that were formed on the downside and have now been filled as the market rose.  A similar pattern can be observed at S&P 500 at 3390, 2870, 2530 and 2300.

 

I'm posting this as a companion visual aid to my previous post (Jan. 13, 2021) on Jeremy Grantham's warning about the current bubble.  Good luck!

PS If you really want to go gap hunting, take a look at Tesla... aaaaaaallll the way down 😆😆

 

Stop The Presses

 President-elect Joe Biden just signaled his intention to boost the US economy with yet another stimulus package of $2 trillion that will rain down money from the helicopter.  Where will it come from? It will be printed by the Fed out of thin air, of course.  To be exact, the Treasury will issue bonds and the Fed will buy all of them, boosting its balance sheet to unimaginable levels (see chart).

Just 12 years ago the Fed’s assets were a mere $1 trillion.  Today they come to $7.3 trillion and, if Mr. Biden goes through with his plan, they will soar to $10 trillion or 50% of GDP. In case you don’t comprehend what this means, it’s really very simple: the government/Fed is printing money. Since the economy is stagnant, this is a debasement of the currency, pure and simple.  The hope is that this torrent of money will kickstart the economy because the recipients will spend it on.... what??? Imported clothes, tablets and games?? (Note: imports are subtracted from GDP).

In hopes of obscuring reality, talking heads are giving this most ancient of government currency debasement actions a new name: it’s now called Modern Monetary Theory.  Oh, sure, the excess money is supposed to be drained in the future future by increased taxation..  but, show me a politician who promises to raise taxes and I will show you a unicorn.

A Real Market Legend Speaks: Is Anyone Listening?

 Jeremy Grantham is one of the most successful asset managers in history. This is what he has to say about the current bubble in stocks and bonds... in sum: it’s a bubble of epic proportions, equivalent, or worse, to the South Seas, 1929 and dotcom bubbles. I agree 100%.

PS The dissonance between the US political situation (the Capitol stormed, 5 dead !!) and the raging bull in stocks is astonishing.

https://www.gmo.com/europe/research-library/waiting-for-the-last-dance/