Top Gun Financial Planning

Revisiting The 2007 Topping Process

“Tops are a process; bottoms are an event.” —Source unknown

I started Top Gun in 2006 to capitalize on my conviction that the bursting housing bubble would cause a nasty recession. 2006 was spent creating my website, studying and taking the Series 65, applying to the State of CA for my RIA (Registered Investment Advisor) license, finding office space and in general getting everything set up. I went live managing money on Jan 1, 2007 with a little less than $1 million AUM. I was 29 years old.

In this Client Note, I want to discuss the topping process in 2007.  The market hit a peak on 7/19/07 with an intraday high of 1555. It then crashed for a month in the wake of the blowup of two Bear Stearns hedge funds invested in subprime mortgage backed securities and pressures on other financial firms and investors holding similar securities, making a bottom on 8/15/07 with an intraday low of 1404. Then, to my dismay, the market embarked on an almost two month long rally, making a marginal new intraday high of 1565 on 10/9/07. The narrative behind this rally was that subprime would be “contained”, as then Fed Chair Bernanke said. (The narrative this time is of a V-shaped recovery). I remember being confounded by the rally at the time, in the same way I am by the current one. In my opinion, the current rally is the exact corollary of the 8/15/07 to 10/9/07 rally. After enduring that 2 month rally, I was vindicated when I returned 15% compared to -38.5% for the S&P in 2008. The same thing will happen this time around.

After an 11-year, 400+% bull market, investors have been conditioned to buy the dip. It has worked for 11 years so they figure it will work again this time. Because they also believe this correction is ONLY about the coronavirus, the consensus is expecting a V-shaped recovery once the virus is contained and the market is already looking ahead to that outcome. For why the consensus is wrong, see my “Understanding The Consensus View And Why It’s Wrong” (4/5/20; The consensus view and why it’s wrong). Ben Graham famously said that the market is a voting machine in the short run and a weighing machine in the long run. Right now, crowd psychology is overly bullish due to the incredible bull run we just experienced from 2009 through 2020 and that is driving the market relentlessly higher. However, reality will ultimately set in as the economy and corporate earnings remain depressed for longer than is now expected, causing share prices to come down, ultimately breaking the March 23 low of 2192.

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Sharp declines in market breadth in the past have often signaled large market drawdowns — David Kostin and his team at Goldman Sachs (4/24/20; Goldman says narrow breadth in S&P 500 a bad sign for stocks)

The market is being driven higher primarily by The Big 5 tech companies – Amazon (AMZN), Apple (AAPL), Google (GOOG, GOOGL), Microsoft (MSFT) and Facebook (FB) – which now make up 21% of the S&P’s market cap – a higher concentration than even the top of the 2000 dotcom bubble.  Correspondingly, while the S&P is 17% below its February 2000 peak, the median stock in the index is 28% below its peak. That’s because The Big 5, who all report earnings this week, are carrying the entire market. Most stocks in the S&P 500 have not bounced nearly so hard, but with The Big 5 making up such a large % of the market cap of the S&P they are able to carry things for now. Once they breakdown, the entire market will as well. That’s why this week is the most important week of the year so far.

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
825 San Antonio Road #205, Palo Alto, CA 94303
(916) 224-0113
Stocktwits (55k followers)/Twitter: @TopGunFP
Instagram: topgunfinancialria

Understanding The Consensus View And Why It’s Wrong

The consensus view is that this crisis is all about the coronavirus. Once the coronavirus is contained, markets will bottom, if they haven’t already, and we’ll rally into year end, eventually making new highs as the bull market resumes.

One of the best examples of this point of view is Goldman Sachs. Goldman is calling for a bottom in the S&P around 2000 around the middle of June and then a ferocious 60% rally to 3200 into year end.

(Added 4/6): Morgan Stanley also holds the consensus view claiming that the market has already bottomed, there will be no retest of the lows, and that this is the end of a cyclical bear market within a secular bull market.

Another excellent example of this point of view comes from Gary Savage of Smart Money Tracker in his 7-minute video “Ignore the permabears they will be wrong again” (Thu 3/26) (https://blog.smartmoneytrackerpremium.com/2020/03/ignore-the-perma-bears-they-will-be-wrong-again.html). In that video, Gary makes the analogy of the coronavirus crash to the 1987 crash which, while violent, lasted a very short time after which the secular bull market that started in 1982 continued on until March 2000. Gary believes the same thing will happen this time. He believes the bottom is already in, though it will be retested in the coming weeks, and that this is the best buying opportunity of a secular bull market that has 10-15 more years to run due to being in the early stages of a technological innovation cycle.

Also sharing this perspective is the renowned hedge fund manager David Tepper who told CNBC on Monday 3/23 that he was “nibbling” and that stocks had bottomed or were close to doing so (https://www.cnbc.com/2020/03/23/watch-the-full-interview-with-david-tepper-on-when-stocks-will-bottom-and-what-hes-buying-now.html?&qsearchterm=David%20Tepper).

Finally, the well known member of CNBC’s Fast Money, Josh Brown (“The Reformed Broker”) wrote a blog post on Sunday 3/29 called “Three reasons it’s not 1929” (https://thereformedbroker.com/2020/03/29/three-reasons-its-not-1929/) concluding: “Everyone knows it’s temporary”.

In an exchange with Howard Lindzon on Stocktwits last Monday (3/30) about Josh Brown’s piece, he said the current downturn would last “a few months” while twice calling me an “angry asshole” for my bearish views (https://stocktwits.com/TopGunFP/message/203470866).

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Unfortunately for those who hold it, the consensus view is wrong. In order to explain why I’m going to make a slight digression.

When I was in Philosophy Graduate School at UC Davis (Fall 2003 through 2005), I took a Philosophy of Science class in which I read Nelson Goodman’s classic Fact, Fiction and Forecast (1954). In that book, Goodman uses the example of lighting a match to make an important point. Under normal circumstances, when you scratch a match against the side of the case, the match lights. However, if the case is wet, for example, the same scratch will not cause the match to light.

What’s his point?

His point is that in order for the match to light, you need the catalyst (scratching the match against the side of the case) plus the proper initial conditions. In the latter instance where the case is wet, the scratching of the match doesn’t cause it to light because of the initial conditions.

What does this have to do with the current situation in the stock market and the economy?

Clearly, the coronavirus was the catalyst for the massive selloff we’ve experienced over the last month. Nobody disagrees with that. But the consensus view contains a hidden premise: Before the coronavirus, the financial markets and real economy were strong and would have continued so absent the virus.  To use Goodman’s terminology, this how the consensus view sees the initial conditions.

However, as I argued in Part II of “The Everything Bubble and The Second Great Depression” (Jan 2019) and “The Possibility of Civilizational Breakdown” (March 2020), the initial conditions were not strong, even before the coronavirus.  For one, financial assets were in an Everything Bubble fueled by 12 years of unprecedented easy money policies from the Federal Reserve (Gary Savage calls the claim of an Everything Bubble “absurd”). Second, the real economy was unbalanced due to massive inequality as a result of the hollowing out of the middle class resulting from the outsourcing of manufacturing jobs to China and other foreign countries with cheaper labor.  This cleaved society into the Haves (the Professional-Managerial Elite consisting of the Top 20% of society) and the Have Nots (those in the Service and Gig Economy catering to the Top 20%).  For an outstanding deep dive into this divide, see Musa al-Gharbi’s “Disposable People”
(4/1) (https://thebaffler.com/latest/disposable-people-algharbi; also Nelson Schwartz’s book “The Velvet Rope Economy: How Inequality Became Big Business (2020)).  Put another way, the match case was wet.

Combining the coronavirus (catalyst) with The Everything Bubble and an unbalanced real economy (initial conditions) leads to a very different conclusion about the depth and duration of the current downturn. In my latest Client Note, “Rethinking My S&P Price Target Under Civilizational Breakdown”, I put the probability of Civilizational Breakdown (think Germany in the early 1920s) at 63.5% and the probability of a Second Great Depression (think The United States in the 1930s) at 36.5%.

In conclusion, I want to say that I am not a permabear. While I have been bearish during the 2009-2020 bull market, that’s because I view it as a massive cyclical bull market within a secular bear market that began in March 2000 – the exact opposite view of Gary Savage. For evidence of this, see the chart on pg. 27 of Jeff Gundlach’s webinar “A Tale of Two Sinks” (3/31) showing that the ratio of the S&P 500 to the price of gold peaked in March 2000 (https://cache.webcasts.com/content/doub001/1296855/content/6eb12e188d39ea9ebfdd866dd60f96aabe006c2e/secured/3-31-2020%20Two%20Sinks.pdf). This suggests to me that the real value of the S&P 500 was lower at both the October 2007 and February 2020 tops than at the March 2000 top.

I love this country. In fact, I believe The United States is the greatest country in history, founded on the Enlightenment principles of reason, liberty (including free markets) and equality. I want to see the country and its citizens do well. And I want to be bullish and hope that once we work our way through the current crisis I can be. My bearishness is not a reflection of a pessimistic or misanthropic psychology; I am not an angry asshole! (LOL) My bearishness is simply a reflection of my best analysis of the current moment.

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
825 San Antonio Road #205, Palo Alto, CA 94303
(916) 224-0113

Rethinking My S&P Price Target Under Civilizational Breakdown

However, in the ~2 weeks since I wrote “The Possibility of Civilizational Breakdown” (Wed 3/18/20, http://www.topgunfp.com/the-possibility-of-civilizational-breakdwon/), it has become clear to me that an 80%-90% decline in stocks is inconsistent with the hyperinflation I am forecasting.  Currently, we are experiencing deflation in the financial markets and in the real economy, due to the lockdowns. As pointed out to me by poker pro Alec Torelli on a Skype session last Tuesday morning (3/31), while enormous, the $2 trillion stimulus package is likely to simply replace demand from lost income rather than be an inflationary force as long as the country is on lockdown.  The next inkling of inconsistency came when I started to re-read Adam Ferguson’s When Money Dies. In that book, he frequently discusses speculation in the stock market as people sought to put their money in real assets as opposed to the declining Mark, of which stocks, being a claim on a physical business, count. Instead of dropping during the hyperinflation, stocks rose, at least nominally if not in purchasing power due to the decline in the value of the Mark (see pg. 118). Lastly, I read an article an article by Lyn Alden Shwartzer on Seeking Alpha (“Why This Is Unlike The Great Depression”, Seeking Alpha, 3/30: https://seekingalpha.com/article/4334887-why-this-is-unlike-great-depression). It’s important to note that in that article she is not saying that this won’t be as bad as The Great Depression, only different: “We’re better and worse off in some ways than the Great Depression, but mainly just different.”

In sum, the coming crisis is likely to be divided into a short (~6 month) Phase I of Deflation followed by a longer Phase II of Inflation. Stocks should bottom at the end of Phase I, and my new target is 1575-2200, a big change from the 340-680 I put forward in “The Possibility of Civilizational Breakdown”. Don’t celebrate just yet, however. While stocks are likely to bottom much sooner than I previously believed, because of the fall in the dollar, their real value is still likely to decline: “In October 1922 [the share price index] dropped to 3/100ths [of its 1913 value in real terms]” (Ferguson, When Money Dies, pg. 118).

I hope everyone is practicing social distancing, staying at home and, in general, being safe out there while the medical authorities gather the data we need to implement sensible public policy about how, when and where to re-open the economy.

Best Wishes,

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
825 San Antonio Road #205, Palo Alto, CA 94303
(916) 224-0113

The Possibility of Civilizational Breakdown

Sent to Client Note List members Wednesday 3/18/20 at 8:35pm PST:

14 months ago (Jan 2019) in my Client Note “The Everything Bubble And The Second Great Depression” (https://www.topgunfp.com/the-everything-bubble-and-the-second-great-depression/), I laid out my case for what I saw as an impending depression. The analogy I had in mind was the Great Depression in the United States in the 1930s and I called for a 2/3 to 3/4 drop from peak to trough. However, the arrival of the coronavirus has thrown a monkey wrench into the equation.

While we don’t know how long it will take to contain, the coronavirus is already and will continue to cause significant economic damage. Many places are already Sheltering At Home – including San Mateo County, where I live – meaning that people in all but “essential” businesses cannot go into work and people can only leave their homes for certain authorized activities. This is causing both a supply and a demand shock. While some people and companies can work from home, many cannot. Even for those who can work from home, it will take time to get up to speed and reach previous levels of productivity. On the demand side, with consumers staying home, all brick and mortar retail businesses will see their sales decline dramaticially.

Adding the coronavirus to an 11 year asset bubble and structural imbalances in the economy that I discussed in Part II of “The Everything Bubble And The Second Great Depression” raises the possibility that this bear market will be WORSE than The Great Depression. For the first time, early this morning before the market opened (Wed 3/18) as the SPY suggested the possibility of hitting the first circuit breaker (-7%, ~2352) which coincided with a significant level of support from the December 2018 lows ~2350, my mind turned to Weimar Germany in the early 1920s.

In The United States over the last 100 years, we have had many bear markets corresponding with recessions and one bear market corresponding with a depression. In Weimar Germany in the early 1920s, in the wake of their loss in WWI and the reparations imposed on them by The Versailles Treaty, they experienced something worse: Civilizational Breakdown. In other words, the downturn went beyond the economic realm, destroying the ability of society to function.

Economically, hyperinflation caused by massive money printing to meet the reparation payments destroyed the Mark as a medium of exchange resulting in a reversion to a barter economy. This greatly complicated economic life, enormously reducing economic activity and causing mass unemployment.

But it went beyond economics. Crime soared, women turned to prostitution to feed their families. It also almost certainly played a role in the rise of Nazism and Hitler in the 1930s which led to WWII. I don’t remember all the details but you can find them in Adam Fergusson’s outstanding history When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany (1975). (I read the book many years ago and have it in storage. But since San Mateo County instituted Shelter At Home starting Monday at 12:01am, I cannot retrieve it. I ordered another copy from Amazon this morning before the market opened (Wed 3/18)).

Combining the coronavirus with a massive asset bubble and the structural imbalances in our economy could result in something similar happening again. Briefly, the structural imbalance I refer to is the enormous inequality in our society, dividing us into The Top 10% and the rest working in the service and gig economy who primarily service the wealthy. As the asset bubble implodes, a negative wealth effect will kick in, causing the Top 10% to spend less on things like eating out, vacations, and all sorts of discretionary purchases. This will hit the service and gig economy, reducing incomes and causing unemployment. It could become so bad that hungry, unemployed, armed men roam the streets looking for people and businesses to rob and women turn to prostitution in order to survive – the same sorts of things that happened in Weimar Germany in the early 1920s.

While a depression would result in a 2/3 to 3/4 drawdown in the S&P 500 peak to trough in my opinion implying a bottom between 850 and 1133, as I wrote in “The Everything Bubble And The Second Great Depression”, civilizational breakdown would be worse. We could see a peak to trough drawdown of 80% to 90%, which would mean the S&P bottoming between 340 and 680. I know this sounds almost unimaginable, but it happened once before and the arrival of the coronavirus puts this scenario on the table again in my opinion. I believe the odds of a Second Great Depression to be 50% and the odds of Civilizational Breakdown similar to Germany in the early 1920s to be 50% [updated from 77.5% Second Great Depression/22.5% Civilization Breakdown to reflect my views as of Friday 3/20/20].

The market will not go straight down. Things will take time to play out and there will be countertrend rallies, maybe some as big as +20-30%, especially once the coronavirus looks to be contained. But while these will be tradable, they will ultimately be bull traps. Use them to sell into strength and position yourself for years of economic dysfunction or worse.

Americans must start to take the coronavirus seriously by sheltering at home, practicing social distancing, washing your hands almost obsessively, etc… We stand on the precipice of a great cliff that could completely derail our country and Western Civilization. It is time for each of us to be the best version of ourselves, to do the right things, to be compassionate towards others. So much depends on it.

Wishing you all the best in this time of crisis,

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
825 San Antonio Road #205, Palo Alto CA 94303
(916) 224-0113

The Evolving Late Stage Bull Market

Last week, James Mackintosh had an interesting article in the WSJ about the stealth bear market. His main point was that stocks have essentially gone nowhere since Jan 26, 2018.  Digging a little deeper, he points out that the Russell Top 50 Mega Cap Index is up over 5% in that period while the Russell 2000 as a whole is down 3.6%. In other words, it’s the very large stocks that are now driving this thin market. If you look at the charts, the biggest 5 stocks (Facebook, Apple, Amazon, Google and Microsoft) are having monster years, but many stocks are not keeping pace.

Mackintosh followed up his article on the stealth bear market this week with one on WeWork and investors shift from seeking growth at all costs to profitability.  WeWork’s massive losses caused the company to essentially blow up during the IPO process, going from a valuation of $47 billion to $8 billion. According to Mackintosh, that’s because investors are no longer willing to pay up for fast growing, money losing startups and instead are focusing more on profitability.

This analysis seems borne out by recent reactions to 3rd quarter earnings reports. Wednesday afternoon, stalwarts Apple and Facebook reported solid, profitable quarters and the market rewarded them, even though they are already up significantly this year.  Apple’s numbers were essentially flat, but that is good enough for a company whose business model is evolving away from complete dependence on a saturated smart phone market and towards wearables and services. Facebook’s revenue was up 29% and operating income 24%.  Tesla’s stock operates according to different dynamics but it got an enormous boost when it reported a surprisingly profitable quarter despite an 8% decline in revenues.

On the other hand, Amazon struggled a bit as 1 day fulfillment added to retail costs and competition from Microsoft and others slowed AWS operating income growth to 9%. Similarly, Google reported strong top line growth of 20%, but increasing expenses hit profitability and caused a slight selloff in the stock.

More broadly, money losing recent IPOs have not fared well.  Uber and Lyft are the most obvious examples. Both are trying to grow market share at the expense of current profitability and the market isn’t having it.

All this suggests that investors are aware that the bull market is in the later stages and are looking forward to the end of easy financing.  If these companies can’t finance themselves through venture capital or bond offerings, their lack of profitability makes it impossible for them to finance themselves internally.  The recent outperformance of value also supports this interpretation.

The food delivery space offers a vivid illustration of this dynamic.  Grubhub reported 3rd quarter earnings on Monday afternoon and 4th quarter guidance showed that competition is heating up.  Investors were caught off guard sending shares down 43% on Tuesday.  The reason is that private DoorDash and Uber Eats have enormous war chests that are enabling them to operate at a loss in an attempt to gain market share.  This is destroying profitability for the whole industry as Grubhub’s results showed.  “We now view this as a race to the bottom with no clear winners” analyst Robert Mollins told the WSJ.

Trends evolve and the shift away from growth at all costs to profitability and the thin mega cap market leadership may not persist.  However, in my estimation, these new wrinkles suggest that investors are concerned that the bull market is entering it’s end stages and are positioning accordingly.  After 10 1/2 years of a relentless bull market, many are still scared of missing out (FOMO), however you can’t catch the very top and these shifts suggest to me that much of the smart money is shifting its positioning. We may be in the kind of market where you have to pick up pennies in front of a steamroller, as Mark Minervini is fond of saying, as opposed to the long uptrending bull market we experienced from March 2009 through January 2018.

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
(916) 224-0113

The Everything Bubble And The Second Great Depression

The importance of Apple to the foundation of the everything bubble cannot be overstated – Kevin Duffy, Co-Founder, Bearing Asset Management

The last few months have witnessed the return of volatility. The S&P is down 14% from its all time highs a few months ago and the Nasdaq 17%.  However, this masks much of the carnage underneath and is only the precursor of what is to come in my opinion.

Apple (AAPL) is the most important stock in the market so when it preannounced a revenue miss last Wednesday afternoon investors took notice.  Apple reduced its 4Q18 revenue guidance to $84 billion from a midpoint of $91 billion given just two months ago.  Crucially, it attributed 100% of this miss to a slowdown in China.  This is important because it is “macro”, having implications for every company that does business in China.  AAPL is now down almost 40% from all time highs reached just a few months ago.

AAPL is not the only economic bellwether to guide down in recent weeks.  On December 18, Federal Express (FDX) reduced the midpoint of its Non-GAAP EPS guidance by 8% citing a slowdown in global trade: “Global trade has slowed in recent months and leading indicators point to ongoing deceleration near term” – Alan Graf, CFO. FDX is down 40% from all time highs reached just a few months ago.

One of the best stocks in the market the last few years has been Nvidia (NVDA).  They have reported phenomenal revenue growth quarter after quarter, including 41% growth for the year ended Jan 28, 2018.  However, on November 15, they forecast 4Q18 revenue of $2.7 billion – a year over year decline from last year’s $2.9 billion.  When hot growth stocks stop growing the bottom can fall out and that’s exactly what has happened with NVDA, which is down more than 50% from all time highs just a few months ago.

We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand – John Maynard Keynes

While the wealthy have profited from an incredible “Everything Bubble” in financial assets over the last decade, the middle class has hollowed out and many are now working in the “Gig Economy”.  The Gig Economy consists of workers who work as independent contractors rather than employees.  Crucially, these workers do not receive healthcare and retirement benefits.  In addition, they have to grind for every dollar they make.  Think of drivers for Uber and DoorDash.  Much of the rest of the population works in service jobs that cater to the wealthy, like restaurants, retail, etc…

This “Everything Bubble”, driven by the Fed’s unprecedented 0% federal funds rate and Quantitative Easing, is now coming to an end in my opinion.  On December 19, the Fed hiked the funds rate for the 9th time to 2.25%-2.50%.  They also initiated Quantitative Tightening in October 2017, allowing maturing securities to run off their balance sheet at a rate that has now reached $50 bil/month.

On Friday, Fed Chairman Jerome Powell said that the Fed is not on a preset course, suggesting they could stop tightening or even loosen policy, resulting in a massive stock market rally.  However, the Fed is in a very tough spot. Having inflated an asset bubble that they have only just recently started to address, they face the dilemma of igniting an even more massive bubble or continuing along the prudent course of restoring sanity to our financial markets and economy.  Even if they opt for the former, they will most likely act too late if history is any precedent.

My personal conviction is that we will see a massive stock market unwinding of 2/3 to 3/4 from peak to trough in the major indexes over the next two to five years.  That implies a bottoming of 750-1000 on the S&P 500.

With the hollowing out of good middle class jobs and the division of most of the population into the Top 10% and the Gig/Service economy, an unwinding of the Everything Bubble will decimate the economy.  The wealthy will see their assets massively diminished and this will decrease their spending on services from the Gig/Service economy.  The wealthy will get by, as they always do, but many in the Gig/Service economy will find themselves struggling more or even jobless.  We may very well be on the precipice of a Second Great Depression.

Greg Feirman
Founder & CEO
Top Gun Financial (www.topgunfp.com)
A Registered Investment Advisor
(916) 224-0113

Confessions of a Frustrated Fund Manager

Why This Bull Market Could Be On Its Last Legs

Yesterday, the Federal Reserve decided to keep the federal funds rate at 0.25%-0.50%.  Since then, markets have soared as investors celebrate the continuation of easy money.  However, the Fed also fairly clearly telegraphed a rate rise on December 14th.  In addition to saying that the case for raising rates had “strengthened”, three members of the committee dissented from the decision, arguing that the Fed should raise rates now.  The headline of today’s WSJ is “Fed Makes Case for Year-End Hike”.  Futures markets are placing a 59% chance of an interest rate hike in December.

This is extremely important because this has been a Fed-fueled bull market.  Ever since 2008, the Fed has taken extreme, and never before tried, methods to prop up markets and the economy, including three doses of quantitative easing.  As that stimulus begins to be slowly removed, it could be lookout below for stocks and other financial assets.  Advisor Jim Stack has written in his Investech newsletter a number of times that this might one of the most interest rate sensitive bull markets in history.

While this bull market continues to defy expectations and prognostications of its demise, 2017 may well be the year the music stops.  Short term investors may want to party on until the last minute but I prefer to clean house ahead of time.  I was early in selling stocks last August but we have not missed much.  In my opinion, this is one of the most interesting economic times to be alive – and that is not necessarily a good thing.  In economics, as Henry Hazlitt wisely wrote, the trick is to judge policies not only by their effect on one group but on all groups, and not only by their effect in the short term but in the long term as well.  Keynes famously quipped that in the long term we’re all dead.  We may be about to find out who was right.

Greg Feirman

Founder & CEO

Top Gun Financial

(www.topgunfp.com)

A Registered Investment Advisor

Bay Area, CA

(916) 224-0113

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Some Caveats On The Retail Recession

NOTE: Every week or two I wrote a Client Note for my clients. I post most but not all of the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.

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Last week was all about the big department stores – Macy’s (M), Kohl’s (KSS) and Nordstrom’s (JWN) – and their sales failures.  This week is all about a number of retailers who have been doing quite well up until now and who will release earnings reports this week and next.

Let’s start with the discounters, TJ Maxx (TJX) and Ross Stores (ROST), who we will hear from later this week.  In February, TJX reported 5% comparable store sales for the year ended Jan 30, 2016 and forecast a 1-2% increase for the coming year.  The stock is near all time highs.  They will report 1st quarter results Tuesday morning.

The story at Ross Stores (ROST) is similar.  Comparable stores were up 4% for the year ended Jan 30, 2016 and they forecast a 1-2% increase for this fiscal year.  The stock is near all time highs.  ROSS will report 1st quarter results Thursday after the close.

Second, let’s consider the home improvement retailers, Home Depot (HD) and Lowe’s (LOW).  HD reported 5.6% comparable store sales growth for the year ended Jan 31, 2016 and forecast 3.7%-4.5% for the current year.  HD stock is trading near all time highs.  They will report 1st quarter earnings Tuesday morning.

Lowe’s (LOW) reported a 4.8% increase in comparable stores for the year ended Jan 29, 2016 and forecast a 4% increase for the current year.  LOW stock is trading near all time highs.  They will report earnings on Wednesday morning.

Beauty retailer Ulta Cosmetics (ULTA) is on fire.  Comparable store sales increased 11.8% for the fiscal year ending Jan 30, 2016 and ULTA forecast an 8-10% increase for this fiscal year.  The stock is near all time highs.  They will report 1st quarter earnings next Thursday (5/26) after the market close.

Finally, Amazon (AMZN) continues to take share from brick and mortar retailers.  For the quarter ended Mar 31, 2016, AMZN reported a 28% increase in revenue.  The stock is at all time highs.

One can therefore ask: Is retail really in recession as I claimed last week?

First, I realized my own confirmation bias in last week’s terrible reports and wanted to counteract that.

Second, another thing I noticed in studying these companies that are doing well is how much they are borrowing to buy back stock.  Financial engineering abetted by low interest rates is playing a big role in squeezing EPS higher.  HD bought back $7 bil in stock in each of the last 2 years, lowering their diluted share count by 4.7% last year.  LOW bought back $3.9 bil in each of the last two years, lowering their diluted share count by 6.2% last year.  HD issued about $6 bil and LOW $3 bil in long term debt over the last 2 years to partly help finance these buybacks.

Third, valuations for these high performing companies are quite high.  HD, TJX and ROST are all trading at multiples of forward earnings in the low 20s and LOW is at 19x.  AMZN, of course, is barely profitable and remains a conundrum.  ULTA trades at about 35x forward earnings.

The next couple weeks will tell us quite a bit about the consumer and if last week’s earnings report were merely company specific or represent broader economic weakness.

Greg Feirman

Founder & CEO

Top Gun Financial (www.topgunfp.com)

A Registered Investment Advisor

Bay Area, CA

(916) 224-0113

Retail Recession

NOTE: Every week or two I wrote a Client Note for my clients. I post most but not all of the notes to my blog but with a time delay usually between 1 day and 1 week. To receive the Client Notes at the same time as my clients, sign up in the box in the right hand corner of the website.

*****

The big retailers are starting to report 1st quarter earnings and the results are not pretty.

It started with Macy’s (M) on Wednesday morning.  Macy’s reported a 5.6% decline in same store sales, its worst since the 2nd quarter of 2009.  Macy’s also lowered full year guidance from $3.80 to $3.90 to $3.15 to $3.40.  Macy’s stock is now down more than 50% from the middle of 2015.

Continuing the negative news parade was Kohl’s (KSS), which reported a 3.9% decline in same store sales on Thursday morning. Diluted earnings per share of 31 cents were down more than 50% from the 63 cents reported in the year ago period.  Kohl’s chart looks similar to Macy’s with shares down more than 50% from early 2015.

Finally, Nordstrom (JWN) reported an ugly quarter after the close on Thursday.  EPS of 26 cents missed estimates for 46 cents and were down 60% from the 66 cents reported in the year ago period.  Nordstrom’s also reduced full year EPS guidance from $3.10 to $3.35 to $2.50 to $2.70.  Nordstrom’s stock chart shows the same pattern peaking in early 2015 and now down more than 50% from those levels.

I bring these earnings reports to your attention for a couple of reasons.  First, these kinds of stock charts support my belief that we are in a stealth bear market that began in 2015.  While some stocks make new highs, like Facebook (FB) and Amazon (AMZN), the market’s leadership is increasingly thinning out.

Second, I want to reiterate my point that the Federal Reserve’s policies are enormously regressive.  That is, they help those who own financial assets such as stocks and real estate while doing nothing to stimulate the real economy and those in the middle and lower classes who depend on earning income from their work.  These policies are creating increasing inequality with the wealthy, on the one hand, and those who serve them through low paying service jobs, on the other.  No wonder Macys, Kohls and Nordstroms are suffering.  Their core market, especially for the former two, is the shrinking middle class.  (In addition, Amazon continues to take share from brick and mortar retailers).

Greg Feirman

Founder & CEO

Top Gun Financial (www.topgunfp.com)

A Registered Investment Advisor

Bay Area, CA

(916) 224-0113

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