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.

On HFT:

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 (www.cross-currents.net):

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.