Friday, 24 October 2014

Monetary Inflation and Stock Market Earnings

“A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply”

Fritz Machlup

The Short Version of the "Austrian" True Money Supply (TMS), as of 13 October 2014

The short version of the Austrian True Money Supply for the U.S., the measure of the money supply applied in this weekly report, decreased 0.05% on last week for the week ending 13 October 2014. At $10.3522 trillion, the money supply is now up $468.9 billion, or 4.79%, year to date.

The growth rate in the money supply headed down sharply during the week. The 1-year growth rate fell to 6.71%, down from 7.36% last week. It was the lowest year on year growth rate reported since the final week of last year. The growth rate also remains significantly lower than the 8.30% average since 1980.

Compared to the growth rate recorded one year ago, the year on year growth rate shred 1.68 percentage points, the sharpest drop since mid April this year.

Taking a look at the longer term data, the 5-year annualised growth rate ended the week on 10.23%. The growth rate is still well above the 7.55% longer term average, but it keeps dropping compared to a year back as it has done now for 46 consecutive weeks. This week it declined 1.78 percentage points compared to last year (the dotted line in the chart below), the biggest drop since week ending 15 September 2008 which happens to be the day Lehman Brothers filed for Chapter 11 bankruptcy protection.

As I started reported some time back, the year on year percentage point drop in 5-year growth rate since August 2011 resembles the trend from December 2001 onwards. What is different this time around however is that the growth rate is dropping faster. As the chart below tries to convey, the current drop in the growth rate is significantly lower than it was as of week 168 the last time around. In fact, the current drop in the growth rate is one year and three months ahead of the 2001 to 2006 trend.

Should this trend continue, we could fast be approaching market turmoil of some sort. Or we could actually be in the storm as we speak. There are certain signs the turmoil has already started as the U.S. stock market has been very volatile in recent weeks*, the 10-year treasury yield has dropped about 37 basis points during the last four months even as the Fed has been tapering and as the VIX shot up to 26.3 just nine days ago, the highest reported since early June 2012.

As banks are increasingly being left with the "burden" of increasing the money supply as the Fed is nearing the end of QE3, the risk of further drops in the money supply growth rate appears high. But maybe QE was never meant to end at all and that QE4 is just around the corner? Or maybe the Fed is becoming scared (now that it has saved the banks) of the inevitable collapse of the monetary system with ongoing inflationary policies and instead will implement full-reserve banking? Time will show, but this is what the U.S. economy has come to as everything hinges on Fed policy. Unfortunately, a central bank can never print itself out of economic problems, only into them.

* The 21 day moving average coefficient of variation of the S&P 500 index has more than doubled during the last few weeks compared to the January 2013 to September 2014 period.



The Short Version of the Austrian True Money Supply vs Austrian True Money Supply, as of September 2014

Thursday, 23 October 2014

DNB ASA Q3 2014 Balance Sheet: Snail's Pace "Capital Building"

"DNB continues to build up capital after a strong quarterly performance" reads the headline of the Q3 2014 news release for DNB ASA, Norway's biggest bank. Well, the bank is (sort of) "building capital", it is just that the capital is being built from a very, very low level and that it is being built very, very slowly.

But on this important measure capital is not growing at all and is lower today than it was in Q1 2010.

DNB ASA therefore continue to pose a serious threat to "financial stability" in Norway and at this snail's pace of "building capital" will continue to be so for a very, very long time indeed. Meanwhile, Norges Bank's printing machine is ready to rescue the company with fresh liquidity at any moment, courtesy of the Norwegian tax payers. 

Apple Inc. 2014 Results: A Great Company With A Share Price to More Than Match It

A few days ago, Apple Inc. (NASDAQ:AAPLreported the results for fiscal year ending September 2014. It's been more than two years since I last wrote a short piece on Apple's results and equity valuation. At the time, 10 September 2012, the Apple share was trading below $95 (just under $663 at the time, there was a 7-for-1 stock split in June 2014). Back then I wrote (bold added),
But for a great company it does not automatically follow that its shares are a great investment. The shares currently trade at a forward P/E of 15.1 (based on forecasted EPS of 44.21 for this year), a P/E of 24.1 based on 2011 earnings with a current P/B of 5.6. Based purely on the trailing P/E of 15.6 reported above the shares are not expensive. Based on average earnings for 2008 to 2011 however, the shares currently trade at a P/E of 46.0. Herein lies the fundamental risk of investing in the Apple share: The last five years have been extraordinarily strong operationally for Apple, but the market is pricing in a significantly better future than that delivered hereto. History shows, and economics teach us, that over the long term, very few companies manage to earn a return on equity significantly higher than its cost of capital as the high returns attracts ever increasing competition until the returns are brought down towards costs of capital. And significantly fewer (none?) manage to deliver a 85% return on equity on a sustainable basis, certainly not when having reached the size Apple now has.
 and concluded,
In conclusion, the probability of the Apple share price dropping seems significantly higher than it increasing, which is why I would not recommend the prudent investor to buy Apple shares at this price level. But look to buy the share if it drops below USD 480 [$68.6 following the share split] if the fundamentals remain strong, a price that implies no future growth from the 2012 expected earnings. The excess cash of USD 80 [$11.4 following the share split] a share is your margin of safety.
Since this report was written, the Apple share price has increased just under 6% to $102.99 as of 22 October 2014. During the same period, the S&P 500 increased more than 34% while the NASDAQ increased close to 40%.

Apple has continued to deliver some staggering accounting numbers during the last two years as well. Total revenue for 2014 was the highest ever reported, having expanded from $37.491 bn in 2008 to $182.795 bn this year. This equates to an annual growth rate just north of 30% during the last six years. Return on equity (ROE) for 2014 came in at 35.4%, the highest ever reported based on data since 2008 and up from the 30.0% reported for 2013. Cash earnings remain significantly higher than net income indicating high quality earnings. The balance sheet remains strong and with equity making up 48% of total assets and almost $72 bn in excess working capital (calculated as the working capital position plus long term marketable securities that exceeds 2.0x current liabilities) the company can survive an economic downturn or two.

A few key measures are however revealing the enormous company Apple has become. Total revenue for the year increased "only" 7.0%, down from 9.2% in 2013 and 44.6% in 2012. Gross profit increased 9.7%, up from the 6.3% decline in 2013, but significantly below the 35% average growth rate during the last six years. The gross profit margin is keeping up quite well, but at 38.6% it was lower than the 39.4% average for the 2008 to 2013 period. Though earnings for the year was up 6.7% on last year, they dropped 5.3% compared to 2012 and the record ROE discussed above was driven solely by increased leverage as both profit margin and asset turnover declined during the year. This is also evident by the declining return on assets (ROA), which fell to 22.6%, the lowest reported for the 2008 to 2014 period, 3.1 percentage points lower than the average during the period. 

Compared to two years ago, my back-of-the-envelope analysis and conclusion about Apple's results and the share price remains large unchanged: it is a great company with a share price to more than match it. The biggest risk of investing in the Apple share also remains largely unchanged in my opinion, namely that the company's results and profitability are so impressive even expecting them not to deteriorate seems like a tall order. The stock market is however pricing in further growth. If you do too, you might just have to settle for poor returns during the next few years as well which I suspect any U.S. stock market investor with a long position will have to settle for anyway.

Soure: EcPoFi, Apple Inc.

Disclaimer: I have no position in the Apple Inc. share and do not intend to enter into any position in the near future. I have a short position in U.S. mid-caps. Read additional disclaimer here.


The Short Version of the "Austrian" True Money Supply (TMS), as of 6 October 2014

Wednesday, 22 October 2014

The Drivers of U.S. Bank Credit Growth

For the week ending 8th October, Bank Credit for all U.S. commercial banks increased $651.2 billion, or 6.5%, compared to the same week last year. Bank Credit is the major asset item on banks' balance sheets and consists of various types of loans and investments and is a key driver of money supply growth (together with the Fed monetizing government and agency debt). 

The chart and table below show the components of bank credit that generated this increase. 

Also read:

U.S. Banks Are Now Operating With 100% Reserves - Is Full-Reserve Banking The Next Step?

Nigel Farage on the Anti-Democratic European Commission

Tuesday, 21 October 2014

Merger Waves and the Austrian Business Cycle Theory

By Jimmy A. Saravia

ABSTRACT: This paper identifies merger waves as parts of Austrian-type business cycles. According to Austrian business cycle theory, when loan rates are reduced below their natural level through bank credit expansion, this falsifies the monetary calculation of capitalist-entrepreneurs, and investments are initiated that calculation showed were not profitable before the interest rate reduction. Since there are not enough resources in the economy to complete the new projects, businesses must increasingly withdraw the resources from other companies. Thus, this paper concludes that the increase in investment activity and the resulting “resource crunch” cause a merger wave that helps prolong the boom phase of the cycle. The merger wave ends when the credit expansion is not sufficient to sustain the economic boom, and the bust phase begins. Conversely, this paper concludes that if the fiduciary media do not enter the economy through the loan market to finance business investment, there is no pronounced and sustained increase in merger activity.

Read the paper here.

The fallacy of the Equation of Exchange (MV=PT)

"What we have in this (Fisher) equation, in short, is two money sides, each identical with the other. In fact, it is an identity and not an equation. All that this equation tells us about economic life is that the total money received in a transaction is equal to the total money given up in a transaction – surely an uninteresting truism. Things cannot determine prices, only individual actors can."
Murray N. Rothbard (Man, Economy, and State)

The Loss of Purchasing Power of The Norwegian Krone

Long gone are the days when Norges Bank, the central bank of Norway, run a tight monetary policy. Just since December 1995 (no data available earlier), the money supply in Norway has increased 254.8%.

Back in 1971, when the Norwegian Krone was partly tied to gold as part of the Bretton Woods system, one Norwegian Krone would buy you 0.003697 troy ounces of gold. Today, you would only get 0.000127 troy ounces for the same amount. Since the Bretton Woods system was ended in 1971, the Norwegian Krone has lost 96.56% of its value compared to gold. 

The reason the Norwegian Krone has lost almost all its value compared to gold is not because there is less gold around today than it was in 1971. Rather, it's all caused by an increase in the money supply of Norwegian Kroner that greatly surpasses the amount of gold mined (click here for more on gold and gold production).

Norges Bank could have chosen to be prudent and run a tight monetary policy. It chose not to in line with all other central banks around the world.

As a consequence of central banking backed by tax payers and fractional reserve banking, most western countries and Japan today suffer economically with bloated public sectors and high debt while the average Norwegian has been turned into a debt slave.

Charts of The Day: Falling Price Inflation Expectations in the U.S.

Monday, 20 October 2014

The Economist discovers the Entrepreneur

By Sean Corrigan

In its latest edition, in a piece entitled ‘Monetary policy: Tight, loose, irrelevant’, the ineffably dire Ekonomista considers the work of three members of the Sloan School of Management who conducted a study of the factors which – according to their rendering of the testimony of the 60-odd years of data which they analysed in their paper, “The behaviour of aggregate corporate investment” – have historically exerted the most influence on the propensity for American businesses to ‘invest’.

The article itself starts by deploying that unfailingly patronising, ‘it’s economics 101′ cliché by which we should really have long ago learned to expect some weary truism will soon be rehashed as fresh journalistic wisdom.

It may be only partly an exaggeration to say that the weekly then adopts a breathless, teen-hysterical approach to a set of results which, with all due respect to the worthies who compiled them, should have been instantly apparent to anyone devoting a moment’s thought to the issue (and if that’s too big a task for the average Ekonomista writer, perhaps they could pause to ask one of those grubby-sleeved artisans who actually RUNS a business what it is exactly that they get up to, down there at the coalface of international capitalism). Far from being a Statement of the Bleedin’ Obvious, our fearless expositors of the Fourth Estate instead seem to regard what appears to be a tediously positivist exercise in data mining as some combination of the elucidation of the nature of the genetic code and the first exposition of the uncertainty principle. This in itself is a telling indictment of the mindset at work.

Continue reading the article here.

Fed Assets and the S&P 500 (as of 17 October 2014)

As Fed assets are fast approaching 0% year on year growth, so is the the U.S. stock market as measured by the S&P 500 index. 

Saturday, 18 October 2014

The Reserve Ratio for U.S. Banks (as of 15 Oct 2014)

The reserve ratio for U.S. banks jumped to 99.2% for the week ending 15 October according to the most recent data from the Federal Reserve, up from 92.6% last week.

Friday, 17 October 2014

Four Reasons the Bernanke-Yellen Asset-Price Inflation May Be Nearing Its End

By Joseph T. Salerno

There are strong indications that the remarkable run up of asset prices in the last few years is beginning to run out of steam and may be on the verge of collapse. We will leave aside the question of whether the asset inflation is symptomatic of a garden-variety inflationary boom or is a more virulent bubble phenomenon in which prices are rising today simply because buyers anticipate that they will rise tomorrow.

Continue reading the article here.

The Short Version of the "Austrian" True Money Supply (TMS), as of 6 October 2014

The short version of the Austrian True Money Supply for the U.S., the measure of the money supply applied in this weekly report, increased 1.02% on last week for the week ending 6 October 2014. At $10.3571 trillion, a new all-time high, the money supply is now up 4.79% year to date.

The 1-year growth rate in the money supply increased to 7.36% for the week, up from 7.06% last week. The growth rate remains lower than the long term 8.30% average and also remains below the 52 week moving average of 7.85%.

In general, the conclusion remains pretty much the same as it's been during the last 14 months: money supply growth is slowing down.


With the Fed having reduced pressure on the monetary pedal during this year, it appears this combined with the slowing money supply growth rate have started spooking the U.S. stock market as the S&P 500 index is down 5.82% this month (the market might not actually be aware that the money supply directly affects stock market prices, it tends to focus on interest rates mostly in my experience). U.S. banks have expanded credit significantly for most of this year, but so far this has not been enough to push the money supply growth rate upwards (represented by the M2 money supply in the chart below).

This stock market drop has already triggered talk and speculation of whether the Fed should and will end tapering and still offer at least some QE on a regular basis going forward. It's important to remember that the U.S. economy is in a right mess with a debt to GDP ratio of around 100% (not including some huge off-balance sheet liabilities) and that budget deficits remain large ($483 bn in the fiscal year ending September 2014). In this sense, the federal government is addicted to the Fed monetizing at least part of its debt.

I see few other "saviours" for the U.S. stock market, bond prices and other asset prices than the Fed again stepping on the pedal. Short term this will help keeping asset prices at elevated, but artificial, levels. Over the medium to longer term however, it can only lead to the creation of more imbalances as pricing mechanisms are put out of action. Or will the Fed be bold, and prudent, and implement full-reserve banking? I don't know, but what I do know is that it is important to focus more on what the Fed actually does rather than speculating at what it might do. As the Fed has actually been tapering all year and as the money supply growth rate has declined combined with bubble level stock market valuations and some other very bearish signs, I've been short the U.S. stock market (and long the U.S. dollar) since the end of June this year.

Visit the short version of the Austrian True Money Supply archive here. 


I'll end this week's commentary on the Austrian true money supply with my conclusions about the U.S. stock market at the beginning of this year (click here to access the full report):

2013 was a remarkable year for U.S. equities by any standard with the S&P 500 index increasing almost 30% to record the best year for 18 years (1995). This increase was however not driven by an increase in earnings (which increased "only" 6.37% on a 10-year average basis during the year). Nor was it driven by a reduction in the 10-year treasury yield (which increased 69.54%). Rather, the price increase of the S&P 500 index was driven largely by an expansion of the P/E multiple which increased by more than 20% during the year. In addition, the S&P 500 has significantly outpaced any improvement in the real economy. For example, the S&P 500 to GDP ratio is rapidly approaching record territory:
  • The S&P 500 to 10-year average GDP ratio is now approaching the previous high from Q1 2007. 
  • The S&P 500 to 4-quarter average GDP has now surpassed the previous record from Q1 2007 though it is still lagging the all-time record high set in Q2/Q3 2000.

What then caused this expansion in the P/E multiple during the year? In my humble opinion the Fed has managed, again, to create another stock market bubble in the U.S. through flooding the market with freshly minted fiat money (by way of monetizing Federal debt). In 2013 alone, the Fed expanded its balance sheet by more than US$ 1 trillion (yes, trillion!), an increase of more than 38%. Going a bit further back to 2009, the Fed has since expanded its balance sheet by almost US$ 1.8 trillion, or more than 80%!

While the 1994 to 2000 (+185%) and 2003 to 2007 (+64%) S&P 500 stock market rallies were driven by aggressive bank credit growth (with the full support of the Fed of course, read: the taxpayer) the 2009 to 2013 (+110%) rally was driven by the Fed alone (as it is "independent", it does not have to support public spending through monetizing the Federal debt, right?). I say this because Bank Credit outstanding only increased a grand total of only about 8.5% from the end of 2008 to the end of 2013 and by only about 0.4% in 2013. This bank credit growth is very low compared to the longer term average. Since the end of 2008 however,M2 money supply outstanding increased by more than US$ 2.8 trillion, or 34% plus change. The majority of the increase in money supply starting in 2009 was hence generated by public spending monetized by the Fed rather than banks creating credit (and hence money). 

There can be no doubt that a big chunk of this new fiat money orchestrated by the Fed has eventually found its way into the U.S. stock market as reflected in an earnings yield for the S&P 500 index which is now almost 34% lower than the average since 1978. Regular readers of this blog will be familiar with this reasoning. Here's however a quick recap on the subject by professor Jesús Huerta de Soto (Money, Bank Credit, and Economic Cycles, 3rd ed, p. 461-462),
In an economy which shows healthy, sustained growth, voluntary savings flow into the productive structure by two routes: either through the self-financing of companies, or through the stock market. Nevertheless the arrival of savings via the stock market is slow and gradual and does not involve stock market booms or euphoria. 
Only when the banking sector initiates a policy of credit expansion unbacked by a prior increase in voluntary saving do stock market indexes show dramatic and sustained overall growth. In fact newly-created money in the form of bank loans reaches the stock market at once, starting a purely speculative upward trend in market prices which generally affects most securities to some extent. Prices may continue to mount as long as credit expansion is maintained at an accelerated rate. Credit expansion not only causes a sharp, artificial relative drop in interest rates, along with the upward movement in market prices which inevitably follows. It also allows securities with continuously rising prices to be used as collateral for new loan requests in a vicious circle which feeds on continual, speculative stock market booms, and which does not come to an end as long as credit expansion lasts.
When reading the above, please note that money expansion generated through the Fed monetizing government debt ultimately has an indistinguishable effect on the stock market (and other asset prices) compared to money generated through increases in bank credit.
The S&P 500 index is not the only U.S. stock market index to post a huge gain for 2013; all but one of the U.S. stock market indices I follow on a regular basis surged during the year and have climbed way above the record highs from before the collapse of Lehman Brothers in September 2008:

On average, the indices in the table above increased by 32.2% in 2013 with a median increase of 34.1%  (as of week ending 27 December), with the Wilshire US Micro-Cap Total Market Index surging a whopping 50.2%. All indices, except for the Wilshire US REIT index, are also significantly higher than their peaks prior to September 2008. Some of these all-time highs set by major stock market indices in the U.S. has led me to publish a series of "bubble charts" in recent days (e.g. here and here).
As stated above, Fed balance sheet expansion was, in my opinion, the major driver of U.S. stock market euphoria and returns in 2013. For 2014, the Fed balance sheet will increase by about 22% based on the Fed buying US$ 75 billion a month in longer term treasuries and agency mortgage-backed securities. Though a significant increase, it is nonetheless substantially lower than the 38% increase in 2013.

Therefore, unless money supply expansion generated by U.S. commercial banks picks up in 2014, the decrease in the growth rate of the Fed balance sheet combined with a significant slowdown in the growth rate of government debt (at 4.2% in Q3 2013, compared to 8.6% during the same period in 2012) will prove strong headwinds for money supply growth in 2014. And a significant reduction in money supply growth will be decisively bearish for equities. More importantly, such a slow down has been in the making for most of 2013 (e.g. see here) and if it continues the next stock market crash and so-called "financial crisis" is not too far ahead. 

In conclusion, the combination of a high stock market valuation of the S&P 500 index, record increases in all but one of the indices in the table above, the significant increase in the 10-year treasury yield since May, the low personal savings ratefinancial risk indicators hitting record lows, weak U.S. commercial banks equity to total asset ratios and a slowing down of the money supply growth rate which is already underway, means that I am now very bearish for U.S. stocks in 2014. Not to mention the debt crisis in both the U.S. and the EU (yes, they have not magically disappeared). There are simply too many indicators signalling the U.S. stock market is peaking or at least indicating a substantial probability that equities will not perform well over the next few years. In short, there is simply too much risk and too many things that could go wrong to justify being a longer term buy and hold investor in U.S. equities at this stage.

A significantly improving money supply growth rate could prove me wrong, but this would only serve to make the inevitable fall that much heavier. 


Related (my favourite video about the banking crisis and the ongoing debt crisis):

Fraud. Why The Great Recession