Amazon - Is Disruption Worth More Than Profits?

In his latest quarterly letter to investors dated October 24th, Greenlight Capital's very successful well-known veteran hedge fund manager David Einhorn wrote the following:

"Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value," he wrote. "What if equity value has nothing to do with current or future profits and instead is derived from a company's ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?"

"Our view is that just because Amazon can disrupt somebody else's profit stream, it doesn't mean that Amazon earns that profit stream. For the moment, the market doesn't agree," he wrote. 

Einhorn's conclusion would prove to be an understatement!

Late Thursday (after the NY market closed), October 26th,  Amazon released its latest quarterly earnings report.  It reported revenue of $43.7 billion as compared to a consensus Wall Street estimate of $42.0 billion, and Amazon reported "adjusted" earnings of $0.52/share versus a consensus estimate of $0.02/share. Investors immediately piled into Amazon's stock, and Friday's 13.22% gain in Amazon's stock price is a clear testament to Einhorn's theory that value may have nothing to do with current or future profits, but may instead be derived more from a company's ability to be disruptive!

In the fine print of Amazon's earnings report, the Company reported $4.58 billion in revenue from it AWS cloud services division which translated into $1.17 billion in operating income from this division. It may be noteworthy that AWS accounts for approximately 10% of Amazon's total revenue and ALL of the Company's profit. In fact, without this $1.17 billion in net income from AWS, Amazon actually LOST $823 million for this latest quarter in all of the rest of its divisions combined!

Amazon's cloud services division currently has 30% of the cloud services market, but competitors are making up ground extremely fast. Microsoft's growth in this sector has beaten Amazon's growth for 8 quarters in a row. Microsoft is now the second largest player in this space with 14% of the total market. Other major competitors include giants like Google, IBM, Alibaba, and Oracle.

Investors now value Amazon at 278 times trailing twelve month earnings! Investors expect Amazon's "earnings" to double over the next twelve months to about $8.00/share (this looks optimistic, at best), which would then translate into a forward price/earnings ratio of about 138 times if we used Friday's closing stock price of $1,100.95/share! This compares to a forward P/E ratio of about 20x for the major market indexes.

Amazon has at least 130 major corporate competitors, mostly in low margin businesses. While all these companies attempt to adjust to Amazon's disruptive (and predatory) low price strategies, it's unclear when (or IF) Amazon will EVER earn substantial profits. Amazon's current "profit engine" is clearly its cloud services division, but given the substantial corporate names now competing aggressively in this space, investors should probably NOT count on the same kind of revenue growth or profit growth in quarters immediately ahead (or EVER) from this key division!

With respect to the broader market last week, despite record all-time highs posted this past Friday in the Nasdaq Composite Index and the S&P 500 Index, the average Nasdaq listed stock actually fell every day last week except on Friday. Even with Friday's big gain, the average Nasdaq stock still lost 0.90% on the week. On the New York Stock Exchange, the average listed stock declined 0.51% on the week!

In my computer trading system, despite record highs in the Nasdaq Composite Index AND the S&P 500 Index:

Weekly chart sell signals were officially triggered at Friday's close in the following stocks: BA, BSX, FIVE, GM, HPQ, MMC, MTH, PCH, PFE, RTN, and UTX.

Monthly chart sell signals were triggered last week in the following stocks: BIIB, BK, BMY, CVX, EBAY, GD, LMT, MMC, RTN, TWX, and UN.

Caveat Emptor: There is something terribly wrong inside the U.S. stock market, and a major correction looks highly probable on the near-term horizon!

The week ahead may prove to be among the more interesting weeks of this entire year. Here are just a few potential triggers of increased volatility:

1. Special counsel Robert Mueller's office is expected to announce its first indictments in its ongoing investigation of Russia's meddling in the November 2016 U.S. Elections (probably Monday, October 30th).

2. Congress is expected to release its first draft of potential tax reform (probably midweek - November 1st. A 1,000 pages of tax cuts (no real tax reform) and hardly any spending cuts is forecast. Current deductions for mortgage interest and State & Local taxes will probably be maintained, which would then violate the $1.5 trillion deficit cap that was agreed to in the budget reconciliation agreement).

3. President Trump is expected to announce his choice for Chairman of the Federal Reserve (unknown date, but probably towards the end of the week - the WSJ is reporting that Jerome Powell will be Trump's pick, but I continue to believe there is a chance that President Trump will choose John Taylor who would be Trump's "own guy" as opposed to an Obama holdover in Powell)

4. The Federal Open Market Committee meets to discuss monetary policy (statement expected on Wednesday, November 1st - no interest rate hike is forecast, but the closing statement will likely be hawkish and indicate that a December interest rate hike is likely along with ongoing regular monthly draw-downs of the Fed's balance sheet as per the schedule already released)

5. The Labor Department will release its latest monthly employment report  for October 2017 (this release is expected Friday morning, November 3rd).

Daily Chart Sell Signals Triggered In Most Major U.S. Stock Indexes Today

Just a quick note here tonight...

Daily chart sell signals were triggered by my computer trading system in most major U.S. stock indexes at today's NY close as follows:

S&P 500 Index (see chart below)

S&P 100 Index

New York Composite Index

Nasdaq Composite Index

Dow Jones Transportation Average

Daily chart sell signals were also triggered in the following major index ETFs:

S&P 500 ETF (symbol SPY)

Dow Jones Transportation ETF (symbol IYT)

Retailers Index ETF (RTH)

A daily chart buy signal was triggered in the double-short S&P 500 ETF (symbol SDS)

S&P 500 Index Daily Chart with Computer-generated Buy & Sell Signals

Has Icarus Flown Too Close To The Sun?

Jacob Peter Gowy's
The Flight of Icarus

Led by a 2% gain in the Dow Jones Industrial Average last week, most major U.S. stock indexes closed at record all-time highs on Friday, October 20th. There were some notable exceptions, such as the Russell 2000 Index of small-cap stocks and the Dow Jones Transportation Average, that didn't post all-time highs. However, even for the most vocal bears, it would be a stretch to call these lagging indexes "dangerous non-confirmations".

Why did the major indexes make new highs last week? Increasing odds of "favorable" tax reform legislation from Congress and well-sourced rumors that Jerome Powell, a known dove on the current FOMC, will be appointed by President Trump as the next Federal Reserve Chairman were two factors boosting stock prices late in the week. The October options expiration may have positively impacted equities on Friday, and quarterly earnings have been mostly "better than expected".

So how does this end? Why should anyone sell stocks? Where's the downside risk? The S&P 500 has not experienced a single-session decline of more than 3% since Nov. 7, 2016. This 241-day period without a single-session drop of that magnitude ties the record stretch from Jan. 26, 1995 to Jan. 9, 1996. There have only been 5 single-session declines this past year of greater than 1% and none greater than 2%! What's going to change?

The 30th anniversary of the great crash of 1987 was this past week on October 19th. There was much press about how "things are different now" and THAT type of negative price action could never happen again. Perhaps not, but how about a meltdown like the one that unfolded on August 24th, 2015, just two years ago! On that wild day the Dow Jones Industrial Average dropped 1,100 points (-6.6%) in the first five minutes of trading. A large drop in Asian equity prices overnight contributed to a 7% decline in  U.S. stock futures before the New York opening on August 24th, 2015. Here are some interesting stats for that eventful day:

1) Only about half of S&P 500 stocks were opened on NYSE by 9:35 a.m.; on most days, nearly 100% of stocks in the S&P 500 are open by 9:35 AM.

2) 765 stocks in the Russell 3000 were actually down more than 10 percent on an intraday basis;

3) There were 1,278 trading halts for 471 different ETFs and stocks.

Because of these problems, it was impossible to calculate the value of many ETFs, or to hedge or to trade ETFs and stocks at a legitimate 'correct' price!

It's not hard to imagine a major catalyst right here and now that could cause this same kind of disruption in our financial markets. The obvious #1 choice is some sort of major confrontation on the Korean Peninsula. The Trump Administration already has enough firepower over there to start World War III. And President Trump just signed an executive order allowing the Air Force to recall up to 1,000 retired pilots to address what the Pentagon has described as "an acute shortage of pilots." This order, which Trump signed Friday, amends an emergency declaration signed by George W. Bush in the days after the September 11, 2001 terror attacks. The Air Force is only allowed to recall up to 25 pilots under current law. This order signed by Trump temporarily removes that cap for all branches of the military. Is the US Air Force preparing to put nuclear-armed bombers back on 24-hour ready alert for the first time since the Cold War ended in 1991? Secretary of State Rex Tillerson said this weekend that Iranian "militias" need to leave Iraq as the fight against Islamic State militants was coming to an end. “Certainly Iranian militias that are in Iraq, now that the fighting against (the Islamic State group) is coming to a close, those militias need to go home,” Tillerson said during a press conference in Riyadh, where the U.S. diplomat is holding talks with top Gulf officials. "All foreign fighters need to go home,” he added. Is President Trump preparing for war in North Korea AND the Mideast? While we all hope and pray that another war will not break out, mistakes can happen when diplomatic efforts are stressed to the limit as they are now!

I think that the global financial markets are underestimating the risks of a major civil war in Spain. That country's leadership in Madrid is playing hardball with "separatists" in Catalonia, who seem dead set on independence. And there are now two separate referendums up for vote in Italy for more autonomy in two of the largest and most productive regions of that country. First there was Brexit, then Catalonia, and now two major regions in Italy. Cracks in the Eurozone continue to widen. And how will the financial markets react when the European Central Bank begins to taper its quantitative easing program. Right now, the ECB buys bonds worth 60 billion Euro per month. Well informed speculation now indicates that the ECB will cut this amount to just 30 billion Euro per month beginning January 1, 2018 (less monetary accommodation, for sure!). This "taper" announcement is expected this coming Thursday, October 26th!

And here at home, how would the financial markets react to the following possible events:

1. What if President Trump unexpectedly nominates John Taylor as the next Chairman of the Federal Reserve (Taylor is my bet, because Trump wants the new Chairman to be HIS chairman, not some leftover from the Obama Administration). John Taylor is a well known "hawk" on monetary policy. Wall Street investors seem to think that Jerome Powell, a well know "dove" on monetary policy, will be Trump's nominee.

2. The Senate passed a budget resolution fairly easily this past Thursday night, which now sets the stage for possible Tax Reform (corporate tax cuts) before year-end. The financial markets have celebrated every time President Trump mentions "massive" tax cuts this year, but there are only so many times you can go to that well. Where's the beef? Where are the details? And can the Republicans navigate the myriad of obstacles already lined up in the path of potentially successful tax reform legislation that will eventually reach the White House? How will the markets react if the Republicans in Washington can't pull this all together? And what about a possible shutdown of the Federal Government in early December (funding and debt ceiling legislation need to be passed)? The Democrats are in the minority in Washington, but they still have power (to disrupt)!

3. Black Swans, by definition, are unknown exogenous events that can cause major disruptions in financial markets. Despite the daily reports from the media on Russian meddling in the U.S. elections of November 2016, not very many on Wall Street or in Washington are talking about potential disruptions to the financial markets from a major unforeseen cyber attack. Russia has proven it expertise in cyber warfare. And reports now suggest that North Korea is also among the best at this extraordinary new weapon of war!

4. Special Prosecutor Robert Mueller seems to be interviewing everyone close to President Trump right now in the ongoing investigation of Russia's interference in our November 2016 National Election. It's not hard to predict that something significant could come out of Mueller's investigation that will move the markets.
5. The U.S. Federal Reserve announced in September it would begin to reduce its $4.5 trillion portfolio of Treasuries and mortgage backed securities. It plans to shed $10 billion per month during the final quarter of 2017, then increase this pace by $10 billion every three months until it reaches a monthly rate of $50 billion. Fed Chair Janet Yellen said late Friday that the initial stage of this "liquidation" of the Fed's balance sheet was going well. With those comments, we now know for sure that the Federal Reserve has actually started on this path to reducing its balance sheet, but we don't have any idea how the markets will receive these planned liquidations over the coming months. "Quantitative Tightening" as this is now being called, is fraught with massive risks! If the Fed executes the sale of at least $10 billion in notes and bonds per month through year end and then another $20 billion per month through the first quarter of next year, $90 billion in Treasury securities will be sold by the Federal Reserve through March 31, 2018. In addition to these sales, the Treasury will need to sell approximately $330 billion in notes and bonds to fund the Government's budget deficit. The total is about $420 billion in Treasury securities sales through March 31, 2018. And if rumors are true that the ECB will taper its bond purchases by 30 billion Euro ($35 billion) per month in the first quarter of the next year, then the market will need to buy an additional $105 billion in sovereign debt in the 1st quarter of 2018 that it didn't have to buy during this same 3-month period in 2017. The current 10-year T-note yield is 2.38% as of Friday's close. The massive additional supply expected in this market over the next 6 months could easily force this key interest rate to near 3.0%! How will U.S. equity prices fare in an environment of 25% higher interest rates? It's not hard to forecast at least a 20% correction for the major stock market averages under this scenario!!
6. How much money is now tied to "short volatility" derivatives activity? I read a frightening research report this weekend from Artemis Capital Management that suggested this number could be as high as $1.4 trillion if all markets are considered (stocks, bonds, FX, etc. - see chart below). One of the biggest contributors to the Crash of October 1987 was "naked" selling of put options in the popular OEX Index Contract. The OEX was officially called the S&P 100 Index back then. More than several "retail" customers were short the limit of 15,000 contracts in "out of the money" puts that suddenly went "in the money". These shorts were forced to cover at the worst possible time Monday morning on October 19th which triggered an avalanche of selling in the underlying related S&P 500 futures as market makers tried to hedge. Short interest in VIX (volatility) futures is currently at or near a record high! I sometimes wonder if these "investors" understand that if there is a sudden correction in the stock market, VIX shorts will explode and cause massive losses (as stock prices freefall and index funds and ETFs get liquidated).

Courtesy: Research from Artemis Capital Management

With all the stock market records in the major indexes that were posted last week, does anyone think it is odd that the average stock on the New York Stock Exchange was only up 0.11% on the week, and on the Nasdaq Stock Exchange the average listed stock was actually DOWN 0.29% on the week! In the latest weekly edition of Barron's Magazine, the P/E ratio for the Russell 2000 Index is now 115 as calculated by Birinyi Associates using the trailing 12-month earnings for each component stock! Does this kind of valuation bother anyone?

And here is a fascinating chart by Dana Lyons (https://lyonssharepro.com/) which tracks the money moving in and out of the Rydex (Guggenheim) Bear Funds:

What's immediately clear from this chart is that almost no one is expecting any kind of meaningful correction in the U.S. stock market right now! 

Is there anything meaningful happening in my proprietary computer trading system? I am glad you asked!

Despite record highs in almost all the major averages on Friday, weekly chart sell signals were officially triggered at Friday's close in the following key FAANG stocks: Amazon, NetFlix, and Apple. A weekly chart sell signal was also triggered in the Biotech ETF (symbol BBH). The broader U.S. stock market looks vulnerable to a major correction as downturns in key leadership equities already appear to be underway! Could there be a melt down on the near-term horizon? Has Icarus flown too close to the sun?

Biotech ETF (BBH)

Biotech ETF Weekly Chart with Computer-generated Buy & Sell Signals

Amazon (AMZN)

Amazon Weekly Chart with Computer-generated Buy & Sell Signals

NetFlix (NFLX)

NetFlix Weekly Chart with Computer-generated Buy & Sell Signals

Apple (AAPL)

Apple Weekly Chart with Computer-generated Buy & Sell Signals

Is President Trump Really A Friend To U.S. Stock Investors?

Since Donald Trump was elected President in November 2016, the U.S. stock market has posted a remarkable upside performance. From the intra-day lows posted on November 4, 2016, the S&P 500 Index has gained 22.5%. The Russell 2000 Index is up 30.0% and the Nasdaq Composite Index is up 31.2%!

In more than a dozen tweets this year, President Trump himself has taken full credit for this stock market advance (even though his administration has yet to pass a single piece of major legislation). When asked about the incredible stock market performance over the past year, Wall Street pundits almost universally point to the perception that the Trump Administration is "good for business" as a result of deregulation (through Executive Orders) and potential corporate tax cuts immediately ahead. And maybe there is some truth to this argument, but are we close to a potential inflection point where smart-money investors reconsider their love affair with "all things Trump" and begin to realize that valuations matter, results matter, buying power matters, leverage matters, and central bank monetary policies matter!

The S&P 500 Index, the Nasdaq Composite Index, and the Dow Jones Industrial Average ALL closed at record highs this past Friday, October 13th. However, almost every major U.S. stock market index ended yesterday very near their intra-day lows! And several key benchmarks actually finished DOWN on the day (i.e. Russell 2000 Index, Dow Jones Transportation Average, Dow Jones Utility Average)!!

Six months from now, when most major U.S. stock market averages are down more than 20% from yesterday's record highs, will we all look back at October 13th, 2017 as THE inflection point when investors finally woke up to the fact that President Trump is actually the Pied Piper of Wall Street leading all of us over the proverbial cliff into the abyss?

Here is the first piece of evidence that President Trump is NOT good for stock investors:

Tweet from President Donald Trump, Saturday, October 14, 2017 at 4:18 AM

"Health Insurance stocks, which have gone through the roof during the ObamaCare years, plunged yesterday after I ended their Dems windfall!"

President Trump seemed to take great satisfaction this morning (Saturday) when he tweeted about the recent collapse of health insurance stocks. The President's attack on the Affordable Care Act with his latest Executive Action was definitely a contributing factor to the broadly based weakness in healthcare insurance stocks last week. And President Trump has obviously taken full credit here for those stock losses, and the tone of his tweet seems almost like a boast! 

Here are the top five health insurance stocks and their investment performance this past week:

United Healthcare (UNH)      -2.80%

Anthem (ANTH)                    -4.86%

Aetna (AET)                           -5.10%

Cigna (CI)                               -2.51%

Humana (HUM)                     -3.71%

Investors lost about $15 billion last week in just these five stocks listed above. And if all the stocks in this sector are included, investor losses probably topped more than $20 billion last week!

One of the arguments for continuation of the great "Trump" rally is so-called "bullish rotation", where certain sectors lead the market for a while, then trade sideways as other sectors regain strength and lead the overall market higher. Bullish sector rotation is definitely a major key to the staying power of any bull market, but at what point do you decide that the "music" is about to stop and there are "no more chairs"!

The Technology sector, led by the so-called FAANG stocks, was clearly among the key market leaders last week.

FaceBook (FB)     +0.88%

Amazon (AMZN) +1.35%

Apple (AAPL)     +1.09%

NetFlix (NFLX)   +0.74%

Google (GOOG)  +1.10%

But media companies were smashed last week:

AMC                     -9.54%

Dish Network        -9.28%

ATT (Direct TV)   -7.49%

Comcast                -5.26%

Viacom                  -4.24%

And bank stocks were severely injured:

Citicorp                 -4.67%

Wells Fargo           -3.40%

Goldman Sachs     -3.04%

Morgan Stanley     -2.93%

Bank America       -1.45%

JP Morgan             -1.09%

So which is it? Will positive sector rotation continue to support this bull market? Or has the tipping point been witnessed when sellers begin to overwhelm buyers?

In my computer trading system, the follow daily chart sell signals were triggered at Friday's close, October 13th:

DJTA, HGX, BA, BMY, COP CSX, CTB, FDX, GD, IYT, JBHT, KBH, LLL, NSC, PAYX, SBUX, UNP, UPS, UTX, XLU, XTN, among others!

Quite frankly, with all-time record highs posted in the S&P 500 Index and the Nasdaq Composite on Friday, I would never have expected so many daily chart sell signals in so many closely watched key stocks!

As very interesting contrary indicators, here are two measures of investor sentiment taken directly from the latest University of Michigan Consumer Sentiment Survey as released late last week:

Investors who were surveyed have NEVER been more confident of rising stock prices over the next twelve months (never, ever)! Simply incredible!! In the latest weekly edition of Barron's Magazine, the P/E ratio for the Russell 2000 Index is now 108.56 as calculated by Birinyi Associates using the trailing 12-month earnings for each component stock. While consumer confidence and investor sentiment are extremely positive and near record all-time highs, why is confidence among Chief Financial Officers waning? In the latest quarterly survey of CFO's, as published by Deloitte in late September, "Net Optimism" in their own companies plunged to 29% in the 3rd quarter from 44% in the 2nd quarter. In the key manufacturing sector, the decline was even steeper, falling from 52% to 22%. And in the energy sector, net optimism among CFO's collapsed to just 19% in the 3rd quarter from 48% in the 2nd quarter.

Food for thought! What could possibly go wrong? Nothing to worry about here!

Bottom line: October 13th, 2017 will be remembered as THE INFLECTION POINT in the great bull market in U.S. stocks that lasted from March 6, 2009 through October 13, 2017. The northbound Trump Train is at its terminus, and the southbound express is about to leave the station! When the inevitable collapse in stock prices gets underway, investors should not be surprised when President Trump blames Congress for this latest tragedy under his watch.

Dow Jones Transportation Average with Computer-generated Buy & Sell Signals

Melt Up? Or The Calm Before The Storm?

It was announced this week that Richard Thaler won this year's Nobel Prize in Economics. Thaler, 72 and a professor at the University of Chicago, is one of the founders of the controversial field of behavioral economics. He won this year's Nobel for his research on how human weaknesses such as a lack of rationality and self-control can impact financial asset prices.

In a wide ranging interview with Bloomberg today, when asked about the U.S. Stock Market, Mr. Thaler said the following: 

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping,” Thaler said, speaking by phone on Bloomberg TV. “I admit to not understanding it.” 

Thaler continued, “I don’t know about you, but I’m nervous, and it seems like when investors are nervous, they’re prone to being spooked.” However, Thaler said, “Nothing seems to spook the market” and if the recent gains are based on tax-reform expectations, “surely investors should have lost confidence that that was going to happen.” Thaler added that he didn’t know “where anyone would get confidence” that tax reform is going to happen. “The Republican leadership does not seem to be interested in anything remotely bipartisan, and they need unanimity within their caucus, which they don’t have.” 

Bottom line: The foremost authority on behavioral economics is "nervous" about the U.S. stock market in this, the riskiest moment in our lives!

A daily chart sell signal was triggered in my computer trading system for the Russell 2000 Small-cap ETF (symbol IWM) at yesterday's close, October 9th. Please see chart below.

Russell 2000 Index ETF (symbol IWM) with Computer-generated Buy & Sell Signals 

While most major indexes have posted record highs this week, volatility, as measured by the VIX at the CBOE, posted record lows. There is a calm, almost eerie feeling about this latest stock market advance. Some Wall Street pundits are now suggesting that we are in a "melt up" phase bolstered by positive talk about tax reform (tax cuts, no real reform) and strong corporate earnings reports expected immediately ahead. In mid-October 1987, U.S. stock prices started to retreat. The Federal Reserve had been raising interest rates for several quarters (just like now), and valuations were considered "stretched" after advancing for more than 5 years (just like now). Corporate earnings were robust (like now) and "Main Street" America was relatively comfortable (like now) after 5 years of economic growth which followed the 1982 recession. No one could have imagined the carnage which would take place on October 19th, 1987 when the Dow Jones Industrial Average lost 23% of it value in a single day. Was their a catalyst that triggered the Crash of 1987? Even though I was a trader in the popular OEX contract at the CBOE at that time, I still can't say for sure what caused that unprecedented Crash. On Friday, October 16, 1987, the trading day before the crash, there were reports that Iranian gunboats fired upon U.S. warships in the Persian Gulf. Maybe this was the spark that triggered Monday's deluge of selling. Most reports of the day and subsequent analysis point to a trading strategy at the time called "portfolio insurance" (basically, everyone was long, without fear!). Today's popular "risk parity" strategies have the look and feel of the "portfolio insurance" scheme of 1987. And later this week, President Trump is expected to refuse to re-certify the Iran Nuclear Deal (Iran again, just like in 1987)! 

Some say that a 1987-type Crash can't happen today or ever again given the precautions now in place by the exchanges. More importantly, most believe that the Federal Reserve and other global central banks will just step in as "buyers of last resort" if there is any significant downturn in stock prices. And maybe that's so, but how far down will prices have to go before central banks begin their "plunge protection" efforts? We live in interesting times, for sure! Is that a black swan I see on the horizon?