Smoke And Mirrors Everywhere

Tyler Durden's picture

From the latest Bert Dohmen Wellington Letter: Smoke and Mirrors Everywhere. Must read commentary with some notable highlights.


There are so many distortions in the markets today that traditional technical indicators are no longer as reliable as in the past. Trading volume in the markets used to be a most reliable indicator. But today, about 50-70% of daily trading volume is from the "high frequency" trading computers. Imagine! If it weren't for these, the stock market might have to shorten hours for lack of interest. But trading volume in the dollar term is at a record high. What's going on? Here is a great chart from our colleague, Alan Neuman's Crosscurrents (

It shows that although the total worth of listed stocks is now lower than in 1998, the dollar value of trading is about 3 times greater. That's the "high frequency" trading operations. They are in a trade only for minutes or a few hours. That's keeping the exchanges alive. They need that business.

Additionally, big volume has come from just four stocks: Fannie Mae, Freddie Mac, AIG, and Citigroup. On some days, these four stocks accounted for 40% of total volume. The first two firms are considered to be totally worthless by some analysts. To us that confirm that this rally has nothing to do with "investing," but more with computerized speculation.

On IPOs:

Have you noticed the number of IPO's and secondary offerings? The private equity firms are taking a bunch of their company’s public. These are firms they acquired during the boom, loaded them up with debt to pay themselves multi-billion dollar fees, and now they are scrambling to shed the over-indebted carcasses.

Other firms are going public as well. They can't get credit, so they sell stock. Is all this bullish or bearish? The media tells you its bullish. It shows that the markets are functioning again. That's true. However, we notice that many of this IPO's aren't working: the stocks quickly drop below the offering price within a few days. That means that the syndicate offering the stock couldn't or wouldn't support it. They didn't want to risk their own money.

Therefore, to us it looks more like an effort to exchange paper (stock) for good cash, much like was seen at the top in 2007. Remember, that was one of our important "canaries in the mine" in 2007, when a major P-E firm hastily went public, grabbing around $4.5 billion of the public's money. The stock imploded thereafter. Our reaction to IPO's that fail is, when Wall Street is eager to sell you something, pretend you're in a used car lot: be suspicious!

On earnings estimates and actual earnings:

In the financial media, you always hear the phrase that so many companies are reporting earnings "better than expectations or estimates." But you seldom hear how much down they were from the earnings a year ago. That is very deceptive.

The "estimated earnings" come from Wall Street. It behooves them to keep them low so that companies can easily beat them. That's what stimulates buying enthusiasm. It's a charade. So, let's see what the real earnings comparisons were. Second quarter earnings for the S&P 500 stocks were down a hefty 27% over the year ago numbers. For the third quarter, they are expected to show declines of 25%. And that's with all the easy cost cutting. What will the companies do next year, when they really have to cut into the muscles to get some cost reductions?

On a valuation basis, this is now a very expensive stock market. Valuations are at levels as high as or higher than what's normally seen at bull market tops. Another mini-bubble has been created by the Fed. They think that piling trillions of debt on top of the trillions existing in 2007 will resolve the crisis. That can only happen in fairy tales.

On valuations:

The S&P 500 Index is now selling at 26 times operating earnings. That's more expensive than at the bull market top in 2007. Are things really better than at the five-year bull market top in 2007? What about the trillions of dollars of bad assets still on the books of financial institutions around the world? Most analysts agree that the market is over valued. Yet they have to participate because the market is going up. They hope to be the first ones out of the exit when the plug is pulled. Do you think you can do that?

And overall market outlook:

On a valuation basis, this is now a very expensive stock market. Valuations are at levels as high as or higher than what's normally seen at bull market tops. Another mini-bubble has been created by the Fed. They think that piling trillions of debt on top of the trillions existing in 2007 will resolve the crisis. That can only happen in fairy tales.

So, if technicals are distorted, and the fundamentals are irrelevant in the markets, what can a trader or investor rely on? The speculators can do well to "go with the flow." That's a high risk proposition. The more prudent investor should go with his own analysis, ignoring all the stuff in the media. He will look at the facts, not the promotions in the media. Listen to the CEO's, who are much more cautious at this time.

We continue to repeat that the current rally has nothing to do with fundamentals. It has everything to do with hope, expectations, and liquidity which are not going into economic activity. The current Fed policy is ZIRP. That means Zero Interest Rate Policy. That's the driving factor, especially for the financial stocks.

Full report below.


h/t J.S.

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Anonymous's picture

Its intellectually dishonest to use improper numbers to justify your thesis. SP500 2009 consensus earnings estimates is 57.97 , which implies a PE of 18.6x. Off of 2010 estimates that number is 15.2x. These numbers are not horribly inconsistent with exit recessionary multiples. There's an argument to be had as to whether we are in that environment, but its understandable why the market has rallied the way it has

Rainman's picture

Speaking of honesty, is the 57.97 figure with or without the effect of hundreds of billions in mark-to-myth earnings puff within the financial sector ??

Just curious.

deadhead's picture

beautiful rainman.

i would add the off balance sheet crap coming soon to a theatre near you.

now, we know the fdic won't require capital raises for this gargantuan turdfest, but at least they will be on the balance sheet for all to see.


Steak's picture

Source data:

Aww how cute, using the operating earnings as the basis for your earnings multiples.  You must be one of those teenage redbull-addled traders that the quant shops use because trained monkeys fling too much poop around the trading room.  I guess no one ever explained the difference between operating earnings and as reported earnings.

2009 as reported earnings estimate: $39.75
2010 as reported earnings estimate: $45.50

But I guess your highschool intro-to-economcs teacher and quant shop recruiter said that writedowns and charge-offs don't matter.  Well here's a little tip to the wise.  If a non performing loan is written off or you have to pay severance to a fired employee, that money isn't available to your company anymore.

Cursive's picture

Are you Steve Liesman or just channeling Steve Liesman?  I would sooner believe in the Tooth Fairy than the fictitious numbers these sell-side analysts are pushing.  Give it up man, it's a sales industry.  I know they're selling stocks and not autos, but it's basically the same once you get past the so-called glitz and glamor of Wall Street.

Cognitive Dissonance's picture

Why is it that when a S&P 500 company has positive earnings, they are counted towards the S&P 500 collective "e" but when they have negative earnings they are not subtracted from the S&P 500's collective "e"?

Is it becuase intellectually it's so very difficult to prove a negative or is the "system" biased towards growth and positive outlook and thus it's OK to cook the books if everyone agrees to do so?

By the way, I'm a little tired of the so called "ex items", that wonderfully vile accounting trick that's supposed to be used for truly one time "surprise" or unexpected expenses.

If you pull up these reports it's amazing what they consider one time unexpected expenses.

Just askin'

rootless cosmopolitan's picture

Aren't they subtracted? S&P reported negative per share earnings summarized over all companies for Q4 2008. This couldn't be, if you were right about this, could it?



Cognitive Dissonance's picture

Lot's of games are played, including using projected forward earnings instead of actual earnings. Many analysis, rating agencies and economists don't consider negative earnings as real and thus back them out of the data.

S&P does the same thing. They also report the actual numbers. It's always instructive to read the actual hard data. Go to the S&P web site and download the actual spread sheets of data if you're interested in hard numbers.,3,2,2,0,0,0,0,0,0,5,0,0,0,0,0.html

Green Sharts's picture

Let's say 450 companies of the S&P 500 have positive earnings of $60 per share and 50 companies lose $30 per share, resulting in S&P 500 earnings of $30 per share. If you were going to apply a P/E multiple to the S&P 500, should you use $60 or $30 for the EPS number?

Unscarred's picture

Green SHARTS?!


Cognitive Dissonance's picture

And that, my friend, is the crux of the question we are discussing. How does one "fairly" measure the P/E.

Do you look back or project forward. Considering how manipulated the numbers are getting, is any forward earnings projection based in reality? Do you back out negative earnings or not? And don't get me started on how they figure the multiple.

I will say one thing. Nearly every analysis report I've been reading lately (with notable exceptions, some of which have appeared here on ZH) appear to have started out with the desired P/E ratio and then worked backwards to create a fantasy to support it.

To answer your question, I think negative numbers/earnings should be subtracted if positive numbers/earnings are being added. But I'm biased because I'm not selling my advice to people who wish to hear only what can justify their bonuses or market calls.

Green Sharts's picture

In the example I gave, I think it makes more sense to use the $60 EPS number, backing out the impact of the 25 money losing companies on the index EPS because the stock of a money losing company can't be worth less than zero.

That's not to say I think the market is undervalued. I think it's considerably overvalued because it incorporates a normal economic recovery and 20%+ increases in EPS in both 2010 and 2011, a pipe dream in my opinion. And quality of earnings is a huge issue as well.

Cognitive Dissonance's picture

Green Sharts,

Your example makes sense. And I'm sure I could successfully argue the other side.

I do find it interesting that because we are discussing how to calculate the S&P P/E, we (the collective we) aren't talking about if the S&P ever hit a low enough number to represent true value.

Take a trip down memory lane and look at all the big market crashes. When we finally hit the "bottom" the P/E was usually in single digit territory, somewhere around 6-8, and rarely above 12 or 13 on smaller recession bottoms.

Did we ever get there this past March? If not, why not? Why are we constantly using yesterday's measuring stick to assess if today's market is fairly valued?

I'm not gonna pay a lot for that muffler.

Cursive's picture

"because the stock of a money losing company can't be worth less than zero."

Yes it can.  Your comment would be more appropriate if there had been no bailouts.  However, they've off-loaded it onto the taxpayer and the rising public debt will squash future economic growth.  We have plenty of this going on now.  The financials were over 20% of the S&P in 2007.  The S&P needs those earnings.  You can't ignore the loss of those earnings.  The TBTF banks are all worth less than zero, but continue to trade at high multiples.  I mean, even Fannie and Freddie are still trading.  I guess your reasoning is prevailing, though.

Cognitive Dissonance's picture

Cursive, you said....

I guess your reasoning is prevailing, though.

You have just described concensus group think. It doesn't need to make sense or be based upon logic or supportable reasoning, it just needs to be widely agreed upon and followed/acted upon.

The bailout money has elevated more than just the financials. The proof is simple. Remove it and see where the market goes. It (the bailout money/stimulus) by definition is an artificial influence on the market. The assumption is that once removed (and after the economy has repaired itself) the market will be self supporting. That is all that's being used to justify these (IMHO) high P/E rations.

I've always wondered about something. If a process of "reasoning" is actually illogical circular group think, is it really "reasoning" or simply a mass delusion. I'm not being dismissive. I've been burned too often by what I consider to be mass delusions.

But define for me momentum or "going with the flow" or any other term for a movement or actions of people supported by no reason other than they are moving.

Cognitive Dissonance's picture


Remember this?

"I've seen the future. You know what it is? It's a 47 year old virgin sitting around in his beige pajamas drinking a banana broccoli shake singing I'm an Oscar Mayer wiener."

Green Sharts's picture

No, a common stock can't be worth less than zero. The maximum loss of an equity holder is the amount invested. The taxpayers can't send a bill to the shareholders of Fannie and Freddie and GM and AIG for the losses the taxpayers will ultimately incur.

With regard to lower future growth due to the financial meltdown and rising debt, I agree with you. That has to be factored into the multiple you're willing to put on individual companies and on the S&P 500. If you look at cyclical companies like banks, CAT, UPS, NUE, etc., the market is pricing them as if we'll have a typical post-recession recovery and revenues, profit margins and earnings will go back to at least in the neighborhood of what they were in 2006-07. I think there's virtually no chance of that happening in the next few years.

The CEO of Nucor, the largest steel producer in the U.S., apparently isn't seeing too many green shoots:

"While overall steel mill utilization increased from 46% in the second quarter to 69% in the third quarter, the increase was primarily due to the end of customer destocking. Our view remains that there has been little improvement in real demand and the uncertainty in our economy is still very high. We also continue to believe that real demand is in for a long, slow recovery."

Steak's picture

My favorite "tell it how it is" CEOs are of NUE, EMR, and'll get no BS out of those folk.

Green Sharts's picture

Andrew Gould of Schlumberger (which reports tomorrow) is another CEO who is a straight shooter.

Cognitive Dissonance's picture

Green Sharts, you are clearly intelligent and I respect your views. Please forgive me because I'm gonna have some fun with your words.

The taxpayers can't send a bill to the shareholders of Fannie and Freddie and GM and AIG for the losses the taxpayers will ultimately incur.

Considering what the Obama Administration just did to the Chrysler bond holders, I wouldn't be so sure about that. In one fell swoop, all the rules of the game were put on notice that they're subject to change based upon the desperation level of the masters of the universe and their pet Ponzi.

We are about to enter The Twilight Zone where anything goes and nothing makes sense.

I pledge allegiance to the Banana Republic of the United States of America.

Cursive's picture

Green Sharts,

We basically agree.  I think I read you to agree that the bank losses and taxpayer bailouts will have a significant cost to our economy.  I was also trying to point out that these losses did not stop at the corporate shell; these losses have been borne by the taxpayer in an attempt to keep the banks solvent.  I agree that common stock can't be worth less than zero, at least from simple equity holder's point of view.  But let's not forget the effect that massive leverage can have on one's portfolio.  A speculator using leverage could lose multiples of their capital.  That is what we are seeing here and it should ultimately be reflected in the multiple assigned to the P/E, as you suggested.

Anonymous's picture

The process is akin to filling out an income tax return. Start at the end and work backwards until everything lines up. What's the problem ?

rootless cosmopolitan's picture

I was actually referring to the hard numbers published by S&P in following spreadsheet:

These data show negative earnings summarized over all companies in Q4 2008 of -$0.09 and -$23.25 for operating and reported earnings, respectively. This is why I wonder. But I think now I might have misunderstood you and you were referring to projected future earnings.



rootless cosmopolitan's picture

But you only assume he is talking about 2009 estimated earnings, don't you? If he actually talks about the 12 month trailing operating earnings up to Q2 2009 a P/E ratio of 26 is about right, according to the data published by S&P. If we take the 12 month trailing reported earnings, instead of the made up operating earnings the P/E ratio is about 140, currently. Also, if we move a quarter forward in time, excluding Q3 2008, but including Q3 2009, the numbers are still about the same.



I need more cowbell's picture

Just as a curiousity, how does it actually feel to have your balls crushed thrice?

EDIT: 5 times

Anonymous's picture

You do not read, and if you do read, you do not understand. Sorry.

Anonymous's picture

Over the past 100 years, during every recession or depression the PE has only been ~4-6.

Anonymous's picture

The goal of any portfolio manager is performance. S&P 666 to 1096 cannot be ignored. The bear case, thanks to ZH, is well known. Regardless of what anyone believes about the markets, the armaggedon scenario is off the table. I believe the days of "cliff diving" are behind us.

geminiRX's picture

Yup - this confirms it, time to sell....



Anonymous's picture

That's what makes a horse race.

Cursive's picture

Agreed, geminiRX.  Thank you to Anon for ringing the bell at the top.  Uh, there will be plenty of cliff diving to come, I only wish we could have avoided the collateral damage.

Anonymous's picture

Too bad you gomers were saying this at Dow 8200. I'll write from the Fire Island beach house I just bought.

Cursive's picture

Oh, great.  More yahoo board flaming.  You can't substantiate your argument so you resort to sounding superior because of some a posteriori stock picking prowess.  Let me be the first to tell you that your fantasy of buying a Fire Island beach house is roughly equivalent to the fantasyland of this stock market.  Please, whatever you may do going forward, buy and hold.

Anonymous's picture

Hey you highbrow take your attitude and your thesaurus and join the legions of ZH fans who continue to delude themselves.
Maybe you should consider joining a cult or at least get out more.

mdtrader's picture

They simply transferred the debt problem from the private sector to the public sector. If this causes a crisis with the currency and or in the bond market, it will make the banking and credit crisis look like Disney World.

Cognitive Dissonance's picture

"I believe the days of "cliff diving" are behind us."

Please define "cliff" and "diving" for me.

A 10 minute google search will undoubtedly bring up thousands of quotes of official and professional pronouncements that the worst is behind us.

These assurances are usually uttered immediately after the "recovery" from the last "cliff diving" episode. My question is, how did that work out each time?

Anonymous's picture

The most common sentiment expressed on this blog is skepticism of the marketplace. I am entitled to my opinion,as is anyone. I think the S&P's are ok here and that is that. The markets are subjective. I get what I need from them as should you.

Anonymous's picture

P.S. Stop googling and watch the tape. Traders trade.

Cognitive Dissonance's picture

Who the hell is Broccolini and where do you think you are? :>))

The most common sentiment expressed on this blog is skepticism of the marketplace.

That is by far the greatest understatement I've read on this blog in a few weeks.

I am entitled to my opinion, as is anyone.

I wholeheartedly agree that you are entitled to your opinion. I'm asking you to explain it, not surrender it.

The markets are subjective. I get what I need from them as should you.

And that's the beauty of the markets. There are always two sides to the trade and you my friend, if you've been a bull, have been on the correct side to date. Cheers.

Anonymous's picture

One in a row for me. Enjoy the weekend.

Anonymous's picture

Broccolini is a term of endearment.

cougar_w's picture

[correct side of the trade]

Let me just remind some of you that if this tanks as badly as it seems set to, then in 10 years hence they won't be marveling that someone was on the correct side of the last trade. They'll be pointing out who imploded the global economy, leaving 500 million former-middle-class penniless, and driving 2 billion others back into the Stone Age for perhaps the remaining duration of human existence on Earth.

I know, who cares. It just seems sad is all. I'll be quiet now.


Divided States of America's picture

If this really turns out to be smokes and mirrors and I lost money via shorting the stock market based on my own perception in the face of the Government, Banks and Media spreading propaganda to depict an economic picture thats more sanguine (green shoots) than reality, is there a way I can start something to gather enough support and recoup some of my losses back? Kinda like those people who made money in the Madoff case having to give back some or all of their gains to those who lost it all. I mean we are basically talking the same thing here, a big ponzi scheme, just on a much larger scale.

casino capitalism's picture

All the right points. I particularly like the comment about comparing earnings to "estimates" instead of yoy.  I have been irritated about that for a while - blatant manipulation.

Anonymous's picture

The plug has been pulled, Tyler. Monday was the high. It won't be seen again until sometime in spring when we actually do get the recently hyped melt-up.

Rainman's picture

Excellent report. A Good read. The dollar trading volume chart is a real eye opener.

Thanx, Tyler.