Stock Market Frenzy: Blame The Machines

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Humans no longer go into battle on the trading floor of stock exchanges. Buy and sell orders have been programmed into machines using complicated algorithms to assess fair market value. Computers make the decisions based on what it perceives to be the correct stock price at that moment and then fires off the orders.

North American stock markets went on a hectic roller coaster ride on Monday and continued throughout the whole week. SEC rules which automatically stops trading for any stock (in the S&P 500) whose price changes by more than 10%, in any five-minute period, didn’t help slow down the selloff.

Dow Roller Coaster

The Machines Caused a Chain Reaction:

Stop Loss Orders: Program trades are responsible for triggering stop-loss orders.  This tends to create very volatile situations because unfilled stop-loss orders automatically turn into “market orders which get filled at any price. For example; putting a stop-loss order at 10% on a $100 stock should trigger a sell order at $90.  What happens if the stock price skipped $90 and when directly down to $85? Then your stock would be sold immediately for $5 less than planned, even if the stock price bounced back up above $90 a share.

Margin Calls: Falling stock prices can generate a margin call from your broker if one or more of the securities you had bought, with borrowed money, decreased in value past a certain point. You would be forced to either deposit more money in the account or the broker would sell off some of your shares.

Short Sellers: A falling stock market attracts speculators to jump in and add to the selling pressure. They sell securities that they borrow but do not owned. Short sellers are motivated by the belief that declining prices will enable the seller to buy back shares at a lower price to make a profit. However, a sudden stock market reversal to the upside can temporary drive share prices higher because short sellers are forced to cover their short positions.

Market Makers: Banks and brokerage companies help keep financial markets running efficiently because they are willing to quote both the bid and the offer price for a stock. They will buy the stock from an investor at the bid price even if they don’t have a buyer at the ask price. They are literally “making a market” for the stock. However, market makers were driven out of the market this week because they have a limited amount of capital and couldn’t handle the  over abundance of sell orders.

The U.S. equity market is dominated by institutional investors. These institutions wanted to do away with humans, wanted completely automated markets, wanted to let the computers and “high frequency” market makers step in and take over. They wanted massive market fragmentation to make the U.S. capital markets “more competitive.” Currently there are 10 exchanges and 60+ alternative venues that do nothing but add to the chaos.

On most days, there are imbalances either to the buy or sell side that could nudge the market’s close in one direction or the other. However, Tuesday’s trading patterns, was an example of how computers generated an avalanche of sell orders on the  Dow Jones industrial average and sent it plummeting to a loss by the time the closing bell rang. Keep in mind that there are only 30 stocks in the Dow which really exaggerates price movements.


So, how’s that working for you, the average investor? Does the current market structure allow for fair and orderly trading when the shit hits the fan? I think not!

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Stock Market Bears Are Growling!

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It would appear that after more than six years of a bull stock market, a 200% gain for the S&P 500, the bears are hungry. They have numerous reasons to be bearish – a sub-par global growth environment, manufactured earnings (with aggressive share buybacks and M&A supporting the bottom line), and high valuations by a variety of measures.

The Fed is talking about starting to take the “punch bowl” away by raising interest rates. Market technicians, with their fancy charts, are pointing to signs of narrowing leadership, the rolling over of the advance-decline line and market breath is deteriorating (ratio of new highs to new lows).

But the bulls say, the market should be looking ahead. Barring some kind of cataclysmic event, the economic backdrop is improving rather than deteriorating. Consumers have been given a tax cut with lower oil prices, corporations remain cash healthy and multiples are high but not atrocious in a low-inflation & low-interest rate environment. The Atlanta Fed’s GDP forecast for the U.S. economy has started to tick up again, growth will be positive in Q3. Jobs are being created and wages are slowly rising.

The ECB is still in there buying $65 billion worth of bonds per month until September 2016. The PMI for both manufacturing and services in the Euro Zone continue to show expansion at a pace slightly better than expectations.

Now, if you have been following the financial news, everyone has been anticipating a correction. The New York markets haven’t had a serious correction since 2011. See the 5 year chart below of the S&P 500:

 

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I have been writing that it is next to impossible to time the market. The U.S. stock market has been on a roller coaster ride for most of this year. Last week’s stock market drop could to the start of an overdue correction. A large one day drop usually is due to  “FEAR”. The chart below is the year to date price action of the S&P 500:

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Is there anything new in the mix? Maybe the realization that China’s economy is weaker than we thought (numbers in the 3-4% GDP growth range are becoming more prevalent) and that the country’s leaders are a little less capable at managing the markets and the economy. The Tianjin explosion has also undermined the people’s confidence in the leadership.

The other big story is the falling price of crude oil. Most oil experts were expecting a big rebound in the price of oil in the second half of 2015. Wall Street gets very nervous when some of their “golden boys”, (hedge fund managers) like renowned oil trader Andy Hall loses money.

Hall’s Astenbeck Capital Management hedge fund reported a loss of $500 million, the second largest loss in the history of the fund. Hall’s past successes at Citigroup earned him a $100 million bonus, plus he has a pricy art collection and owns a castle in Germany.

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Fasten your seatbelt, expect a lot of turbulence in the stock markets around the world. We are in for a very bumpy ride. Cash is king, get ready to pick up some real bargains!!!

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.” – Peter Lynch  

 

 

 

 

 

Tesla Motors, Wall Street Hype or a Real Car Company?

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The CEO of Tesla, Elon Musk is a visionary but can he turn his vision into a real car company? It’s crunch time for Tesla Motors. The Silicon Valley automaker is losing more than $4,000 on every Model S electric sedan it sells and it burned $359 million in cash last quarter in a bull market for luxury vehicles.

Musk has taken investors on a thrill ride since taking Tesla public in 2010. Now he’s given himself a deadline, promising that by the first quarter of 2016 Tesla will be making enough money to fund a jump from making one expensive, low volume car to mass producing multiple models, and expanding a venture to manufacture electric power storage systems.

Traditional automakers consume cash to pay for assembly line equipment, including metal dies and plastic molds, as well as testing to meet safety and emissions standards. A typical new car can cost $1 billion or more to engineer and bring to market.

Tesla has just $1.15 billion on hand as of June 30, down from $2.67 billion a year earlier. Established automakers such as General Motors has more than $28 billion in cash equivalents as of June 30. GM sells more than 9 million vehicles a year, while Tesla plans to build between 50,000 and 55,000 cars this year.

Tesla is going to be burning through cash for the next few quarters and for the next couple of years. There is no other way to grow as an automaker without investing in more infrastructure. Tesla will have to raise more cash in order to build more cars.

Tesla Press Release:

PALO ALTO, CA — 08/13/15 — Tesla announced today that it intends to offer, subject to market and other conditions, $500 million of additional shares of common stock in an underwritten registered public offering. In addition, Tesla intends to grant the underwriters a 30-day option to purchase up to $75 million of additional shares of common stock.

Elon Musk, Tesla’s CEO, intends to purchase $20 million of common stock in this offering at the public offering price.

Tesla intends to use the net proceeds from this offering to accelerate the growth of its business in the United States and internationally, including the growth of its stores, service centers, Supercharger network and the Tesla Energy business, and for the development and production of Model 3, the development of the Tesla Giga factory, and other general corporate purposes.

Wall Street loves stocks like Tesla that require more cash in order to fulfill their vision. New shares being issued means more underwriting fees for their brokerage businesses. Wall Street has had a history of selling “The Dream” but what about reality? If electric cars are to help solve the world’s carbon emissions problem, there needs to be a fundamental revision of electricity production.

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Electric cars are only as green as their power grid

More than two-thirds of global electricity production still comes from fossil-fuel powered plants. America’s electricity is still mostly coal-fired, with natural gas being a close second and nuclear a distant third.

In China, the grid is said to draw upwards of three-quarters of its power from fossil fuels. Mostly coal, which has heavy pollution problems. The U.S. is second only to China, in annual carbon dioxide emissions from the use of coal.

Researchers Bjart Holtsmark and Anders Skonhoft recently noted, “Indeed, the pollution from power stations is so dangerous and so widespread that even electric bicycles, of which China has 100 million, are only a fraction more environmentally beneficial than gasoline-driven cars.”

If you are Canadian, you may remember Ballard Power located in Burnaby, British Columbia that was going to revolutionize the automotive business. They built a fuel cell that would consume hydrogen, produce electricity and fit in a car.

Wall Street sold “that Dream”, the stock chart below shows the rise and fall!

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In my humble opinion, investors who own Tesla shares should be worried. Profit margins in the automotive manufacturing business are very slim. It requires a lot of capital spending to get plants up and running. Tesla will have to continue to sell shares in order to raise money to fund increases in auto production. Selling more shares makes your current shares worth less over time.

No matter how you look at it, Tesla shares are way overvalued compared to other auto manufacturers. The concept of everyone driving an electric car is very appealing. However, realistically we are decades away from reducing the number of gas guzzling automobiles.

In my experience, overvalued stocks can continue to maintain their upward momentum. You will never get a clear signal as to when to sell. A stop loss sell order is a good way to protect yourself!

 

 

Where’s the Growth?

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Travel back to 1984, to a time when a simple question could spark a nationwide meat-craving frenzy. Wendy’s debuted their now-iconic “Where’s the Beef?” commercial, starring Clara Peller as an old lady demanding more meat from her fast-food hamburger.

Investors are now asking China “Where’s the growth”? The second largest economy has been hiding their economic beef under a large bun of secrecy. China’s surprise devaluation of its currency is a sign of economic weakness.

The People’s Bank of China on Tuesday implemented a one-time depreciation of nearly 2 percent to the yuan to levels last seen three years ago against the dollar. The move was also the biggest one-day fall since a massive devaluation in 1994. Don’t be surprise if the devaluation continues to the 5% to 10% level over the coming months.

It looks as though the weakened trade numbers were the last straw for China’s tolerance of a strong exchange rate in the face of weak global demand for its exports. Chinese exports slumped 8.3 percent in July, the biggest drop in four months and far worse than expectations for a 1 percent fall. Exports to the European Union fell 12.3 percent in July while those to the United States dropped 1.3 percent.

The currency move also comes amid a shaky Chinese stock market, which the government has been trying to stabilize. The Shanghai composite has rocketed more than 80 percent higher over the past 12 months but has plunged 23 percent since hitting a seven-year high on June 12.

Is the Chinese leadership starting to run scared? I am thinking that China may be in real trouble! The price of commodities are at recession lows. Devaluation makes commodities even more expensive and the rebound in the price of oil will not materialized anytime soon. Which raises the question, “Is it an oversupply problem or lack of demand?

Now, I have never trusted the GDP numbers coming out of China but I am starting to wonder if the economic beef underneath the bun is a lot smaller than many market watchers believe. I am scratching my head. China has been  trying to shift away from an export driven economy and create a domestic market for Chinese goods. Have they given up?

My Friend at “Bear with the Bull” and I have similar thoughts on China.

 

Made in China RED (Macro)
Made in China RED (Macro)

When the government of the second largest economy in the world decides to devalue its currency, people, companies, and indeed the entire world notice.  That is what happened this past week when China devalued its currency, the yuan.

But what does that really mean?  And how does it affect the rest of us? 

Cheaper Imports, More Expensive Exports – for us.

For stuff made in China, a weakened yuan is your friend. When the yuan falls in value, goods imported from China become cheaper. And China makes a lot of things from cars and computers to clothing and furniture. Conversely, businesses will find it more expensive to sell their goods to China. 

  • China is a huge market for both technology and luxury brands. The slowdown in China was already a worry. A devalued currency will cut further into their earnings.
  • Companies that make chips for mobile phones do a lot of their business — sometimes most of it — in China.
  • For some tech companies like Apple the effects are two way. It manufactures its phones in China, so presumably it will be able to buy its hardware for a lower price. However, Apple sells iPhones in China too, and the currency move makes iPhones more expensive to ordinary Chinese consumers. Investors took the news as an overall negative.
  • Companies that sell raw materials in China sank. China has been a big customer for companies that mine iron ore, copper and aluminum, among other metals. The fear is that a weaker yuan will drive up the cost of raw materials at a time when demand is already depressed.
  • For companies that purchase most of their goods from China, such as Walmart, their cost of doing business could go down, and therefore those savings would be passed on to the consumer. 

Lower Interest Rates

The Federal Reserve is poised to raise historically low interest rates as employment returns to healthier levels. A stronger dollar against the yuan could depress inflation because Chinese goods are cheaper. 

  • The Fed could hold off on upping rates this fall because it already is worried about inflation being too low.
  • Those with mortgages rates, or looking to buy a home, explicitly tied to base rate moves would benefit.
  • Income investors and savers looking for more interest — not as much. 

Cheaper Gas

China, consumes a lot of oil, second only to the U.S. However, oil prices are denominated in dollars, so a devalued yuan means China’s purchasing power is reduced, which could prompt the Chinese to spend less on oil-based products. 

  • That reduction in demand could lower prices, an upside for American drivers.
  • For stocks and investors who follow the price of oil, the price is going down.

 You can find many more interesting posts at https://bearwiththebull.wordpress.com/

 

 

Has Disney Lost Its Magic Touch?

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The Magic Kingdom has certainly lived up to its name of late, at least as far as stock performance is concerned. Shares of Disney has been the best performer on the Dow this year. Its historic run began in February 2014, at about $71 a share and hit a 52 week high of $122 prior to earnings being released.

Disney continued its long winning streak with its latest quarterly report Tuesday, with earnings of $1.45 a share beating analysts’ expectations for the 11th quarter running. Revenue pushed upward to $13.10 billion, beating the year-ago figure of $12.47 billion by a neat 5%.

The stock market Bears came out and cut the shares down to $109 this week. Citing operating income and revenue growth is projected to be in the mid- to high-single digits from Disney’s television networks. CEO Bob Iger on the company’s earnings conference call didn’t help when he said the cable networks experienced “some subscriber loss.”

The Bears argued that subscriber losses do matter because Disney bids on sports programming for viewing on ESPN. It needs subscribers to pay for all of that programming. Cable bundles that include ESPN stations and the Disney channel are very lucrative.

Now one could argue that Disney’s stock was priced for perfection coming into the quarter, trading at 25 times earnings. However, when a stock seems expensive, the Bears only need to spread a little fear to drive the stock price down. In fact, all media stocks got hammered this week.

There is still plenty of magic left in the Kingdom

The movie business continues to do well, spurred along by success from the latest “Avengers” movie. The upcoming reboot of the “Star Wars” franchise is expected to be huge. Analysts predict that “Star Wars” will gross around $2.2 billion globally. The sequel to Frozen is also in the works.

The Disney movie studio is a big catalyst for boosting sales in its consumer products business. Frozen has become a global brand being used in merchandising, video games, theme parks, cruise ships and selling music. I wouldn’t be surprise to see Frozen on Broadway (just like the Lion King) and on Disney’s stars on ice. The new characters in the Star Wars will add even more dollars to the consumer product side of the business.

The theme parks are continuing to drive growth, with higher attendance and more spending. New rides based on successful movies keep consumers coming back again and again. The Shanghai Disneyland Park is scheduled to open next year which could be an added bonus to revenue growth in 2016.

Disney’s media networks, including ESPN, will continue to cause investors to worry. Cable is slowing losing subscribers but Disney could easily sell ESPN and the Disney channel directly to consumers. I am not worried because Disney, unlike other media companies, has a huge library of content to reboot within its media empire.

I still believe in the magic of Disney

The company has embarked on a strategy of reviving and remaking its classic animated films as live action fantasies. Alice in Wonderland, Cinderella and Maleficent (reworking of Sleeping Beauty) were highly successful. Upcoming new releases include Pinocchio, Mulan, Beauty and the Beast, Dumbo, Winnie the Pooh, as well as a sequel to Alice in Wonderland.

Disney has a unique formula of making movies that they can turn into theme-park rides, sell products and cross promote in its giant media empire. In my humble opinion, Disney is one of the few stocks that you could own for the next 10 years and not have to worry.

Disclaimer: I own shares in Disney.

Are Share Buybacks Good or Bad for Investors?

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There are a number of ways in which a company can entice investors to buy their stock. The two most common ways of doing this are share price appreciation and dividends. However, many company executives have turned to financial engineering in the form of share buybacks to increase the company’s share value.

Under a share buyback, a company purchases a certain number of its own shares on the open market. Sometimes they even make a tender offer to existing shareholders at a slight premium to the market price. The company then cancels the purchased shares, reducing the total number outstanding, making each remaining share worth that much more.

The size of the pie is the same, your slice just got bigger

apple pie   apple slice

In theory, management only repurchases stock if it expects to enhance shareholder value more that way than by using the cash for capital spending, acquisitions, product development or dividend distributions.

One of the most obvious reasons for the growth of such programs is to help offset the dilutive effects of generous stock compensation packages for employees, including stock options and stock contributions to 401(k) programs. Earnings are “diluted” when the number of shares outstanding increases, reducing per-share earnings.

Benefits of share buybacks

In most countries, taxes on capital gains are lower than dividends, leaving more money in shareholder’s pockets. Using buybacks in order to grant management stock options can improve their performance and may make it easier for the company to hire better managers. Buybacks can boost share price which can benefit short term investors and traders.

 

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Pitfalls of share buybacks

Buybacks artificially increases earnings per share and reduces price to earnings ratio (PE). Reducing the amount of cash on the balance sheet and reducing the number of shares effects other financial ratios. Less cash means higher return on assets (ROA) and less shares increases return on equity (ROE). Increasing share prices and engineering ratios can hide poor performance by management plus increases their compensation package.

Wall Street loves stock repurchases

  • Higher share prices equals more commissions
  • Higher earnings and lower price to earnings ratio (PE) entice more stock buying
  • Buybacks increases the value of stock options, triggering more trading, and more commissions
  • Selling tool, the company’s executives feel that their stock price is undervalue, time to buy

 

cautionNot all buybacks are actually implemented, too many buybacks can also indicate the company’s revenue growth is slowing down.

Bottom Line: Not all buybacks are equal and some buybacks seem to be nothing more than an attempt to manipulate the stock price.

What are your views on share buybacks?