The Truth About Wall Street Analysis

Authored by Lance Roberts via RealInvestmentAdvice.com,

Turn on financial television or pick up a financially related magazine or newspaper and you will hear, or read, about what an analyst from some major Wall Street brokerage has to say about the markets or a particular company. For the average person, and for most financial advisors, this information as taken as “fact” and is used as a basis for portfolio investment decisions.

But why wouldn’t you?

After all, Carl Gugasian of Dewey, Cheatham & Howe just rated Bianchi Corp. a “Strong Buy.” That rating is surely something that you can “take to the bank”, right?

Maybe not.

For many years, I have been counseling individuals to disregard mainstream analysts, Wall Street recommendations, and even MorningStar ratings, due to the inherent conflict of interest between the firms and their particular clientèle. Here is the point:

  • YOU, are NOT Wall Street’s client.
  • YOU are the CONSUMER of the products sold FOR Wall Street’s clients.

Major brokerage firms are big business. I mean REALLY big business. As in $1.5 Trillion a year in revenue big. The table below shows the annual revenue of 32 of the largest financial firms in the S&P 500.

(The combined revenue of the 32 largest firms last year was in excess of $1 Trillion with the revenue of the 97 financial firms in the S&P 500 bringing in $1.5 Trillion.)

As such, like all businesses, these companies are driven by the needs of increasing corporate profitability on an annual basis regardless of market conditions.

This is where the conflict of interest arises.

When it comes to Wall Street profitability the most lucrative transactions are not coming from servicing “Mom and Pop” retail clients trying to work their way towards retirement. Wall Street is not “invested” along with you, but rather “use you” to make income.

This is why “buy and hold” investment strategies are so widely promoted. As long as your dollars are invested the mutual funds, stocks, ETF’s, etc, brokerage firms collect fees regardless of what happens in the market. These strategies are certainly in their best interest – they are not necessarily in yours.

But those retail management fees are simply a sideline to the really big money.

Wall Street’s real clients are multi-million, and billion, dollar investment banking transactions, such as public offerings, mergers, acquisitions and bond offerings which generate hundreds of millions to billions of dollars in fees for Wall Street each year.

In order for a firm to “win” that business, Wall Street firms must cater to those prospective clients. In this respect, it is extremely difficult for the firm to gain investment banking business from a company they have a “sell” rating on. This is why “hold” is so widely used rather than “sell” as it does not disparage the end client. To see how prevalent the use of the “hold” rating is I have compiled a chart of 4625 stocks ranked by the number of “Buy”, “Hold” or “Sell.”

See the problem here. There are just 2.8% of all stocks with a “sell” rating.

Do you actually believe that out of 4625 stocks only 124 should be “sold?”

You shouldn’t.  But for Wall Street, a “sell” rating is simply not good for business.

The conflict doesn’t end just at Wall Street’s pocketbook. Companies depend on their stock prices rising as it is a huge part of executive compensation packages.

Corporations apply pressure on Wall Street firms, and their analysts, to ensure positive research reports on their companies with the threat that they will take their business to another “friendlier” firm.  This is also why up to 40% of corporate earnings reports are “fudged” to produce better outcomes.

Earnings Magic Exposed, an article written by Michael Lebowitz last year, provides details on the games played on Wall Street when it comes to forecasting corporate earnings. He summarized the article as follows:

Consider the ploy that companies and Wall Street are using to fool the investing public.

  • First, they grossly overestimate earnings for the upcoming year. By overestimating earnings, they tout financial ratios based upon inaccurate expected earnings and sell investors on a bright future. How many times have analysts claimed that forward looking price to earnings ratios are constructive for price gains? How “constructive” would they be if the expectations were reconciled to reality and lowered by 75%?
  • Second, they progressively lower expectations prior to the earnings release so that financial results are effectively underestimated. The same analysts that peddled double digit earnings growth a year earlier somehow can now claim that earnings are better than they expected.

If actual earnings varied somewhat randomly from above expectations to below expectations, we would likely fault the analysts and corporations with being poor forecasters. But when such one-directional forecasting errors routinely and consistently occur, it is more than bad forecasting. At best one can accuse Wall Street analysts and the companies that feed them information of incompetence. At worst this is another pure and simple case of institutions gaming the system through a fraud designed to prop up stock prices.  Take your pick, but in either case, it is advisable to ignore the spin that accompanies earnings releases and apply the rigor of doing your own analysis to get at the veracity of corporate earnings.

Wall Street Needs You To Sell Product To

When Wall Street wants to do a stock offering for a new company they have to sell that stock to someone in order to provide their client, a company, with the funds they need. The Wall Street firm also makes a very nice commission from the transaction.

Generally, these publicly offered shares are sold to the firm’s biggest clients such as hedge funds, mutual funds, and other institutional clients. But where do those firms get their money? From you.

Whether it is the money you invested in your mutual funds, 401k plan, pension fund or insurance annuity – at the bottom of the money grabbing frenzy is you. Much like a pyramid scheme – all the players above you are making their money…from you.

In a study by Lawrence Brown, Andrew Call, Michael Clement and Nathan Sharp it is clear that Wall Street analysts are clearly not that interested in you. The study surveyed analysts from the major Wall Street firms to try and understand what went on behind closed doors when research reports were being put together. In an interview with the researchers John Reeves and Llan Moscovitz wrote:

“Countless studies have shown that the forecasts and stock recommendations of sell-side analysts are of questionable value to investors. As it turns out, Wall Street sell-side analysts aren’t primarily interested in making accurate stock picks and earnings forecasts. Despite the attention lavished on their forecasts and recommendations, predictive accuracy just isn’t their main job.”

The chart below is from the survey conducted by the researchers which shows the main factors that play into analysts compensation.  It is quite clear that what analysts are “paid” to do is quite different than what retail investors “think” they do.

“Sharp and Call told us that ordinary investors, who may be relying on analysts’ stock recommendations to make decisions, need to know that accuracy in these areas is ‘not a priority.’ One analyst told the researchers:

 

‘The part to me that’s shocking about the industry is that I came into the industry thinking [success] would be based on how well my stock picks do. But a lot of it ends up being “What are your broker votes?”‘

 

A ‘broker vote’ is an internal process whereby clients of the sell-side analysts’ firms assess the value of their research and decide which firms’ services they wish to buy. This process is crucial to analysts because good broker votes result in revenue for their firm. One analyst noted that broker votes ‘directly impact my compensation and directly impact the compensation of my firm.’”

The question really becomes then “If the retail client is not the focus of the firm then who is?”  The survey table below clearly answers that question.

Not surprisingly you are at the bottom of the list. The incestuous relationship between companies, institutional clients, and Wall Street is the root cause of the ongoing problems within the financial system.  It is a closed loop that is portrayed to be a fair and functional system; however, in reality, it has become a “money grab” that has corrupted not only the system but the regulatory agencies that are supposed to oversee it.

Why You Need Independence

So, where can you go to get “real investment advice” and a true consideration of the value of YOUR money?

Thankfully, starting at the turn of the century, the rise of independent, fee-only, financial advisors, private investment analysts, research and rating firms began to infiltrate the system. 

Here is an example of the difference.

As an independent money manager, I use valuation analysis to determine what equities should be bought, sold or held in client’s portfolios. While there are many measures of valuation, two of my favorites are Price to Sales and the Piotroski f-score among others. I took the same 4625 stocks as above and ranked them by these two measures.

See the difference. Not surprisingly, there are far fewer “buy” rated, and far more “sell” rated, companies than what is suggested by Wall Street analysts.

Here is something even more alarming.

Just after the “dot.com” bust, I wrote a valuation article quoting Scott McNeely, who was the CEO of Sun Microsystems at the time. At its peak the stock was trading at 10x its sales. (Price-to-Sales ratio) In a Bloomberg interview Scott made the following point.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees.That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?

How many of the following “Buy” rated companies do you currently own that are currently carrying price-to-sales valuations in excess of 10x?

 

The next time someone tells you that you can’t “risk manage” your portfolio and just have to “ride things out,” just remember, you don’t.

 

HuffPo Yanks Article On Russiagate Hysteria By Award Winning Journalist Joe Lauria – So Here It Is

 Award-winning journalist and UN correspondent of 25 years, Joe Lauria, penned an outstanding article on the origins of “Russiagate” which he published to the liberal Huffington Post this week.

24 hours later, HuffPo yanked the article – leaving a dead link and a sad message in its place.

Perhaps the insights offered in the article didn’t quite conform to HuffPo’s approved narratives, or maybe it has something to do with Lauria’s new book “How I Lost By Hillary Clinton,” with a forward written by Julian Assange.

Considering Joe Lauria’s tenure as the Wall St. Journal’s UN correspondent of nearly seven years, as well as the Boston Globe’s for six – covering just about every major world crisis over the past quarter-century, his unique perspective on the matter merits a read.

Reproduced below for your edification:

The Democratic Money Behind Russia-gate

As Russia-gate continues to buffet the Trump administration, we now know that the “scandal” started with Democrats funding the original dubious allegations of Russian interference, notes Joe Lauria.

By Joe Lauria

The two sources that originated the allegations claiming that Russia meddled in the 2016 election — without providing convincing evidence — were both paid for by the Democratic National Committee, and in one instance also by the Clinton campaign: the Steele dossier and the CrowdStrike analysis of the DNC servers. Think about that for a minute.

We have long known that the DNC did not allow the FBI to examine its computer server for clues about who may have hacked it – or even if it was hacked – and instead turned to CrowdStrike, a private company co-founded by a virulently anti-Putin Russian. Within a day, CrowdStrike blamed Russia on dubious evidence.

And, it has now been disclosed that the Clinton campaign and the DNC paid for opposition research memos written by former British MI6 intelligence agent Christopher Steele using hearsay accusations from anonymous Russian sources to claim that the Russian government was blackmailing and bribing Donald Trump in a scheme that presupposed that Russian President Vladimir Putin foresaw Trump’s presidency years ago when no one else did.

Since then, the U.S. intelligence community has struggled to corroborate Steele’s allegations, but those suspicions still colored the thinking of President Obama’s intelligence chiefs who, according to Director of National Intelligence James Clapper, “hand-picked” the analysts who produced the Jan. 6 “assessment” claiming that Russia interfered in the U.S. election.

In other words, possibly all of the Russia-gate allegations, which have been taken on faith by Democratic partisans and members of the anti-Trump Resistance, trace back to claims paid for or generated by Democrats.

If for a moment one could remove the sometimes justified hatred that many people feel toward Trump, it would be impossible to avoid the impression that the scandal may have been cooked up by the DNC and the Clinton camp in league with Obama’s intelligence chiefs to serve political and geopolitical aims.

Absent new evidence based on forensic or documentary proof, we could be looking at a partisan concoction devised in the midst of a bitter general election campaign, a manufactured “scandal” that also has fueled a dangerous New Cold War against Russia; a case of a dirty political “oppo” serving American ruling interests in reestablishing the dominance over Russia that they enjoyed in the 1990s, as well as feeding the voracious budgetary appetite of the Military-Industrial Complex.

Though lacking independent evidence of the core Russia-gate allegations, the “scandal” continues to expand into wild exaggerations about the impact of a tiny number of social media pages suspected of having links to Russia but that apparently carried very few specific campaign messages. (Some pages reportedly were devoted to photos of puppies.)

‘Cash for Trash’

Based on what is now known, Wall Street buccaneer Paul Singer paid for GPS Fusion, a Washington-based research firm, to do opposition research on Trump during the Republican primaries, but dropped the effort in May 2016 when it became clear Trump would be the GOP nominee. GPS Fusion has strongly denied that it hired Steele for this work or that the research had anything to do with Russia.

Then, in April 2016 the DNC and the Clinton campaign paid its Washington lawyer Marc Elias to hire Fusion GPS to unearth dirt connecting Trump to Russia. This was three months before the DNC blamed Russia for hacking its computers and supposedly giving its stolen emails to WikiLeaks to help Trump win the election.

“The Clinton campaign and the Democratic National Committee retained Fusion GPS to research any possible connections between Mr. Trump, his businesses, his campaign team and Russia, court filings revealed this week,” The New York Times reported on Friday night.

So, linking Trump to Moscow as a way to bring Russia into the election story was the Democrats’ aim from the start.

Fusion GPS then hired ex-MI6 intelligence agent Steele, it says for the first time, to dig up that dirt in Russia for the Democrats. Steele produced classic opposition research, not an intelligence assessment or conclusion, although it was written in a style and formatted to look like one.

It’s important to realize that Steele was no longer working for an official intelligence agency, which would have imposed strict standards on his work and possibly disciplined him for injecting false information into the government’s decision-making. Instead, he was working for a political party and a presidential candidate looking for dirt that would hurt their opponent, what the Clintons used to call “cash for trash” when they were the targets.

Had Steele been doing legitimate intelligence work for his government, he would have taken a far different approach. Intelligence professionals are not supposed to just give their bosses what their bosses want to hear. So, Steele would have verified his information. And it would have gone through a process of further verification by other intelligence analysts in his and perhaps other intelligence agencies. For instance, in the U.S., a National Intelligence Estimate requires vetting by all 17 intelligence agencies and incorporates dissenting opinions.

Instead Steele was producing a piece of purely political research and had different motivations. The first might well have been money, as he was being paid specifically for this project, not as part of his work on a government salary presumably serving all of society. Secondly, to continue being paid for each subsequent memo that he produced he would have been incentivized to please his clients or at least give them enough so they would come back for more.

Dubious Stuff

Opposition research is about getting dirt to be used in a mud-slinging political campaign, in which wild charges against candidates are the norm. This “oppo” is full of unvetted rumor and innuendo with enough facts mixed in to make it seem credible. There was so much dubious stuff in Steele’s memos that the FBI was unable to confirm its most salacious allegations and apparently refuted several key points.

Perhaps more significantly, the corporate news media, which was largely partial to Clinton, did not report the fantastic allegations after people close to the Clinton campaign began circulating the lurid stories before the election with the hope that the material would pop up in the news. To their credit, established media outlets recognized this as ammunition against a political opponent, not a serious document.

Despite this circumspection, the Steele dossier was shared with the FBI at some point in the summer of 2016 and apparently became the basis for the FBI to seek Foreign Intelligence Surveillance Act warrants against members of Trump’s campaign. More alarmingly, it may have formed the basis for much of the Jan. 6 intelligence “assessment” by those “hand-picked” analysts from three U.S. intelligence agencies – the CIA, the FBI and the NSA – not all 17 agencies that Hillary Clinton continues to insist were involved. (Obama’s intelligence chiefs, DNI Clapper and CIA Director John Brennan, publicly admitted that only three agencies took part and The New York Times printed a correction saying so.)

If in fact the Steele memos were a primary basis for the Russia collusion allegations against Trump, then there may be no credible evidence at all. It could be that because the three agencies knew the dossier was dodgy that there was no substantive proof in the Jan. 6 “assessment.” Even so, a summary of the Steele allegations were included in a secret appendix that then-FBI Director James Comey described to then-President-elect Trump just two weeks before his inauguration.

Five days later, after the fact of Comey’s briefing was leaked to the press, the Steele dossier was published in fullby the sensationalist website BuzzFeed behind the excuse that the allegations’ inclusion in the classified annex of a U.S. intelligence report justified the dossier’s publication regardless of doubts about its accuracy.

Russian Fingerprints

The other source of blame about Russian meddling came from the private company CrowdStrike because the DNC blocked the FBI from examining its server after a suspected hack. Within a day, CrowdStrike claimed to find Russian “fingerprints” in the metadata of a DNC opposition research document, which had been revealed by an Internet site called DCLeaks, showing Cyrillic letters and the name of the first Soviet intelligence chief. That supposedly implicated Russia.

CrowdStrike also claimed that the alleged Russian intelligence operation was extremely sophisticated and skilled in concealing its external penetration of the server. But CrowdStrike’s conclusion about Russian “fingerprints” resulted from clues that would have been left behind by extremely sloppy hackers or inserted intentionally to implicate the Russians.

CrowdStrike’s credibility was further undermined when Voice of America reported on March 23, 2017, that the same software the company says it used to blame Russia for the hack wrongly concluded that Moscow also had hacked Ukrainian government howitzers on the battlefield in eastern Ukraine.

“An influential British think tank and Ukraine’s military are disputing a report that the U.S. cyber-security firm CrowdStrike has used to buttress its claims of Russian hacking in the presidential election,” VOA reported. Dimitri Alperovitch, a CrowdStrike co-founder, is also a senior fellow at the anti-Russian Atlantic Council think tank in Washington.

More speculation about the alleged election hack was raised with WikiLeaks’ Vault 7 release, which revealed that the CIA is not beyond covering up its own hacks by leaving clues implicating others. Plus, there’s the fact that WikiLeaks founder Julian Assange has declared again and again that WikiLeaks did not get the Democratic emails from the Russians. Buttressing Assange’s denials of a Russian role, WikiLeaks associate Craig Murray, a former British ambassador to Uzbekistan, said he met a person connected to the leak during a trip to Washington last year.

And, William Binney, maybe the best mathematician to ever work at the National Security Agency, and former CIA analyst Ray McGovern have published a technical analysis of one set of Democratic email metadata showing that a transatlantic “hack” would have been impossible and that the evidence points to a likely leak by a disgruntled Democratic insider. Binney has further stated that if it were a “hack,” the NSA would have been able to detect it and make the evidence known.

Fueling Neo-McCarthyism

Despite these doubts, which the U.S. mainstream media has largely ignored, Russia-gate has grown into something much more than an election story. It has unleashed a neo-McCarthyite attack on Americans who are accused of being dupes of Russia if they dare question the evidence of the Kremlin’s guilt.

Just weeks after last November’s election, The Washington Post published a front-page story touting a blacklist from an anonymous group, called PropOrNot, that alleged that 200 news sites, including Consortiumnews.com and other leading independent news sources, were either willful Russian propagandists or “useful idiots.”

Last week, a new list emerged with the names of over 2,000 people, mostly Westerners, who have appeared on RT, the Russian government-financed English-language news channel. The list was part of a report entitled, “The Kremlin’s Platform for ‘Useful Idiots’ in the West,” put out by an outfit called European Values, with a long list of European funders.

Included on the list of “useful idiots” absurdly are CIA-friendly Washington Post columnist David Ignatius; David Brock, Hillary Clinton’s opposition research chief; and U.N. Secretary General Antonio Guterres.

The report stated: “Many people in Europe and the US, including politicians and other persons of influence, continue to exhibit troubling naïveté about RT’s political agenda, buying into the network’s marketing ploy that it is simply an outlet for independent voices marginalised by the mainstream Western press. These ‘useful idiots’ remain oblivious to RT’s intentions and boost its legitimacy by granting interviews on its shows and newscasts.”

The intent of these lists is clear: to shut down dissenting voices who question Western foreign policy and who are usually excluded from Western corporate media. RT is often willing to provide a platform for a wider range of viewpoints, both from the left and right. American ruling interests fend off critical viewpoints by first suppressing them in corporate media and now condemning them as propaganda when they emerge on RT.

Geopolitical Risks

More ominously, the anti-Russia mania has increased chances of direct conflict between the two nuclear superpowers. The Russia-bashing rhetoric not only served the Clinton campaign, though ultimately to ill effect, but it has pushed a longstanding U.S.-led geopolitical agenda to regain control over Russia, an advantage that the U.S. enjoyed during the Yeltsin years in the 1990s.

After the collapse of the Soviet Union in 1991, Wall Street rushed in behind Boris Yeltsin and Russian oligarchs to asset strip virtually the entire country, impoverishing the population. Amid widespread accounts of this grotesque corruption, Washington intervened in Russian politics to help get Yeltsin re-elected in 1996. The political rise of Vladimir Putin after Yeltsin resigned on New Year’s Eve 1999 reversed this course, restoring Russian sovereignty over its economy and politics.

That inflamed Hillary Clinton and other American hawks whose desire was to install another Yeltsin-like figure and resume U.S. exploitation of Russia’s vast natural and financial resources. To advance that cause, U.S. presidents have supported the eastward expansion of NATO and have deployed 30,000 troops on Russia’s border.

In 2014, the Obama administration helped orchestrate a coup that toppled the elected government of Ukraine and installed a fiercely anti-Russian regime. The U.S. also undertook the risky policy of aiding jihadists to overthrow a secular Russian ally in Syria. The consequences have brought the world closer to nuclear annihilation than at any time since the Cuban missile crisis in 1962.

In this context, the Democratic Party-led Russia-gate offensive was intended not only to explain away Clinton’s defeat but to stop Trump — possibly via impeachment or by inflicting severe political damage — because he had talked, insincerely it is turning out, about detente with Russia. That did not fit in well with the plan at all.

Joe Lauria is a veteran foreign-affairs journalist. He has written for the Boston Globe, the Sunday Times of London and the Wall Street Journal among other newspapers. He is the author of How I Lost By Hillary Clinton published by OR Books in June 2017. He can be reached at joelauria@gmail.com and followed on Twitter at @unjoe.

Another name for a Tulip is……..

The USD price of Bitcoin just exploded higher – near $7900 – on heavy volume as CoinDesk reports The organizers of a controversial bitcoin scaling proposal are suspending an attempt to increase the block size by way of a software upgrade. Bitcoin is up over 10% today, now up over 650% YTD:

Real Motive Behind Saudi Purge Emerges: $800 Billion In Confiscated Assets

From the very beginning, there was something off about Sunday’s unprecedented countercoup purge unleashed by Mohammad bin Salman on alleged political enemies, including some of Saudi Arabia’s richest and most powerful royals and government officials: it was just too brazen to be a simple “power consolidation” move; in fact most commentators were shocked by the sheer audacity, with one question outstanding: why take such a huge gamble? After all, there was little chatter of an imminent coup threat against either the senile Saudi King or the crown prince, MBS, and a crackdown of such proportions would only boost animosity against the current ruling royals further.

Things gradually started to make sense when it emerged that some $33 billion in oligarch net worth was “at risk” among just the 4 wealthiest arrested Saudis, which included the media-friendly prince Alwaleed.

One day later, a Reuters source reported that in a just as dramatic expansion of the original crackdown, bank accounts of over 1,200 individuals had been frozen, a number which was growing by the minute. Commenting on this land cash grab, we rhetorically asked “So when could the confiscatory process end? As we jokingly suggested yesterday, the ruling Saudi royal family has realized that not only can it crush any potential dissent by arresting dozens of potential coup-plotters, it can also replenish the country’s foreign reserves, which in the past 3 years have declined by over $250 billion, by confiscating some or all of their generous wealth, which is in the tens if not hundreds of billions. If MbS continues going down the list, he just may recoup a substantial enough amount to what it makes a difference on the sovereign account.”

Then an article overnight from the WSJ confirmed that fundamentally, the purge may be nothing more than a forced extortion scheme, as the Saudi government – already suffering from soaring budget deficits, sliding oil revenues and plunging reserves – was “aiming to confiscate cash and other assets worth as much as $800 billion in its broadening crackdown on alleged corruption among the kingdom’s elite.

As  reported yesterday, the WSJ writes that the country’s central bank, the Saudi Arabian Monetary Authority, said late Tuesday that it has frozen the bank accounts of “persons of interest” and said the move is “in response to the Attorney General’s request pending the legal cases against them.” But what is more notable, is that while we first suggested – jokingly – on Monday that the ulterior Saudi motive would be to simply “nationalize” the net worth of some of Saudi Arabia’s wealthiest individuals, now the WSJ confirms that this is precisely the case, and what’s more notable is that the amount in question is absolutely staggering: nearly 2x Saudi Arabia’s total foreign reserves!

As the WSJ alleges, “the crackdown could also help replenish state coffers. The government has said that assets accumulated through corruption will become state property, and people familiar with the matter say the government estimates the value of assets it can reclaim at up to 3 trillion Saudi riyals, or $800 billion.”

While much of that money remains abroad – and invested in various assets from bonds to stocks to precious metals and real estate – which will complicate efforts to reclaim it, even a portion of that amount would help shore up Saudi Arabia’s finances.

A prolonged period of low oil prices forced the government to borrow money on the international bond market and to draw extensively from the country’s foreign reserves, which dropped from $730 billion at their peak in 2014 to $487.6 billion in August, the latest available government data.

Confirming our speculation was advisory firm Eurasia Group, which in a note said that the crown prince “needs cash to fund the government’s investment plans” adding that “It was becoming increasingly clear that additional revenue is needed to improve the economy’s performance. The government will also strike deals with businessmen and royals to avoid arrest, but only as part of a greater commitment to the local economy.”

Of course, there is a major danger that such a draconian cash grab would result in a violent blowback by everyone who has funds parked in the Kingdom. To assuage fears, Saudi Arabia’s minister of commerce, Majid al Qasabi, on Tuesday sought to reassure the private sector that the corruption investigation wouldn’t interfere with normal business operations. The procedures and investigations undertaken by the anti-corruption agency won’t affect ongoing business or projects, he said. Furthermore, the Saudi central bank said that individual accounts had been frozen, not corporate accounts. “It is business as usual for both banks and corporates,” the central bank said.

However, this is problematic: first, not only is the list of names of detained and “frozen” accounts growing by the day…

The government earlier this week vowed that it would arrest more people as part of the corruption investigation, which began around three years ago. As a precautionary measure, authorities have banned a large number of people from traveling outside the country, among them hundreds of royals and people connected to those arrested, according to people familiar with the matter. The government hasn’t officially named the people who were detained.

… but the mere shock of a move that would be more appropriate for the 1950s USSR has prompted crushed any faith and confidence the international community may have had in Saudi governance and business practices.

The biggest irony would be if from this flagrant attempt to shore up the Kingdom’s deteriorating finances, a domestic and international bank run emerged, with locals and foreign individuals and companies quietly, or not so quietly, pulling their assets and capital from confiscation ground zero, in the process precipitating the very economic collapse that the move was meant to avoid.

Judging by the market reaction, which has sent Riyal forward tumbling on rising bets of either a recession, or devaluation, or both, this unorthodox attempt to inject up to $800 billion in assets into the struggling local economy, could soon backfire spectacularly.

Meanwhile, for those still confused about the current political scene in Saudi Arabia, here is an infographic courtesy of the WSJ which explains “Who Has Been Promoted, Who Has Been Detained in Saudi Arabia

We Are Already In Depression (If Borrowing Money Is Not Income)

 

  • The U.S. economy is not as solid as it appears.
  • Statistical anomalies hide profound weakness.
  • I will examine actual GDP and actual employment.
  • Warning: not for the faint of heart.

Do you consider debt as income? Before you answer that, let’s perform a thought experiment. Imagine that you had taken a long cruise last fall and charged $10,000 to an American Express card. When you did your taxes this year, would have told the IRS that you had $10,000 income from American Express? Of course, you wouldn’t. Suppose a major oil company issues $800 million worth of bonds to develop a new old field. Would the company report that as income to the stockholders or the IRS? Of course, they wouldn’t. I am sure those sound like silly questions as the answer is a self-evident “NO!” We do not consider borrowed money as income. It is a liability that must be paid back. Then why do we count Federal Government debt when measuring national income? I will leave speculation as to the “why” to the readers and focus on the fact that we do count new Treasury Debt as income.

The modern concept of GDP was first developed by the Department of Commerce in 1934. Commerce commissioned Nobel Laureate Simon Kuznets of the National Bureau of Economic Research to develop a set of national economic accounts. Professor Kuznets headed a small group within the Bureau of Foreign and Domestic Commerce’s Division of Economic Research. I picture them meeting to develop statistical measures that would help the government to determine if the economy was recovering from the Depression. They are debating on how to measure all of the various sources of income. One economist suggests that regardless of the source of his income, there are only two things he can do… Spend it or invest it and we know how to measure consumption and investment (& savings). This was the foundation of the expenditure approach to measure GDP. I can imagine another one of the economists suggesting that when we sell more to other countries, the excess should be added to national income and subtracted if we buy more than we sell (Balance of Trade). Then another economist suggests that there is a third alternative to the idea that he will either spend or invest his income and that is paying taxes. Since the government takes a portion of National Income and spends it, they decided to add Government spending into the GDP calculations. While each component of this basic formula for GDP breaks down into hundreds or thousands of sub-components, the final calculation is:

GDP= PI + BT + GS

Where PI is private income (measured as consumption or investment)

Where BT is balance of trade

Where GS is government spending

So the final formula for GDP includes Government Spending. Notice that the government spending component does not take into account whether or not the government spent money taken out of private income (taxes) or borrowed it. When measuring National Income, we are giving equal weight to spending taxes on actual Private Income and money the Treasury borrows.

I suggest that government debt is not part of “ National Income” because it is not income. It is borrowed (often from sovereigns that are not our friends) and must be paid back eventually. We do not consider borrowed money as income anywhere else and it shouldn’t be considered as National Income. Debt is artificial stimulus, not National Income! Governments must pay back debt either through higher taxes, inflation/depreciated currency, reduced services or some combination thereof. If we want an accurate picture of whether or not the economy is self-sustaining, then we need to consider a measure I would like to introduce as “Actual National Income” which does not count artificial stimulus. Therefore to accurately measure the health of the economy, government debt must be subtracted from the formula. Please consider the GDP formula with the following modification.

Actual GDP = PI + BT + (GS – GB)

Where GB is government borrowing

So, if you acknowledge for the sake of argument that government debt is not actual national income, the following graph is how the U.S. economy looks like excluding stimulus. This is Actual GDP excluding artificial stimulus.

The data and chart comes from the Federal Reserve Economic Database (FRED.) It is Gross Domestic Product minus Treasury Debt. If you download them to a spreadsheet GDP is expressed in billions so 1,000,000,000 is expressed as 1, while Federal Debt is expressed in millions so 1,000,000,000 is expressed as 1,000. That is why the chart is (Gross Domestic Product * 1000.)

The government has always borrowed and spent money but actual GDP has grown as far back as the Fed has data. That is until 2008. Then something in our economy broke. Since then it appears the economy has been in what would be considered a depression but masked by huge Federal Government stimulus borrowing. Have we reached a level of economic activity that could sustain itself without this artificial stimulus? What would happen if the Government was forced to balance the budget? You decide for yourself, but remember that would remove 5-7% of our GDP. An economic depression is generally defined as a severe downturn that lasts several years. Does this look like a severe downturn that is still lasting several years? This is what our GDP minus artificial stimulus looks like.

Does that chart look like the data on a self-sustaining recovery? If it were self-sustaining the slope would be rising as it was prior to 2008. It continues to decline and is therefore anything but self-sustaining. In economics, deficit spending has long been called “Fiscal Stimulus.” Since 2008, this artificial stimulus has averaged 7.45% of GDP. The arithmetic (GDP-GB) is quite simple; without the artificial stimulus created by spending the proceeds of newly issued Treasury bonds, our GDP has declined an average of 7.45% each year since 2007! The following data/proof is downloaded from the source of the previous chart.

From 1929 to the end of the Great Depression and WWII, the Fed increased its balance sheet from 6% of GDP to 16% of GDP. From 2008 to 2014 the Fed grew its balance sheet from 6% of GDP to over 22% of GDP. The effective FED Funds target rate sank to 0-¼% band at the end of 2008 and stayed there until the end of 2015 when they went to 1/4-1/2% and stayed there a year. In fact, the Fed did not start serially raising rates until the end of 2016. Essentially, the Fed sat at the zero boundary for 8 years. Many wonder why they took so long to start the process of normalizing rates.

The FED has given us 8 years of “0” rates and almost twice as much of an increase in balance sheet expansion as they used in the Great Depression and WWII. Why? Did they see something that was more dangerous than the dual threats to the U.S.’s actual existence than the Great Depression and WWII combined? Or perhaps they were just engaged in a reckless and potentially dangerous monetary experiment? I have been asking those questions since the Fed’s balance sheet expansion exceeded that of the Great Depression & WWII. I believe what I have been describing as “ Actual GDP” may provide the answer. The Fed & the Government may have seen a depression that had the potential to be more threatening, deeper and longer than that of the 1930’s. If that assumption is correct, then the Fed & the Government have successfully masked a depression, avoiding a negative feedback loop and giving the economy time to heal. Has it healed? Please refer to the first graph “GDP minus Federal Debt” chart and tell me if you think the actual economy has healed. It is still heading down so I believe an informed and rational answer would be NO. If it has not healed one wonders what the Fed is doing.

In a report published on Wednesday, August 30, 2017, titled “With A Shutdown, There Will Be Blood”, U.S. chief economist at S&P, Beth Ann Bovino, writes that “failure to raise the debt limit would likely be more catastrophic to the economy than the 2008 failure of Lehman Brothers and would erase any of the gains of the subsequent recovery.” I believe Bivino is on to something, even though we now have a temporary extension of the debt ceiling. With the Federal Government borrowing and spending over 6-7% of GDP, then it stands to reason that without the Government’s ability to borrow new money, GDP would collapse 6-7% before a negative feedback loop type mechanism is engaged making it worse. It is just arithmetic. Since 2010 the amount of net new Treasury Bonds issued has averaged 6.5% of GDP. If the Federal Government were unable to issue new bonds then that amount would no longer be in GDP. Again, It is just arithmetic.

The labor market is reported as having created millions of jobs, but what kind of jobs? We often hear that we have full employment and a very tight labor market, that we have created so many jobs the Fed must raise rates. Since no one wants to raise a family working multiple part-time jobs, let’s examine U.S. employment in terms of full-time jobs,

The Federal Reserve database (drawing on U.S. Bureau of Labor Statics) tells us there were 121,875,000 people employed with full-time jobs in November of 2007 (just before the 2008 crises). As of August 2017, there were 125,755,000 people with full-time jobs. That means our economy has added a paltry 3,880,000 full-time jobs in almost 10 years as the population grew by about 23 million.

According to the National Center for Educational Statistics, there were 3,897,000 people who received a college degree including associates, bachelors, masters, and PhDs in the school year 2016-2017.

The good news is that most of the people who graduated from college in the 2016/2017 school year can have full-time jobs. The bad news is that in the 2016/2017 school year, those who dropped out of college graduated from high school or dropped out of high school do not have a full-time job. The really bad news is that everyone who graduated from college, who dropped out of college, graduated from high school or dropped out of high school from 2007 through 2016 do not have a full-time job. There have not been enough full-time jobs created in our economy for anyone out of high school or college in the last 9 out of 10 years. If the creation of enough full-time jobs to employ only 1 year of college graduates out of 10 years sounds like a tight labor market to you and not a depression, then perhaps some of the readers would like you to share some of whatever you are smoking.

In conclusion, I believe the U.S. economy is in a depression masked by debt. I further believe there is no indication we have had an actual recovery of the actual economy.

These observations could inform intermediate and long-term strategies. I am not using these observations as a timing tool, but rather as a depth finder for assessing risk when the next crisis unfolds or when market participants realize the emperor, not only has no clothes, he maxed out his credit cards buying them.

 

Why many Americans are still haunted by the Great Recession

  • Forecasts for America’s economic growth potential have been slashed post-crisis.
  • US GDP remains 15% below the pre-Great Recession trend, according to a study.
  • This helps explain the lack of wage growth and the sense of exclusion from the recovery.

Expectations are everything, especially in economics.

That’s why a distinct lack of progress in a few basic measures of economic progress, particularly relative to pre-crisis expectations, has left many Americans questioning how much they have personally benefitted from the economic recovery.

A new report from the Roosevelt Institute, a liberal think tank in Washington, highlights a number of ways in which “the recovery since 2009 is, in a sense, a statistical illusion.”

The study finds the nation’s total economic output, its gross domestic product, “remains about 15% below the pre-recession trend, a larger gap than at the bottom of the recession.” The first chart below shows that lag, while the second offers insights into just how badly the crisis dented expectations about the future.

ROOSEVELT1Roosevelt Institute

Roosevelt2 Potential forecastsRoosevelt Institute

Strong employment gains in recent months have brought the jobless rate down to a historically-low 4.3%. However, this decline has not been accompanied by rising incomes or consumer prices, generally associated with a sustainable economic boom. Some Federal Reserve policymakers have found this trend puzzling, while many labor economists point to underlying weaknesses in the job market, including high levels of underemployment and long-term joblessness, as drags on income.

Stagnant wages amid rising profits have meant that the wage share in US national income has fallen from 63% to 57% in the last 15 years, according to the report.

Roosevelt4 labor shareRoosevelt Institute

“It is impossible for the wage share to ever rise if the central bank will not allow a period of ‘excessive’ wage growth,” writes J.W. Mason, who authored the report. “A rise in the wage share necessarily requires a period in which wages rise faster than would be consistent with long term macroeconomic stability.”

In other words, if Fed officials tighten monetary policy at the first sign of wage increases, they will never allow the imbalances that have built up, including deep income disparities, to be torn down. Average hourly earnings rose just 2.5% on a yearly basis in July, nothing to write home about and certainly not enough to begin the ground lost over the last decade and more.

Business investment, which is key to long-run economic growth, has also been dismal during the now eight-year expansion.

“There is no precedent for the weakness of investment in the current cycle. Nearly ten years later, real investment spending remains less than 10% above its 2007 peak,” Mason writes.

“This is slow even relative to the anemic pace of GDP growth, and extremely low by historical standards. In the three previous [economic] cycles lasting that long, real investment spending had increased anywhere from 30% to 80%. Even shorter cycles saw substantially greater investment growth.” Roosevelt 3 investment growth Roosevelt Institute

Finally, Mason looks at whether the economy is at risk of running hot, generating inflation, which central bank officials cite to justify interest rate increases. The Fed has raised interest rates three times since December 2015 to a range of 1% to 1.25%.

“On the contrary, we argue, while a myopic focus on one or another data series might support a story of binding supply constraints, the behavior of the economy as a whole is much more consistent with a situation of depressed demand—an extended recession,” the report concludes.

Restaurant Sales, Traffic Tumble: “The Industry Hasn’t Reported A Positive Month Since February 2016”

 There appeared to be a glimmer of hope for the restaurant industry last month, when despite ongoing negative restaurant sales and traffic performance in April, BlackBox Intelligence Executive Director, Victor Fernandez said that “there are some reasons to be cautiously optimistic about the second quarter, at least in terms of improvement over what we’ve seen in the recent past” adding that “the move of the Easter holiday meant that April’s results were likely softer than they would have been without this shift, meaning spending in restaurants was probably a little stronger than the numbers show.”

Alas, any trace of optimism was doused with the latest BlackBox snapshot report (based on weekly sales data from over 27,000 restaurant units, and 155 brands representing $67 billion dollars in annual revenue) which found that May was another disappointing month for chain restaurants by virtually all measures.

Same-store sales were down -1.1%, which represents a 0.1% decline from April. At the same time, same-store traffic “growth” also dropped by -3.0% in May, down 3.2% on a rolling 3 month basis. Although traffic results improved from prior month, the growth in check average was lower than it has been in recent months, causing the fall in sales growth vs. March and April.

More concerning is that the restaurant industry has not reported a month of positive sales since February of 2016, according to BlackBox.

The latest report from the National Restaurant Association found much of the same: as a result of softer sales and customer traffic levels and dampened optimism among restaurant operators, the National Restaurant Association’s Restaurant Performance Index (RPI) registered a sizable decline in April. The RPI – a monthly composite index that tracks the health of and outlook for the U.S. restaurant industry – stood at 100.3 in April, down 1.5 percent from a level of 101.8 in March.

  • The Current Situation Index, which measures current trends in four industry indicators (same-store sales, traffic, labor and capital expenditures), stood at 99.1 in April – down 2.3% from a level of 101.4 in March. April represented the sixth time in the last seven months with a reading below 100, which signifies contraction in the current situation indicators.
  • The Expectations Index, which measures restaurant operators’ six-month outlook for four industry indicators (same-store sales, employees, capital expenditures and business conditions), stood at 101.5 in April – down 0.7 percent from March. Although the Expectations Index remained above 100 – signaling the anticipation of generally positive business conditions in the months ahead – it declined to its lowest level in six months.

April’s sharp decline in the RPI was the result of broadbased drops in both the current situation and expectations indicators. And, as BlackBox found, the Natl Restaurant Association confirmed that restaurant operators reported a net decline in same-store sales and customer traffic, which followed modestly stronger results in March. In addition, restaurant operators’ six-month outlook for both sales growth and the economy retrenched from more positive readings in recent months.

Restaurant operators reported a net decline in same-store sales for the sixth time in the last seven months. Only 34% of restaurant operators reported same-store sales increase between April 2016 and April 2017, down sharply from 57% of operators who reported higher same-store sales in March. 47% of operators said their sales declined in April, up from 30 percent who reported similarly in March.

Restaurant operators also reported softer customer traffic levels in April. Only 26% of restaurant operators reported an increase in customer traffic between April 2016 and April 2017, down from 41 percent of operators who reported higher traffic in March. Fifty-two percent of operators reported a decline in customer traffic in April, up from 38% in March.

* * *

Discussing the latest results, Fernandez said that “at this point, we believe the most likely scenario for the current quarter will be an improvement over recent quarters, while still suffering negative sales given the current consumer spending trends.” Or, as we would put it, no actual improvement.

Looking at the macro picture,  where there has recently been an upturn in retail spending on most goods and services, adds to the confusion as it stands in stark contrast to the continued decline in sales growth at restaurants. Consumers appear to be maintaining their spending at restaurants – at a declining pace – but increasing it for other goods and services. This change in consumer spending patterns was identified about a year ago and how much longer it will continue is unclear.

Additionally, the restaurant operators’ outlook for the economy is not as bullish as it was in recent months. 22% of restaurant operators said they expect economic conditions to improve in six months, down 15% points from the reading in December 2016. 12% of operators expect economic conditions to worsen in six months, while about two-thirds think conditions in six months will be about the same as they are now.

The details:

  • May sales were weak across all segments. Only the fine dining segment was able to achieve very small positive same-store sales growth during the month. The second best performing segment during May was quick service. That soft performance notwithstanding, the best performing segments continue to be those with the lowest and highest average guest checks. “Dining experience on one end and value and convenience on the other seem to continue to be key components of restaurant sales performance based on current consumer spending trends,” said Fernandez.
  • The weakest performing segment in May was casual dining. This was a bit unexpected since the segment showed improved performance during the first four months of 2017 after lagging the industry for several years. Casual dining has added a modest number of new units, but same-store sales declines have contributed to its overall loss in market share.
  • Despite weak sales results year-to-date, fast casual continues to win the market share battle. It gained the most share in the first quarter of 2017 compared with the same quarter a year ago. Aggressive expansion has driven total sales growth, but increased competition and market build-out have undoubtedly impacted same-store sales for the segment. The only other segment that gained market share year-over-year was quick service.

There is a silver lining: while overall sales continue to decline for most of the industry, there are pockets of opportunity that some brands have capitalized on to boost performance. Dine-in sales have been negative year-to-date, but to-go is up 2.9 percent, perhaps facilitated by recent introductions of smartphone-based ordering. Sales are also up in catering, delivery, and drive-thru. From a day part perspective, breakfast and mid-afternoon sales offer continued opportunities for growth, while lunch and, especially, dinner sales continue to stumble.

Ironically, in addition to challenges from falling guest counts and consumer spending, strong challenges continue to confront restaurants in both staffing and retaining enough qualified workers. We say ironically because as we showed after the latest jobs report, restaurant/fast food/waiter/bartender hiring remains the only strong spot in the US labor market. As the chart below shows, starting in March of 2010 and continuing through April of 2017, there have been 87 consecutive months of payroll gains for America’s waiters and bartenders, an unprecedented feat and an all-time record for any job category.Putting this number in context, total job gains for the sector over the past 7 years have amounted to 2.378 million or just under 15% of the total 16.4 million in new jobs created by the US over the past 87 months

And yet, according to BlackBox, restaurant operators are pessimistic regarding the difficulty of recruiting in the upcoming quarters. Part of the problem is that hiring for new restaurant positions has started to pick up again. The number of employees in the chain restaurant sector increased by 1.9 percent during April compared with a year ago, up from 1.5 percent growth recorded in March. The other issue affecting staffing is rising turnover. Turnover rates for both hourly employees and management staff increased again during April. “The turnover numbers that we are reporting are stunning”, said Joni Thomas Doolin, CEO of TDn2K. “Many of the brands that we track are already facing unsustainable levels of staffing vacancies. Most alarming is the fact that over 70% of employees are leaving voluntarily as opportunities for better work increase”.

Meanwhile, the overall labor market nearing full employment doesn’t hint at relief for operators anytime soon. The consequences of turnover are well documented by TDn2K. Not only does it impact service levels and guest satisfaction, which correlate to traffic and sales, but it is also a huge source of additional costs hurting the bottom line. According to a recent study by People Report, it costs on average about $2,200 to replace a single restaurant hourly employee, while the cost of turnover for all levels of restaurant management is on average about $15,000 per manager.

“The companies who are leading in the marketplace are starting by winning in the workplace. Being a great employer has never been more important,” stressed Doolin.

The summaryafter 14 months of continuous declines for the restaurant industry, the end of the tunnel is nowhere in sight.

State Corporate Tax Receipts Just Crashed The Most Since The Recession

After flatlining for the past year, US income tax receipts – both at the federal government and on a state and local level – have been disappointing, and have posted a sharp drop since the start of the year, which is “sounding an alarm about the health of the US economy” in BofA’s words (in addition to the countless other alarms about the health of the economy, which however are ignored due to the record stock market).

As Bank of America highlights something we warned about last September, according to the Rockefeller Institute and CBO, US federal income tax receipts have come in about 3% below expectations this year.

Digging deeper, the disappointment was largely in personal current tax receipts, with withheld tax receipts showing little growth over the prior two-quarters. The story is a bit different for state and local governments where personal tax receipts were fairly stable, but there was a significant decline in tax receipts for corporate income.

In fact, corporate income tax receipts fell a sharp $7bn in 1Q, the biggest drop since the recession. Since corporate income tax receipts only make up about 14% of the total, there was still a modest gain in overall state and local tax receipts. While there has been a particular weakness of late, the trend through last year was weak; according to the Rockefeller Institute, total state tax collections grew only 1.2% in FY16 (declined in real terms), the weakest performance since 2010.

In an attempt to explain away this otherwise troubling development, the CBO has proposed that the weakness in tax receipts may reflect the shift of taxpayer income into later years on the anticipation of legislation to reduce tax rates, which however is looking increasingly unlikely. Presumably, this would have the biggest effect on high income and high net-worth individuals. And this will matter for the aggregate figures as the top 1% of earners account for almost 40% of federal personal income tax receipts.

If indeed, it is the case that high-net-worth individuals and smaller corporations are delaying payments, there would be pent-up tax receipts. As such, tax receipts should jump if and when tax reform is passed or it becomes clear it will fail. Either way, behavior should shift, leading to an increase in declarations of income. The question is over timing

A more likely explanation is that state tax collections continue to be strain from the energy sector, which pays taxes based not on non-GAAP imaginare “wishful earnings”, but on hard cash, which for most companies, is still a trickle. This is confirmed by a map of tax receipts on a geographical basis which isolates the energy-patch states. There is a clear pattern of weakness in energy states like Wyoming, West Virginia, Texas, Oklahoma, and North Dakota. Alaska is also heavily oil-dependent and while growth in tax receipts increased sharply, it is coming from a subdued base.

While a modest recovery in oil prices earlier in the year may have helped, the recent decline will undoubtedly add to further pressure on state corporate tax receipts.

Why does this sharp drop in tax revenues matter? Simple: tax receipts are tracked for varioous reasons, most directly they influence the forecast for government spending. As BofA notes, “a slowdown in tax receipts could lead state and local governments to reduce spending or increase taxes to make ends meet.”

According to the Rockefeller Institute, uncertainty surrounding federal tax reforms “leaves the states in the dark as they are finalizing state budgets for the fiscal year 2018.” It would seem the combination of potential policy changes on the horizon and the weakening in tax collections results in weak state and local spending. And the data already show hesitance on the part of state and local governments, with state and local government expenditure slicing an average of 0.06ppt from GDP growth over the past four quarters (Chart 3).

 

On a federal level, it will impact the amount the government has to borrow to fund its deficit, therefore determining when the government will hit the debt ceiling. This is quite relevant today since the debt ceiling was officially reached on 17 March and has been extended using extraordinary measures. However, the weakness in tax receipts could create challenges, pulling forward the date that the debt ceiling is hit. This was likely a motivating factor for Treasury Secretary Mnuchin to ask Congress to raise the debt ceiling before the Congressional summer recess begins on 28 July. In our view it is possible this becomes another point of conflict in Washington in coming weeks.

But most importantly, economists care about tax receipts because it is one of the few unvarnished, unadjusted, and realistic data points regarding the health of the overall economy. Tax receipts are a function of income creation in the economy: a slowdown in tax receipts indicates a slowing in income creation and therefore overall economic performance. Growth in federal tax receipts trends with the growth in aggregate payrolls (aggregate hours worked x earnings), which is why the recent deterioration in federal tax receipted is especially troubling.