April 8, 2019
Recently, Wall Street has been myopically focused on the IPO of a ride-sharing company called Lyft, which by the way, is hemorrhaging money. Since investors have become much less concerned about profits and valuations, this offering was an incredible 20 times oversubscribed. Meaning, the underwriters received $47 billion of orders for Lyft shares but raised $2.3 billion. The company generated $2 billion in revenue last year and lost an incredible $911 million! Investors rewarded this profligate business model with a market cap of $27 billion.
This is a great example that Wall Street has gone nuts. The Lyft IPO price was $72 per share and shot up to $88.60 on its first day of trading. But the following trading day those shares were down 24% from the high. Indeed, this is emblematic of the dead canary in Wall Street’s coal mine.
Wall Street’s mispricing of this IPO is a perfect illustration of how the yield suppression from central banks has caused another stock market mania. The LYFT IPO should provide prudent investors with a stark warning: It is crucial to ignore the lure of lemmings and groupthink. Rather, they should concentrate on the fundamentals and the data—both of which point to a massive equity bubble.
Recent data points prove that the US and the global economy are weak, at best and cannot support the stock market at this level.
The Commerce Department said recently that retail sales fell 0.2 percent in February. Over the past year, retail sales increased by a slight 2.2%. Hence, after adjusting for inflation, growth in retail sales was not evident at all. Durable goods orders for February fell 1.6%. A key measure of business investment, known as core capital goods orders, fell for the fifth time in the last seven, dropping 0.1%.
You can forget about the capital spending boom, and productivity gains hoped for from the tax cut. Ex-autos and gas the number was -0.6% vs. +0.3% expectations. Spiking prices at the pump boosted the headline retail sales number but didn’t help most consumers’ wallets. The Chicago PMI in March slowed to a reading of 58.7 from 64.7. Order backlogs fell into contraction territory, while production and new orders fell from the previous month’s level. Remember, March data is hugely important because those readings occurred after the government reopened at should show a strong rebound–if not, the economy is in deep trouble. The March ISM Services Sector PMI, which fell to 56.1, was the weakest print since August 2017 and down from 59.7 in February.
The US automotive sector is giving us another warning sign about consumers’ health. Fiat Chrysler reported a 3% decrease in U.S. Auto sales for the first quarter of 2019, while General Motors sales fell 7% in the first quarter as all four of its brands recorded losses. Toyota Motor Corp reported a 3.5% fall in U.S. sales in March and a 5% drop for the first quarter. Nissan Motor Co. posted a 5.3% drop in sales in March, and its first-quarter sales were down a significant 11.6%.
The economic slowdown is even worse in Europe. Factories in the Eurozone had their worst month for almost six years in March. The EU’s IHS Markit’s March final manufacturing Purchasing Managers’ Index declined for an eighth month, coming in at 47.5 from February’s 49.3. China’s March PMI improved to 50.8, which is barely in expansion mode. However, Wall Street ignored the horrific EU data in favor of the hopes that China can bounce back. But the truth is Red China is a debt-disabled nation with a shrinking labor force and falling productivity. China’s household debt increased by 716%, Non-financial corporate debt jumped by 400%, and total government debt climbed by 416%, all since 2008. This was the product of its past stimulus packages. It is extremely doubtful that robust and viable growth can be produced from yet another round of government stimulus.
Turning back to the US, the data does not indicate the real estate sector will be aiding to the hopes of a second-half rebound in the economy.
February made it 14 straight months of year over year declines in pending home sales. The drop in pending sales was down 4.9% from January. The takeaway is clear: home prices have shot up well above incomes each year since 2012 due to Fed’s ZIRP. Now, home prices have become unaffordable for the first-time buyer for the most part, even though mortgage rates are coming down. Perhaps that is why we are starting to see the inexorable rise in home prices begin to reverse. The median sales price of a new home in February fell 3.6% to $315,300. The Home price/income ratio now stands at 4.4. It ranged from 3-3.5 from 1969-2001 and hit an all-time of 5.1 in 2005. Manhattan real estate sales fell for the 6th quarter in a row. That is the longest losing streak in the past 30 years.
Interest rates are falling commensurately with decelerating economic growth. Demand is down for homeownership due to affordability issues, and at the same time, banks are less incentivized to lend due to shrinking margins on new loans. The yield curve inverted recently and that inversion has led to a recession seven out of the last seven times it has occurred.
The most salient question is whether or not China’s massive stimulus efforts combined with the Fed’s abeyance with rate hikes and promise to end QT come October, will be enough to provide for viable global growth.
With all this, there are some small signs of stable data in the US, for example, the March ISM Manufacturing Index registering 55.3 in from 54.2 in February, which was a small increase. But that slight blip higher in the ISM was offset by the IHS Markit manufacturing PMI, which fell to 52.4 vs. 53 in February, which the lowest reading since June 2017.
The plain truth is the overwhelming majority of global data still points towards contraction and an anemic debt-disabled world. There is a contraction in global trade; the Baltic dry index has crashed; tax receipts are falling and, according to FactSet, there was the largest cut to Q1 S&P 500 EPS estimates since Q1 2016. EPS was cut by 7.2% to $37.33. The interesting part is that for all of last year the earnings for the S&P 500 was $161.57 & the projection for 2019 EPS is $168.19, or 4% growth. However, with Q1 projected to post just $37.33, it will take an absolute surge in global GDP and EPS to achieve anything close to that 2019 estimate. The current run-rate 2019 for full-year EPS on the S&P is below $150!
Therefore, the global equity market has priced in the environment that a return to a globally synchronized recovery is indeed already an established fact. Nearly every economist and market strategist is bullish; predicting a favorable outcome to Brexit, the trade wars, the slowdown in global GDP, the current recession in parts of Europe, the zero growth in Japan, US GDP growth slowing from 4.2% last year to 1.3% in Q1, which is projected by the NY Fed. They see no issues at all with record global debt levels and the $10 trillion worth of negative-yielding sovereign bonds; there is no fear over the threat from Donald Trump to close the southern border, or Trump imposing tariffs on autos from the EU. The level of complacency is astonishing. Only the tech bubble of 1999 can compare with the lunacy that Wall Street exhibits today.
Therefore, the only logical outcome is that disappointment lies ahead for the perma-bulls
A big drop in the stock market is inevitable. That collapse in asset prices will set the Fed up for a massive move back to ZIRP and QE along with fiscal spending that would make even Alexandria Ocasio Cortez blush, which will render the economy into a deep battle with stagflation. That stagflation will lead to some great opportunities on the long side but will also eventually set us up for a huge plunge in asset prices that will make Q4 of 2018 and 2008 look like a bull market. Such are the consequences derived from abrogating the free market in favor of the hubris of central planners.