• The madness of men
• The real reason stocks go up

By Selva Freigedo in Albert Park

You may have noticed that Bitcoin is making headlines again.

And no, we are not talking about bitcoin’s price…even though it has seen quite a jump.

Over the last month, bitcoin has increased by almost 30%. But, that’s the nature of bitcoin, it’s very volatile. In fact, since we started writing this morning, the price has already dropped by 5%.

But we are talking about different headlines, those mentioning Satoshi.

By Satoshi we refer to Satoshi Nakamoto, the creator of Bitcoin.

The name is a pseudonym, as nobody knows the true identity of the creator. We don’t know if Satoshi is a he or a she, if it is a person or a group, or even if he/she/they are dead or alive.

In 2008, Nakamoto published a white paper on Bitcoin in response to the 2007 crisis. Then, in 2009, he (she/or they) released an open source program — software that anyone can inspect and change — called Bitcoin.

How do we know bitcoin came about in response to the crisis? Well, because there was a bit of text written on the genesis block, that is, the first block — block 0 — of the chain. It said: ‘The Times, 03/Jan/09, Chancellor on brink of second bailout for banks.’

This was the headline of The Times on the day the genesis block was created. It is most likely there as a time stamp…and to remark on the instability created by central banks.

Satoshi not only created bitcoin, but is thought to be holding a large share of them, almost a million. That’s quite a number, considering that there will only ever be 21 million bitcoins created.

In 2010, Satoshi stopped communicating and then disappeared. His bitcoins have remained untouched.

While Satoshi’s identity has remained a mystery, there have been several attempts to find out who he is.

And there are a lot of theories out there.

Some have said it is a cryptographer called Hal Finney.

Others that bitcoin was created as a joint effort between Samsung, Toshiba, Nakamichi and Motorola. As you can see, their names could be an amalgam for Satoshi Nakamoto.

Australian businessman Craig Wright has also self-proclaimed himself Nakamoto.

Now John McAffee, the creator of the antivirus company, has said he has found Satoshi’s true identity. According to him, it isn’t Wright, but a man living in the US.

And he has said he will be revealing Satoshi’s true identity.

As McAffee claimed, Satoshi is not pleased about this. As he told Bloomberg:

‘I’ve spoken with him [Satoshi], and he is not a happy camper about my attempt to out him.’

But after making the announcement, McAffee decided to wait. 

Why?

Well, McAffee is concerned that revealing bitcoin’s creator identity could open him to more lawsuits.

So far, Satoshi’s identity is still a mystery.

Even then, it is interesting to see how far Bitcoin has come. Remember, Bitcoin is an idea that was born out of distrust from our current system.

Take a look at the chart below, it shows bitcoin’s daily transactions. As you can see, transactions keep increasing.

And bitcoin has brought with it something else: blockchain.

If you are not familiar with blockchain, it is the technology behind bitcoin. It is essentially a shared public ledger — a database that every member of the network can see and contribute to.

And blockchain has the ability to disrupt plenty of industries. Industries like the supply chain.

Blockchain has the potential to give people the ability to track where that product has been since its creation before purchasing it. From where it was made to how long it has been in transit until reaching the store.

A recent white paper from Weforum noted that blockchain could have a large effect for global trade.

‘Distributed ledger and blockchain technology promise to have far-reaching implications for global trade and supply chains. In fact, providing increased efficiency, transparency and integration throughout supply chains has been one of the most fertile areas for blockchain experimentation. Whether or not your organization or business unit is an early adopter, there is a high likelihood that most supply chains will be affected by blockchain technology at some point – whether using blockchain technology directly or at the application level, with connectivity or integration into an underlying blockchain-enabled data layer.’

We may never find out who Satoshi is.

Bitcoin may or may not be around in another 10 years.

But blockchain has a lot of advantages over our current system, and the potential to disrupt the way we do things.

Best,

Selva Freigedo,
Editor, Markets & Money

PS: This revolution is just starting. If you are keen to get into the crypto space but are not sure how, editor Sam Volkering has developed a step by step guide. Check out all the details here.

The Madness of Men
By Vern Gowdie in Gold Coast, Australia

‘I can calculate the movement of the stars, but not the madness of men.’

Sir Isaac Newton, 1720

The rise, rise, rise and fall of the South Sea Company share price was the source of Newton’s bewilderment, frustration and more importantly, the reason he lost of his fortune.

After a successful foray into the stock — ‘buying low and selling higher’ — he could not resist the temptation to go back for more.

Newton’s second and even bigger investment was his undoing — buying high and selling low.

Newton is recognised as one of Britain’s greatest physicists.

He was no stranger to logic. But, as we should know by now, emotions are not logical…they’re irrational.

Nearly two centuries later, another bunch of really clever people made the same mistake…allowing greed to short circuit rational thinking.

‘Long-term capital management (LTCM) was a large hedge fund led by Nobel Prize-winning economists and renowned Wall Street traders that nearly collapsed the global financial system in 1998 as a result of high-risk arbitrage trading strategies.’

Investopedia

Human nature is so predictable.

Yet, as so often is the case, it’s only with hindsight that we open our eyes to what history has shown us to be foreseeable.

We appear destined to never really learn how to exercise rational thought when it comes to money and markets.  

This includes those charged with the responsibility of managing the global financial system in — allegedly — a prudent and responsible manner.

The central banker actions since 2008 are a prime example of genuine madness.

Thinking you can solve a debt crisis with more debt is insanity…as defined by Einstein.

What does US13 trillion buy?

Since the beginning of 2008, the world’s major central banks have created over US$13 trillion…out of thin air.

And, after 2008, the major central banks all followed the same interest rate path.

The US has broken ranks in recent years…but has signalled that it’s days of raising rates are over. Best guess is the next movement in US rates will be back towards the zero per cent marker.

But none of this is news to anyone with a passing interest (no pun intended) in financial markets.

Why the Central Banks went to these extreme lengths is well documented.

Former Fed Chair, Ben Bernanke, explained the ‘wealth effect’ theory in The Washington Post on 4 November 2010…

‘Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.’

Before embarking on this grand experiment, Bernanke should have listened to Yogi Berra…‘In theory there is no difference between theory and practice; in practice there is.’

Lower corporate bond rates will encourage investment…well, that’s true.

But that all depends on your definition of investment.

Maybe Bernanke was naïve enough to think Corporate America would actually invest in their businesses to make them more productive and in turn, more profitable.

In practice, that’s not how it worked out.

Corporate America went on a share buyback spree…artificially boosting earnings per share (EPS) and triggering corporate bonuses.

The short termism and executive self-interest in the buy-back strategy (funded in part by issuing corporate debt) was the subject of a two-part series titled ‘The Cannibalized Company’ published by Reuters…

‘As corporate America engages in an unprecedented buyback binge, soaring CEO pay tied to short-term performance measures like EPS [earnings per share] is prompting criticism that executives are using stock repurchases to enrich themselves at the expense of long-term corporate health, capital investment and employment.’

Corporate America also accessed the abundant pool of cheap money (by issuing corporate debt) to boost dividend payouts…another trick to lure in yield hungry investors to (temporarily) boost share prices.

US corporates are not on their own with this one…

‘[Telstra’s] Operating cash flow of $3.2bn is used primarily to fund capital expenditure of $2.2bn. The remaining $1bn of free cash flow isn’t enough to cover the generous dividend of $1.9bn. Telstra borrowed almost $1bn to maintain its dividend, increasing net debt by 5%.’

Money Magazine February 2017

Wherever you look, you’ll see the effects of this easy money at work.

US margin debt levels — in inflation adjusted terms — are well beyond the market peaks of 2000 and 2007.

In late 2017, the Trump tax cuts gave the market additional stimulus …propelling the Dow even higher.

According to the article…

‘Once the Senate and House of Representatives reconcile their respective versions of the legislation, the resulting bill could cut corporate tax rates to 20 percent from 35 percent.’

These one-off effects act like an adrenalin shot. Boosting market energy levels temporarily.

But in the end, a company’s share price is determined by a reasonable multiple being applied to a track record of earnings.

Those earnings — on average — expand or contract based on underlying economic activity.

With the Fed signalling rates have effectively been capped at a level slightly above 2%, this indicates sluggish times ahead…even with the tax cuts.

But we’ve seen these ‘tax reform’ headlines before…

In October 1986, President Ronald Reagan ushered in significant personal and corporate tax cuts.

The top personal rate was cut from 50% to 28% and the corporate rate was reduced from 46% to 34%.

The Dow surged higher…

Within 12-months there was a new headline…the crash of ’87.

The moral of the story…Wall Street will use any excuse to make an expensive market even more expensive.

But, as Newton discovered to his great cost, it always ends the same way.

Boom turns to bust.

In reality, the Fed’s so-called ‘wealth effect’ has not happened…unless of course you belong to the top 1%.

The concentration of wealth amongst the top 0.01% is edging towards levels last seen at the peak of The Roaring Twenties.

Left wing advocates should take heart in this chart.

After the Great Depression, the ‘haves’ did not have quite as much.

The gap began to close. Balance was restored to society.

If history is to repeat/rhyme the re-balancing act of the 1930s, then another Great Depression-like event is in our future.

Extremes in both directions are ALWAYS corrected.

So, what has US13 trillion bought us?

The greatest asset bubble in history.

One that will lead to the greatest market collapse in history.

And that’s when we’ll witness the madness of central bankers…the bizarre theories, policies and strategies they will concoct to reflate yet another bubble.

Regards,

Vern Gowdie,
Editor, The Gowdie Letter

The Real Reasons Stocks Go Up
By Bill Bonner in Youghal, Ireland

Word on the street yesterday was that stocks were going up to record highs ‘on earnings.’

The casual listener was invited to believe that corporate America was earning more money; therefore, it should be worth more. Why else would people pay more for stocks?

Earnings come from Main Street. With hard work and luck, products and services are made and delivered. Wages are paid. Profits are what you have left over. If profits are rising, the economy must be doing well.

But where are the earnings?

River of no returns

Our old ‘river of no returns’ stock, Amazon, for example, earned some $10 billion last year. Not bad.

But those earnings don’t come close to justifying a market cap that is edging close to $1 trillion. On those numbers, a buyer would have to drift downriver for almost a century to get his money back from earnings.

Even at today’s artificially low rates, banks are advertising 3% interest on CDs. You only have to wait 33 years to earn your money back…without the risk of owning one of the flakiest companies on Wall Street.

AMZN may be an outlier in many ways. So, let’s look at the entire market.

Hardly booming

In the first quarter of 2012 — seven years ago — US corporations made a total of $2.2 trillion in pre-tax profits (annualised). In the last quarter of 2018, corporate earnings (again annualised) toted to only $2.18 trillion.

And that was way below the $2.32 trillion of pre-tax profits set in the third quarter of 2014.

In other words, corporate America is not making more money — at least, not by selling goods and services. And the Main Street economy hardly seems to be booming.

As far as we know, there has been no appreciable change in wages or GDP growth rates. And inflation is so quiet and lifeless, it was pronounced dead.

So, how come investors think stocks are so much more valuable? In 2012, the S&P 500 was around 1,500. Now, it’s nearly twice as high. What made prices double?

Three things.

First, corporate buybacks reduced the number of shares; this didn’t increase corporate earnings, but there were fewer shares to share them. Naturally, earnings per share rose; share prices rose, too.

According to Goldman Sachs, net buybacks averaged $420 billion annually over the last nine years — by far the biggest source of demand in the market. Net, average annual demand from households, mutual funds, pensions funds, and foreign investors was less than $10 billion each.

Second, the tax cut at the end of 2017 favoured corporations and their owners. The tax savings fell to the bottom line…and then could be distributed to shareholders, managers, workers, or consumers either through ‘special dividends,’ lower prices, higher wages, or the above-mentioned buybacks.

Third, the feds pumped ‘stimulus’ into the economy in the form of ‘quantitative easing,’ negative real rates, and deficits. It didn’t stimulate the economy, but it was catnip to Wall Street.

Let’s look at each of these things more closely.

Cardiac royale

Go back to 2012. Stocks and GDP were about the same — at around $15 trillion. Now, stocks are worth $30 trillion and GDP is only $20 trillion. Prices rose three times faster than GDP. Share buybacks don’t explain that.

And look at P/Es; same story. An average P/E on the S&P 500 in 2012 was about 15. Now, it’s 22. Prices outpaced earnings growth by 50%. Why? Not because of share buybacks.

2. Most serious observers regarded the unfunded tax cut of 2017 as irresponsible. The feds were already spending far more than they took in in tax revenue. But rather than cut the fat, they went directly to the ice cream shop, and ordered the Cardiac Royale, with three big scoops, smothered in chocolate sauce.

The tax cut did little for Main Street but it added sugar to the corporate world. After-tax earnings are higher. And corporate stocks should be worth more, right?

But wait. Where did the money come from?

It has to come from somewhere. We’ve seen that ‘stimulus’ measures are frauds and scams. They only result in more debt. In this case, the feds borrowed more money so taxes could be reduced. And eventually, somehow, the debt will have to be reckoned with…by the workaday, common people of the Main Street economy.

Uh…well…there, you see the problem as well as we do. These are the same people who buy corporate products. Now, they will have less money to spend. Corporate sales and profits should go down as a result.

3. Finally, we come to the real cause of high stock prices.

In the pseudo emergency in 2009, the feds panicked. They cut rates and borrowed heavily. Then, 10 years later, the Fed — which had been cautiously returning to a ‘normal’ monetary policy — chickened out.

In the fall of 2018, stock prices had begun to sink. But the Fed couldn’t bear the thought of a correction…neither of the stock market, nor of the economy. It let investors know that it still had their backs…and that it would continue to lend money at real rates close to zero, perhaps forever.

And so you see. Stocks may be up. But not ‘on earnings.’

Regards,

Bill Bonner

From the Archives...

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