Capital Expenditures

The still-dominant consensus view that America’s economy is poised to single-handedly yank the world out of its lethargy is likely to be disappointed once again with the odds high that our economy will remain burdened by growth-inhibiting monetary policies. In addition, it will continue to be negatively impacted by various other impediments, including a populace that is increasingly under-employed, an unwieldy and inscrutable tax code, a Rube Goldberg-like healthcare system, an increasingly ossified infrastructure, and a regulatory apparatus that congests the lungs of our economy, small businesses... weaning the stock market off of casino capitalism promises to be anything but pain-free. But did any responsible adult really believe there would be no pay-back for all these years of the Fed’s force-fed gains? If you do, you probably also believe foie gras grows on trees.

"Everybody knows interest rates are going to rise." Whether you agree with this premise, or not, is largely irrelevant to this discussion. The current "bullish" mantra is the "great bond bull market is dead, long live the stock market bull." However, is that really the case? When the bond bubble ends this means that bonds will begin to decline, potentially rapidly, in price driving interest rates higher. This is the worst thing that could possible happen.

This eruption of late cycle bubble finance hardly needs comment. Below are highlights from a Bloomberg Story detailing the recent surge of leveraged recaps by the big LBO operators. These maneuvers amount to piling more debt on already heavily leveraged companies, but not to fund Capex or new products, technology or process improvements that might give these debt mules an outside chance of survival over time. No, the freshly borrowed cash from a leveraged recap often does not even leave the closing conference room - it just gets recycled out as a dividend to the LBO sponsors who otherwise hold a tiny sliver of equity at the bottom of the capital structure. This is financial strip-mining pure and simple - and is a by-product of the Fed’s insane repression of interest rates.

• Q1 revenue $2.5 billion, beats expectations of $2.36 billion
• Q1 revenue from advertising $2.27 billion
• Q1 EPS $0.34, beat expectations of $0.24
• Free cash flow - Free cash flow for the first quarter of 2014 was $922 million.
• Capital expenditures - Capital expenditures for the first quarter of 2014 were $363 million.
• Cash and marketable securities - Cash and marketable securities were $12.63 billion at the end of the first quarter of 2014.
• Monthly active users (MAUs) were 1.28 billion as of March 31, 2014, an increase of 15% year-over-year. Unclear how many of these are bots originating out of Egypt and India.

There’s been some buzz recently about a pick-up in business lending. Unlike some pundits, though, we’re not convinced that a surge in business credit is such a good thing. We don’t doubt that more lending to small businesses, in particular, might do some good if it doesn’t go too far. Lending to large corporations, on the other hand, is a different story. Corporations are already borrowing at a pace that’s only before been seen near cyclical peaks...

As we reported last night, whether as a result of Snowden revelations and NSA blowback by BRIC nations, or simply because the global economy is contracting far faster than rigged and manipulated markets worldwide will admit, IBM's Q1 revenues not only missed consensus earnings, but dropped to their lowest level since 2009. And yet, IBM stock is just shy off its all time highs and earnings per share have been flat if not rising during this period, leading even such acclaimed investors who never invest in tech companies as Warren Buffett to give IBM the seal of approval. How is that possible? Simple: all that investment grade companies like IBM have done in the New Normal in order to preserve the illusion of growth, is to use cash from operations, or incremental zero-cost leverage, to fund stock buybacks. In essence a balance sheet for income statement tradeoff. However, that "great stock buyback gimmick" as we call it, is finally coming to an end.

We summarized yesterday's both better and worse than expected Chinese GDP data as follows: "a substantial deterioration of the economy, one which was to be expected yet one which can be spun as either bullish thanks to the GDP "beat", and negatively if the purpose is to make a case for more PBOC stimulus." Sure enough here are the headlines that "explain" the latest overnight futures surge which has once again brought the S&P into the green on the year - a 40 point Spoo move in hours since yesterday's bottom when the Nikkei "leaked" Japan's economy is on the ropes :

• Stocks Rise on China Stimulus Speculation

Here one should of course add the comment that launched yesterday's rebound, namely the Japanese warning that its economy is about to contract, adding to calls for more BOJ stimulus, and finally this other Bloomberg headline:

• The Strengthening Case for ECB Easing

And there you have it - goodbye "fundamental" case; welcome back "central banks will once again bail everyone out" case. Hopefully today's news are absolutely abysmal to add "US economic contraction fear renew calls for untapering" to the list of headlines that should send the S&P to all time highs by the end of today.

For the 8th month of the last 9, the Empire Manufacturing missed expectations. Tumbling to its lowest since December (despite the apparent let-up in weather freakishness), this is the biggest miss since Jan 2013. The average workweek slowed significantly, but the overall index was modestly saved by a push higher in 'hope' as the six-months-forward index jumped back to Feb highs. Perhaps most concerning, given the supposed pent-up demand that we have been told to expect when the weather picked up, was the tumble in new orders to their lowest since November.

We live in a pretend economy. It is important to recognize this condition, especially if you are an investor. Current market behavior is concerning.  Bonds and stocks remain volatile and near record levels. Markets ignore the continuing stagnation in the pretend economy, buoyed apparently by government liquidity injections. To justify investing today in these markets, one must anticipate one or both of the following: economic growth is about to surge; and/or market values can continue to rise from here, potentially further widening the already large gap between valuations and fundamental economics. No reading of the economic tea leaves suggests a surge in economic growth is coming. Indeed, a critical analysis of the data makes one question whether there has been a recovery at all. Certainly any recovery has to be labeled as abnormal. Playing these markets in any conventional manner is akin to writing insurance policies for suicide bombers.

Employment is a function of demand by customers on businesses. As opposed to many economists and politicians, businesses do not hire employees to be "good samaritans." While such a utopian concept is fine in theory, the reality is that businesses operate from a "profit motive." The problem is quite clear. With the consumer heavily leveraged, the inability to "spend and borrow" is reducing aggregate demand.  As stated, the current level of aggregate demand simply isn't strong enough to offset the rising costs of taxes, benefits and healthcare (a significant consideration due to the onset of the Affordable Care Act) associated with hiring full-time employees. Therefore, businesses initially opt for cost efficient productivity increases, and only hire as necessary to meet marginal increases in customer demand which has come from population growth.

To understand economics experts in Feynman’s absence, the best analogy that we can think of is to the methods of a magician. Magicians operate by showing their audience a small window on reality, and then tricking people into mentally filling in the rest incorrectly. Because the economy has so many moving parts, a similar approach also works in economics. Pundits can draw our attention to a couple of indicators, ignore everything else, and make claims that sound realistic even though they make little sense in the bigger picture. One difference between economists and magicians, though, is that economists are often unaware of their trickery because they fool themselves before fooling others. To be clear, we don’t claim to be immune to such deceptions, but we do try to root them out as best we can and will do that here. We’ll look at capital expenditures (capex), in particular...

As happens at the end of every year, sellside analysts and economists, all predicted that this year would be different, and the long overdue capex spending would finally be unleashed. Apparently they had far greater visibility on this matter, than on the topic of snowfall in the winter, and its disastrous impact on a $17 trillion economy, whose Q1 GDP growth forecast has cratered from 3% at the start of the year, to barely half that number currently. One of the firms that preached that the CapEx recovery is imminent is none other than Goldman Sachs, the same firm that also year after year predicts a new golden age for the US, only to see its forecast crash and burn some 4-6 months later, couched in the tried (or is that now trite) and true scapegoatings: snow, unrest in Europe, inflation or deflation in Japan, the usual. However, this time may indeed be different, and the same Goldman has just released a piece wondering "Why no capex recovery?" (despite the firm's own forecasts to the contrary -just recall David Mericle's "Capex: The Fundamentals Remain Strong" which now in retrospect is completely wrong).

In what has become a quarterly tradition, Wal-Mart once again swung and missed, largely as expected - after all it snowed in the quarter. Just kidding. While the WMT bottom line was more or less in line, with Adjusted EPS of $1.60 beating expectations of $1.59, the world's largest retailer missed on the top line posting $129.71 billion in Q4 revenue compared to $130.24 billion expected. What also disappointed was the decline in free cash flow which dropped from $12.7 billion in 2012 to $10.1 billion in 2013. What is worse is that the company reported sliding Q4 comp store sales, which declined -0.4% with and without fuel, compared to an expectation of a +0.2% increase, and well below the 0.5% increase a year ago. But the biggest hit was in the company guidance which now expects Q1 and Full Year EPS of $1.10-1.20 and $5.45-$5.55; both below the sellside consensus of $1.24 and $5.55. Alas for Walmart, it is impossible to blame the weather for weaker upcoming results, and so the company didn't even try. Instead what the company did blame for the current and future weakness is, naturally, the economy, the weak consumer, who is now receiving less government handouts, as well as tighter credit and notably, higher healthcare costs. These combined made Walmart admit that it will be "difficult to achieve the goal we have of growing operating income at the same or faster rate than sales."

Today, the pundits are a-buzz making sense of the latest jobs report. But most of us care more about the state of one particular job: our own. How relevant is this latest bit of data to that? Not very. So, to better understand the trends in the work environment most likely impact our own paychecks, it will help to look at another bellwether similar to our fuzzy groundhog friend: AOL. AOL, a once-important pioneer in the transition to the 'digital economy', is once again showing us where the future of work is headed. Unfortunately, like the health of AOL's business over the past decade, it's not a pretty picture. As we've transitioned to an economy in which corporate profitability -- and thereby, stock prices -- is THE metric for success, the employer-employee relationship has become much more superficial than in past generations; and the encroachment of automation remove income options for those temporarily out of work, but it's increasingly limiting the options for the large pool of unskilled labor with few other alternatives

In order to understand what solutions to our energy predicament will or won’t work, it is necessary to understand the true nature of our energy predicament. Most solutions fail because analysts assume that the nature of our energy problem is quite different from what it really is. Analysts assume that our problem is a slowly developing long-term problem, when in fact, it is a problem that is at our door step right now.