Wall Street Thieves…

On Tuesday, the Dow Industrials rocketed higher by more than 282 points to close the day at 16,167. That was more than enough to wipe out all of the previous day’s losses.

Interestingly, the catalysts for the move higher was optimism surrounding the earnings reports from two Dow components, 3M (NYSE: MMM) and Proctor & Gamble (NYSE: PG). Both companies reported their quarterly reports early Tuesday morning.

By the closing bell, each stock harvested gains of roughly 5% on the day. But a closer look at each company’s results is very telling about the degree of fluff Wall Street will publish as authentic analysis of U.S. equity markets.

You see, 3M had the slightly better day; closing up nearly 5.2% on what Reuters called a “better-than-expected quarterly profit and backed its 2016 forecast.” Complete gibberish!

3M had a disastrous quarter. The company’s revenues declined by 5.45% compared to the same period a year ago. In addition, earnings declined by 12%, and the company’s net margin also decreased from the year ago period. In short, 3M sucked wind.

So what made the dunderheads at Reuters so giddy?

3M cut 1,500 jobs in Q4 in an effort to save $130 million in pretax earnings for 2016! What this means is that Wall Street has lowered the bar so low that a company is no longer graded on its ability to grow revenue and earnings, but rather on its ability to reduce its tax bill by cutting jobs.

But wait, there’s more…

Proctor & Gamble closed the day on Tuesday 4.9% higher on good news, too. What was the news?

P&G reported a 2% gain in “organic” sales. Sounds like some new type of beauty product, right?

Nope. It’s a financial term whereby the company “strips out the effects of currency moves, acquisitions and divestments” from its quarterly reports. By implementing this accounting chicanery on shareholders, the company gives the appearance of prosperity when the reality is quite the opposite.

You see, in the real world, a company can’t strip out the effects of a stronger dollar and other activity. Those are real world events, and they affect a company’s bottom line in a tangible way.

But at the end of the day, Wall Street hucksters think it’s easier to turn a blind eye to doctored financials than to announce that Proctor & Gamble’s earnings are now forecast to fall $0.37 per share as a result of currency moves and acquisitions. By the way, the $0.37 decline in earnings is more than triple its previous forecast of $0.11 cents a share. That fact wasn’t even disclosed.

But we know why. Telling the truth about a company’s performance might not make a stock price jump 5% in a day. And that wouldn’t be healthy for the performance bonuses for management or the pump and dump schemes of Wall Street thieves.

 

 

Fewer Americans Buying Life Insurance

The number of American households with life insurance is now at its lowest level in more than 50 years. This has put millions of families at significant financial risk should the family’s breadwinner die prematurely.

At present, about 44% of American households have some form of individual life insurance. Another 26% have life insurance through an employer–based plan. That leaves 30% of American households with no form of protection from the calamitous effects of a loss of income.

Even more concerning is knowledge that approximately 11 million American households with children under the age of 18 remain at risk due to the death of a breadwinner. Many of these households are headed by a single parent, which puts an undue strain on the lives of relatives and on the budgets of government welfare programs.

These numbers represent a decline of nearly 39% from 1960 when about 72% of American households owned individual life insurance. The numbers were even higher when adding the number of Americans enrolled in an employer-based plan in the 1960s. Interestingly, this drop in coverage comes at a time when premiums for life insurance have never been lower.

You see, life insurance premiums are based on mortality tables from which insurers calculate the likelihood of premature death. Advances in medicine are responsible for life expectancies in the Unites States reaching 78.8 years in 2015. The longer lifespans means insurers can spread smaller monthly payments over a longer period of time.

Now, despite the trend in lower premiums, life insurers will continue to see falling numbers of policies sold in the United States, which have declined by about 27% – from 40 million policies in 2001 to roughly 27 million policies in 2013. But perhaps more important is something not apparent from those numbers…

You see, in 1960 the average life insurance policy was held for more than a decade before a customer stopped making premium payments. That figure no longer holds true. In 2014, more than 25% of new life insurance policies sold will lapse for non-payment in the first three years after being issued. That figure grows to more than 40% of all life insurance policies after five years.

But this isn’t the only trend working against the sale of life insurance in the United States. Despite several years of moderate improvement in the economy since the height of the financial crisis, the number of workers in the civilian labor force continues to decline.  The number of working Americans is lower now than at any time since 1977 – despite the U.S. population increasing by more than 100 million individuals.

This has resulted in fewer workers earning a paycheck, but something else, too. Growing numbers of family members once on their own are moving back home to live with parents. This is increasing the size of the average American household. It also raises the risk of financial ruin should the primary breadwinner die unexpectedly.

But the problems facing the insurance industry aren’t limited to falling policy counts. Even the 70% of American households that have individual or employer based plans face the consequences of poor decisions.

You see, the main purpose for life insurance is to replace the lost income of a breadwinner. And that means a life insurance policy will need to replace an annual income of about $45,000 per year, according to census data.

But the face amount of life insurance sold in the U.S. has stabilized at roughly $168,000 after rising for nearly two decades. This is an important point.

You see, after paying last expenses and funeral costs, most Americans are left with enough money to replace a breadwinner’s lost income for slightly more than three years. After that, family members will be forced to alter living standards. This often includes the sale of a family home.

It need not be this way. Remember, costs for life insurance have never been lower. It’s possible for a 45-year old male to purchase upwards of $1 million or more of life insurance for less than $50 per month. Of course, the premium will be based on the specific age and health condition of the applicant. But a million dollar policy will easily replace the lost income of a breadwinner.

But the real benefit is that the income is replaced forever – not just three years. And this just might make you a hero to your loved ones.

 

Of New Year’s Resolutions…

Like many Americans, Federal Reserve Chairwoman, Janet Yellen, made some positive New Year’s resolutions that have recently become known.

Her goal for 2016 is to accomplish the Fed’s goals of 2015, which should have been completed in 2014 because of promises made in 2013 from plans that were made in 2012.

But already her resolutions are in trouble…

According to the Bureau of Labor Statistics, the Fed’s favorite measure of inflation, the core PCE, remains stuck at 1.3% – well below the Fed’s stated goal of 2%. The core PCE, or personal consumption expenditures, measures the average prices of goods and services targeted towards individuals, but excludes food and energy prices.

And this is a problem for the Fed. You see, the Fed has two mandates from Congress.

First, they are to work towards full employment, which translates to a 5% unemployment rate. If you discount the record number of Americans who are not in the labor force, the Fed has achieved one of its primary objectives.

Of course, it’s a Pyrrhic victory. Currently, the labor force participation rate is about equal to the number of working Americans while I was a high school student in the late 1970s. That leaves upwards of about 90 million able bodied Americans out of the labor force.

Please don’t ask me to explain how we can have 90 million Americans NOT in the labor force and yet still have full employment. I don’t understand government math either.

But the second Fed mandate is where Janet Yellen is having trouble…

You see, the Fed signaled last month that it intends to raise the fed funds rate four times this year by as much as 250 basis points. While I don’t expect Yellen to pay too much attention to falling stock prices, she can’t ignore the accumulating evidence for a global slowdown.

There is no way she will be able to stick to her plans for four interest rate hikes. The economy is barely growing now, and any stubborn insistence to maintain the resolution risks tipping the economy into full-blown recession. Using Bayes’ Theorem, the chance for four rate hikes in 2016 are less than 20%.

But there’s another headwind to higher rates…

Should the global slowdown hit the U.S. sooner than expected, Janet Yellen won’t have any ammunition available to avoid recession in the U.S. Lowering rates will have a minimal impact since they’ve been so low for so long.

And any benefits of negative rates will do little to quell recessionary fears while decimating the returns of seniors trying to earn interest on their pensions and other assets.

So that leaves one terrible possibility…

The Fed could potentially accomplish a stealth quantitative easing via a technique called debt monetization. The government could create massive spending programs to stimulate growth and then incur huge deficits to support the spending. The deficits would be financed with government debt printed by the Fed.

This would likely be the beginning of terrible consequences for America if we were to go down than long dark road. In 10 years, the government would have just enough money to pay for two budget items only: interest and entitlements! There would be no money left for defense, infrastructure, or government salaries.

Not exactly a positive outcome…

Until Janet Yellen throws out her New Year’s resolutions, expect 2016 to see a lower stock market, higher Treasuries, and flat precious metals (gold) prices.

At the end of the day, maybe it’s a good thing her resolutions are in trouble. The alternative could be much worse!

More Silliness from CNBC

Serious journalism has been on the decline in America for the better part of a quarter century.

And this couldn’t be more true than in what passes as financial journalism at CNBC. Now, don’t get me wrong. CNBC is my financial channel of choice.

Their stock crawlers and index screens are unbeatable in relaying up to the second market action. Fox Business News could learn a thing or two about how to keep an investor in the know.

Unfortunately, that’s about all CNBC has going for it…

The talking heads are so unprepared to discuss relevant financial matters with anyone that the sound on my TV has to remain muted – otherwise I risk tossing my TV out a window.

Take a recent quote by one of CNBC’s perma-bulls that the stock market is now fairly priced on an historic basis. He suggested that now is the time to get back into the market for most individual investors.

How could he make such an irresponsible statement?

In his report, he indicated the market has a current price/earnings ratio (P/E) of 15.5, which is very close to the historic average. Moreover, a 15.5 P/E ratio is 34% lower than the recent highs in 4Q2015 – which in his mind means it’s time to pile back into stocks.

But in another example of journalistic failure, he got it completely wrong…

You see, he used ‘operating earnings’ in his calculations instead of the usual ‘reported earnings.’

What’s the difference between operating earnings and reported earnings? A lot!

Operating earnings are ‘adjusted’ earnings, which can be significantly higher than a company’s real net income. This is because companies can legally label some of their expenses as “special” or “one-time” expenses and leave them out of their earnings calculations.

In short, it’s a way to fool shareholders into believing a company posted better quarterly results than the reality. This helps prop up stock prices and provides management a bigger piece of the pie since their bonuses are tied to performance.

But ever since the debacle at Enron, company officers have been required to sign off on their financials. And trust me, a stiff jail term awaits any corporate officer signing off on ‘operating profits’ in their official reports filed with the Securities and Exchange Commission (SEC).

You see, every publicly traded company must file a copy of its quarterly results to the SEC using earnings reported under generally accepted accounting principles, or GAAP rules. This means a company must report what actually happened to the SEC. No fuzzy math or fictional ‘one-time’ expenses allowed.

So let us examine how the differences in operating earnings and reported earnings impact decisions about fair value in the stock market.

According to the CNBC talking head, the stock market is currently priced at approximately 15.5 times earnings. With today’s S&P 500 close of 1,868, a 15.5 P/E translates to corporate earnings of $120.

How does this jive with actual earnings reported under GAAP rules as required by SEC rules?

It’s not even close.

You see, according to actual earnings reported under generally accepted accounting practices, corporate profits were $94.87. This translates to a real market price/earnings ratio of 19.69, or a ratio 27% higher than the one promulgated by the errant CNBC host.

Despite the recent declines in the stock markets, today’s price/earnings ratio remains higher than 90% of all previous markets – meaning the stock market is still over-priced at current levels.

And it’s more evidence that a journalism degree remains the world’s most expensive 8th grade education! Somehow, I think that wouldn’t please my 8th grade journalism teacher, Ms. Millar!

Social Insecurity

Today’s post comes from a reader’s question concerning the likelihood of the Baby Boomer generation getting all of the promised benefits of social security…

The long-term efficacy of social security isn’t a popular question for Americans because it rightly terrifies them.  But there are several points that must be made…

Social security is in trouble. And not 15 years from now, but NOW!

In 2014, the social security administration took in $786 billion through the FICA tax. That’s a lot of money. Unfortunately, it was $73 billion short of the amount needed to pay the claims of $859 billion. For the first time in its history, Social security is in deficit mode.

Now, before you think this was a one-time event, let me set the record straight. Between now and 2026, the social security administration will run up a cumulative deficit of $1.6 trillion!

Here’s where this gets interesting…

We’ve been told for decades that the social security trust fund holds trillion in assets (cumulative social security surplus revenues since 1935) that are collecting interest. At the end of 2014, we were told the trust fund owned more than $2.8 trillion of assets.

Unfortunately, this is incorrect. There is not a single dollar in the social security trust fund. Nada. Zip. Zilch. So, where did the money go?

It was used for general budget activities such as defense spending and studying the mating habits of fruit flies. Now, I can already hear the comments from the political crowd saying I’m wrong. After all, the Social Security Act of 1935 mandated that the funds collected under the program could only be used by social security.

Not true.

In the landmark case whereupon the Supreme Court ruled favorably on the constitutionality of Social Security (Helvering v. Davis, 1937), the Court ruled that Social Security was not a ‘contributory’ insurance program. The Court ruled, “The proceeds of both the employee and employer taxes are to be paid into the Treasury like any other internal revenue generally, and are not earmarked in any way.” (italics mine)

In other words, the United States government can (and does) use social security taxes any way it deems appropriate. There are no laws requiring that social security money be used solely for social security purposes. The federal government has used this money to pay for increased federal spending at all levels of the federal government – from defense spending to pay raises for government employees.

Still, Americans have a ‘right’ to collect their social security in old age, right?

Again, not true.

You see, in another Supreme Court ruling (Fleming v. Nestor, 1960), the Supreme Court ruled that workers have no legally binding or contractual rights to their Social Security benefits. Furthermore, the Supreme Court indicated that social security benefits could be cut or eliminated at any time.

Specifically, the Court said, “To engraft upon the Social Security system a concept of ‘accrued property rights’ would deprive it of the flexibility and boldness in adjustment to ever changing conditions which it demands. It is apparent that the non-contractual interest of an employee covered by the [Social Security] Act cannot be soundly analogized to that of the holder of an annuity, whose right to benefits is bottomed on his contractual premium payments.” (italics mine)

In layman’s terms, you have NO legal right to ‘your’ social security. Never have. Never will.

Now, this doesn’t mean the government is going to suddenly stop paying social security benefits. Not for now, anyway. That would be political suicide for anybody to suggest an end to this system.

But the system is in imminent trouble. And unlike in the past where politicians could kick the can down the road far enough that they could retire before the problems became evident, this is no longer the case.

You see, social security has had two problems from the start that no amount of political posturing could solve. The first problem was the retirement age. In 1935 when the program was designed, the retirement age was set at 65. The government used this age because they knew most people in 1930s America wouldn’t live long enough to collect benefits. This is due to the average life expectancy being just 59 years in 1935. And sadly, the framers of social security didn’t address the possibility that life expectancies would increase. Today, the life expectancy in the United States is 78.8 years.

The second major problem from the start of the program is one of demographics. Here again the framers failed to take into consideration demographic trends throughout much of the 20th Century. When social security began, there were 41.9 workers for every retiree. Actuarially, it isn’t difficult to fund a program where more than 40 workers support a single retiree. In 2015, there are just 2.8 workers supporting every person collecting social security benefits. In fifteen years, the ratio will be 2:1. No amount of financial smoke and mirrors will prevent the system from collapsing under its own weight.

Now let me take a moment to channel a political commentator at MSNBC…

Sir, the social security trust fund is well funded through 2075. You’re just using scare tactics to frighten old people into believing the system won’t meet its promises for all Americans. You clearly have a political axe to grind.

So let’s look at the trust fund assets.

According to the social security trustees, there is $2.8 trillion in surplus funds on the books at the Social Security Administration. But it’s important to remember that these assets are book assets, not actual dollars. The dollars were spent the minute the government collected the taxes.

Now, in exchange for the actual dollars, the Treasury Department gave the Social Security Administration a paper ‘IOU” redeemable at a future date – including the payment of interest on the principal amount. In other words, the left hand of the government took money from the right hand of government, and promised to pay it back at some future date. Until the payment is made, the ‘borrowed’ funds would earn interest.

But remember, not a single dime of the money has ever been invested in anything, including the government’s own bonds. And the interest being credited to the government? Phantom. It isn’t real. The interest being credited to the surplus is nothing more than an accounting fiction.

Let me tell you, any company doing its books in this manner would see its managers rightly prosecuted and jailed. Fortunately, the day of reckoning for the government fraudsters is fast approaching, and I think some jail time for politicians is desperately needed.

But this brings up the question of how the government expected to pay the debts of the trust fund seeing that there were no real assets in the trust fund. Great question.

The fraudsters thought they could grow GDP fast enough (and big enough) while projecting implausible payroll tax revenues to cover future needs. What kind of GDP growth are we talking about? How about 5.1% annual GDP growth (on a nominal basis)!

Yep, the government expects to see annual GDP growth of 5.1% every year over the next 12-years to replace the interest not actually accruing on the social security trust funds. But there’s a problem that anyone other than a government fraudster could see a mile away…

The actual annual GDP growth rate of the United States of America hasn’t come anywhere near a nominal 5.1% rate in any year for the entirety of the 21st Century. Furthermore, coupled with ever-growing government regulations and a falling labor force participation rate, the government has a zero chance of growing GDP at sufficient levels over the next 12-years. It’s nothing short of a pipedream.

What this means is that the government had to print money to cover last year’s $73 billion shortfall.

Now, in the scheme of things, a $73 billion deficit in Washington DC is nothing. We’re used to the inability of elected officials and Ivy League lawyers to balance a budget.

The problem, however, is that Barack Obama has left the nation in even worse financial shape than George W. Bush. The year after Barack Obama leaves office, the government estimates that budget deficits will total $8 trillion in 12-years. And that’s NOT including social security spending.

Printing $73 billion is easy enough to hide from taxpayers and credit rating agencies. Printing $8 trillion borders on the insane. It can’t be done without destroying the economy.

And without the ability to effectively print their way out of a hole, the government will finally be forced to come clean to the American people. Of course, this means there will significant pain for people born after 1960.

We’re going to see benefit cuts of at least 33% in the next 12-15 years. And if you expect to retire at age 67 (actual retirement age for those born after 1960), good luck with that. The retirement age will have to go to 69 or higher (age 72 is consistent with the math) to keep the system in operation. And for those hoping to retire early on reduced benefits, eligibility will likely move to 64 years of age or higher (66 is likely).

That’s the good news…

If you were born after 1970, you had better plan your retirement with the expectation that whatever system is in force by then will pay a fraction of the benefits today’s retirees receive.

Simply put, you were born too late to get the same free ride as your parents and grandparents.

On the other hand, you will get the privilege of paying the bills of the four or five generations of retirees that voted idiots into office. And that’s thanks enough.

Impossible Trinity Taking the Market Lower

Despite claims to the contrary, economists have envied physicists for decades.

Physics envy is based on the desire for economic theories to replicate the beauty and symmetry of the mathematical formulae of physicists.

And a big part of this phenomena is the emphasis of finding equilibria.

You see, the concept of equilibrium in economics was imported from the field of physics, even though it isn’t a proper fit. Because economics is essentially a science of human action, the empirical data necessary to mimic the mathematical equations of physicists will forever remain out of reach.

It’s also the reason that former Federal Reserve Chairman, Ben Bernanke, recently told an audience in Korea that his policies were ‘economic experiments,’ and that the costs and benefits of his policies wouldn’t be understood for decades. Not exactly a resounding endorsement of activist monetary policy!

But make no mistake. Economists are able to formulate certain economic rules that, if violated, will cause economic harm to various participants.

One such rule is the Impossible Trinity.

The Impossible Trinity is a rule developed by Nobel Prize winning economist Robert Mundell in the early 1960s.

The premise of the rule is that no country can have an independent monetary policy, an open capital account, and a fixed exchange rate at the same time. Any attempts to do so will be met with the loss of monetary sovereignty when currency arbitrageurs use the resulting carry trade to their advantage.

China is the latest country to make a futile attempt to circumvent the rule. Of course, they have failed miserably. But their failure will not be confined to themselves. The country risks precipitating a massive global currency crisis.

China started the current crisis in early December by switching from a dollar currency peg to a trade-weighted exchange basket. The inability of the People’s Bank of China to properly make the switch inadvertently set off capital outflows from China. Now, the PBOC is struggling to pick up the pieces.

In the meantime, the PBOC is perilously close to a devaluation crisis as the yuan threatens to break through the floor of its currency basket. This is occurring despite a massive intervention by the central bank to defend their exchange rate.

The chart below illustrates China’s inability to support its currency.

Yuan

Now, in December, China burned through more than $120 billion of foreign reserves, and it’s a clear signal that capital outflows have reached systemic proportions.

But the PBOC doesn’t fully appreciate their problem. Not by a long shot.

In the near future, China will be forced to devalue its currency further, and possibly close or modify its capital account to some extent in order to preserve its remaining reserves.

This is a dangerous condition…

By devaluing its currency further, a strong deflationary signal will be received by a global economy already on the cusp of recession.  Even more worrisome, further devaluing by the PBOC risks setting off a chain-reaction much larger and more dangerous than the Asian crisis of 1998.

For now, any further currency devaluations will roil U.S. markets. It’s time to consider taking profits as a precautionary step to Chinese induced volatility.

The stock market will be unable to rise to its previous highs in light of the surge in volatility. Worse, the risk of a serious global recession becomes a greater possibility.

Economists don’t have the beautiful math formulae of physicists, but we do have rules by which an economy functions.   China has violated the rules, and without swift action to remedy the errors, a financial bloodbath is a distinct possibility.

 

 

 

Can the Fed Really Raise Rates?

Most Wall Street pros expect to see the Fed Funds rate rise between 300 and 375 basis points over the course of the next couple of years. At least that’s their belief…

The problem, though, is that it’s complete gibberish.

You see, the Fed front loaded an historic market rally beginning in March 2009. The financial mismanagement of Ben Bernanke and Janet Yellen was a concerted effort to create a wealth effect.

Unfortunately, their combined efforts have been an abysmal failure.

Here we are six years later and economic growth remains tepid at best – earning this recovery the title of most sluggish economic recovery in history. Worse, the current business cycle is now at 78 months. This is longer than 29 of the 33 previous expansions after a recession since 1854.

And the data indicates this expansion is on its last legs, as illustrated by the Atlanta Fed’s GDP NOW chart below…

A-gdpnow-forecast-evolution

Sans a miraculous turnaround in economic data, the U.S. economy is clearly heading for recession. And the Fed is completely helpless to stop the progression.

You see, the Fed has no ammunition at its disposal. Despite the recent rate hike, the Fed has no real room to lower rates. Now, they could go forward with negative rates like much of Europe, but there’s no reason to expect the Fed would fare any better than the ECB at generating economic activity.

No, the Fed is utterly impotent.

So what does this mean for investors?

A market selloff is in the cards in the very near future.

The markets are heavily priced. They are trading at roughly 19 ½ times earnings without any organic ability to grow their top or bottom lines.

It’s a recipe for disaster.

At best, the markets will trade flat for the next year. But believe me when I say that’s a best case scenario. A more likely scenario calls for the S&P 500 to see a 10-20% correction by 2Q2016.

But that doesn’t mean it’s time to flee the market.

You see, for the first time in several years, investors will be required to conduct real fundamental analysis when picking stocks. An accommodative Fed policy will no longer raise all the boats in the harbor.

In the end, that’s the way it should be. Price discovery depends on free and open markets without insulated government bureaucrats muddying the waters of economic discovery.

Don’t get me wrong, the Fed will continue to lead most people astray – it’s what they do best. And sadly, most Wall Street analysts will continue following the Fed right off the cliff.

But investors courageous enough to use fundamental analysis to find fairly priced stocks of companies growing their bottom lines will achieve lasting success.

Good hunting…