Control Panel: Trend change

As your humble METAR weather reporter, I try to separate market signal from noise. I rarely call a trend change since the signal takes time to develop. I believe that this may be the beginning of a secular bear market, a true trend change. I’m not the only one with this feeling.…

American capitalism has experienced economic boom and bust cycles since the 19th century. These were driven by imbalances in the free market of goods, services, property and debt. It was only after the popping of the tech stock bubble in 2000 and the rather minor 2001 recession that the Federal Reserve began to meddle in the free markets by suppressing interest rates, setting off asset bubbles with fiat money lending. The Fed’s assets now equal almost $9 Trillion, which is 37.5% of GDP ($24 Trillion). This monetary pumping caused bubbles in stocks, bonds and real estate.

The Fed lends to banks. Little of the monetary stimulus got into consumer hands, which was why inflation was relatively low until Congress provided huge pulses of fiscal stimulus directly into consumer hands to prevent a serious depression due to Covid shutdowns. Federal spending amounted to 15% of GDP in 2020 and even more in 2021. This excess demand would have been inflationary even if not for supply chain problems caused by Covid-19 which are still problematic.…

The Fed’s mandate is to maintain stable prices and full employment. Their mandate does NOT include maintaining stable asset prices, although they have acted to support the stock and bond markets since 2000 with the “Greenspan put” and Quantitative Easing from the 3 subsequent Fed chairs, including Jerome Powell, the current chair.

Now that inflation is raging out of control, Powell has finally realized his true mandate and is channeling his inner Paul Volcker. The Fed has only just begun to raise the fed funds rate and announce that they will begin to roll off (and possibly sell) their Treasuries and mortgage bonds. This jawboning has already impacted the markets. Treasuries and mortgage yields are way up.

Nonfinancial Corporate Business Debt Securities and Loans are at a record high, close to 50% of GDP. Many of the “growth” stocks that are “Saul type” high flyers were issued by companies that can’t pay off their debts and must “roll over” their existing debts at a higher interest rate now.

A widely accepted definition of a zombie is a business with an interest coverage ratio of less than 1 for three years. On that measure, 11% of Russell 3000 Index companies were unviable in 2020, a figure that jumped to 19%, or 571 companies, on a 12-month basis. The article below lists names. The Fed is aware of these zombies. The Fed found that 10% of companies are zombies, but they concluded “Don’t worry, be happy.” Of course, they said the same about rising inflation last year. As interest rates rise, these zombies will be strangled. Many of these zombies are tech companies.………

**The Tech Industry’s Epic Two-Year Run Sputters**
**Investors are divided about whether technology companies are set for a deep retrenchment or if growth is simply slowing from pandemic highs**
**By Sebastian Herrera and Akane Otani, The Wall Street Journal, May. 8, 2022**

**The pandemic strengthened the tech industry’s dominance. As the economy shut down, many consumers relied on technology like never before — helping lift the fortunes and share prices of online retailers, videoconferencing platforms and streaming services to new heights.**

**A confluence of factors has upended that dynamic this year. Inflation is running at a four-decade high, pressuring wages for drivers and warehouse workers and crimping consumer spending power. Rising interest rates have started to damp the flood of capital seeking high returns in tech investments. The reopening of bricks-and-mortar restaurants and stores has sapped demand for items ordered online, prompting e-commerce companies to recalibrate their expansion. Covid-19 lockdowns in China are creating new supply-chain disruptions for iPhones and other gadgets....** [end quote]

The Shiller P/E ratio for the S&P 500 (the Price-to- earnings ratio based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted P/E Ratio (CAPE Ratio), has come down a little but is still above the 1929 peak. The Buffett Indicator (the ratio of total United States stock market valuation to GDP) is above the 2001 bubble peak. If you can look at these charts without a shudder you have stronger nerves than I do.…

The Fed’s announcement that they will seriously address inflation by raising the fed funds rate and Quantitative Tightening is a true trend change. The most vulnerable are the financially-weak NASDAQ stocks that have already been hit, but all stocks are vulnerable and the market has much further to fall.

The Control Panel is ugly all over. Only the USD is rising – and that will hurt overseas competitiveness and the dollar earnings of multinational companies.…

The Fear & Greed Index is in Fear (but not Extreme Fear).

The April 2022 Manufacturing ISM® Report On Business® shows the April Manufacturing PMI® registered 55.4 percent, a decrease of 1.7 percentage points from the March reading of 57.1 percent. This is the lowest reading since July 2020 (53.9 percent). The April 2022 Services ISM® Report On Business® PMI® registered 57.1 percent, 1.2 percentage points lower than March’s reading of 58.3 percent. The Prices Index reached an all-time high.

GDP fell 1.4% in 1Q22 but the Atlanta Fed predicts a real +2.2% in 2Q22. This may happen…if the Fed’s tightening doesn’t cause a recession.

The trade deficit ballooned shockingly to a record.

The “mungofitch 99-day rule” has a couple of weeks to run, but I seriously doubt whether the SPX will suddenly make a new high in that time.

The METAR for next week is not just bad weather, but a change in season. Outside, we are moving into spring but the markets are moving into winter. Until inflation is decisively controlled, the Fed will continue to tighten. And once the bubble begins to pop it may pull the entire market with it, which has happened many times before.



" Many of the “growth” stocks that are “Saul type” high flyers were issued by companies that can’t pay off their debts and must “roll over” their existing debts at a higher interest rate now."

I totally get that rising interest rates for debt laden companies are a bad thing. But some of the
“Saul type stocks” are very far from being debt laden companies.
I’m not up on all “Saul type” stocks, but I do own a few.
Just a quick and cursory look at cash to debt and FCF on ones I own.

Cash and Short term investments - long term debt: ( #'s taken from most recent quarter,on balance sheet)
Free Cash Flow: total cash from operations - Capex ( most recent quarter, on cash flow statement )

net cash / FCF
DDOG: + $935 Million net cash / +$129,901 Million positive free cash flow
CRWD: + $1,257 Million net cash / +$441 Million positive fcf
S: + $292 Million net cash / -$1 Million Negative fcf
UPST: +292 Million net cash / +$153 Million positive fcf
ZS: +$680 Million net cash / +$112,816 Million positive fcf

Big Tech Stocks ( not Saul type stocks )
net cash / FCF
MSFT: +$40,228 Million net cash / +$47,391 Million positive fcf
AAPL: - $68,470 Million Net Debt / +$69,815 Million
NVDA: + $$10,262 Million / +$8,132 Million

Other than S ( SentinelOne ), these tech companies look like cash generating machines.
AAPL is net debt against balance sheet cash, but they are stellar cash generator. Of course, that
can change if everybody quits buying their products. I’m willing to take that chance.
And even S looks like they can survive for quite some time while being cash flow negative.
How are rising interest rates going to be the death knell for these companies ?

Now of course if Europe devolves into WW3, then all bets are off.
But I’m not sweating owning the above listed stocks. And yeah, they can go lower, lol,
ain’t no doubt about that.

But if a person took to heart the advice to keep ALL short term money ( at least 5 years
cash, varies depending on personality, I’m at close to 10 years ) OUT of the stock market,
then I think they’ll do okay.

disclaimer: have had a couple of glasses of wine, lol, so wouldn’t be surprised at
any math errors


lol, fcf’s are off by 3 000’s on datadog and Zscaler. They are of course not
generating $129 billion and $112 billion in most recent quarter fcf, rather $129 Million
and $112 Million. But they are still kicking out a whole lot of cash.

( damn red wine on an empty stomach, lol )