Felder: "Same Old Greed In A Shiny New Wrapper"

The flows into tech funds of late have been absolutely astounding if not totally surprising.

The FAANNG stocks have been the market darlings for quite some time now so it's understandable investors would chase this performance just as they do during every bull market.

Flows following flows. Money going into tech is on course for a record $37bn this year. Via BofAML: pic.twitter.com/JzpD7ekfpH

— Tracy Alloway (@tracyalloway) June 25, 2018

It's not just tech-focused funds overweighting the FAANNG stocks. There is a huge number of non-tech-focused funds that own these stocks, as well, and in a significant way further supporting their popularity in the marketplace. You can find them represented in size today in everything from consumer discretionary, retail, media and entertainment to momentum, cloud computing, internet and social media. In fact, without Amazon and Netflix, the consumer discretionary sector would be down on the year rather than up.

The market cap of the entire S&P 500 Consumer Discretionary index has gained $318bn so far this year, of which Amazon and Netflix on their own account for $375bn. Strip out these gains and the rest of the index has dropped $57bn in market cap for the year.https://t.co/QzzKwBZmKZ pic.twitter.com/HoOp8wkXgH

— Jesse Felder (@jessefelder) June 23, 2018

What's more, in many cases, the ownership of these companies in many funds appear to be clear violations of their implicit if not explicit mandates. To demonstrate, let's just run through the FAANNG stocks by market cap beginning with the biggest: Apple. There are fully 92 ETFs, according to ETFdb.com, that not only own the stock but also have an overweight (relative to the S&P 500) allocation to the shares. So not only are Apple fans and traditional passive investors buying tons of Apple stock, these other ETF investors are even more aggressively acquiring shares.

What I found notable in this case was that Apple was found in both value and growth-focused ETFs. I guess this isn't really much of a stretch theoretically. A high-growth stock can become cheap just like any other. What is strange in Apple's case, though, is that the stock now trades at its highest price-to-free cash flow in years. At the same time, the company's 5-year average revenue growth is now the lowest in its history. Still, these systematic funds somehow find reason to not just own it but to overweight it as both a value stock and as a growth stock.

Apple's free cash flow yield - UST yield = 2.93%. In other words, since $AAPL became a FCF machine it's never been less attractive, perfect timing for a pair of 90 yr old guys that like railroads & farms to go all-in. pic.twitter.com/uvYQJKnxVl

— J Pierpont Morgan (@pierpont_morgan) May 4, 2018

Next we have Google. Here we have over 100 different ETFs that see fit to overweight the stock in their portfolios.

Included in this group is at least one "low volatility" ETF. According to Yahoo!Finance Google shares have a beta of 1.31 currently meaning they are 31% more volatile than the broad stock market. Yet this fund somehow sees fit to classify it as a "low volatility" stock. Alrighty then.

Turning to Amazon, again we have over 100 different ETFs that have overweighted the stock.

Included in these are several funds that purport to only invest in "best employers" or companies that demonstrate "employment equality." This is certainly ironic considering this company has become the poster child for income disparity. Jeff Bezos is the now the richest man in the world with some of the lowest paid employees in the country and yet these ETFs somehow justify owning it and in greater size than the index.

The average #amazon employee would have to work 1.2 million years to match #jeffbezos increase in fortune in 2017 #ceopay#incomeinequality pic.twitter.com/thElM2mrs2

— Inequality.org (@inequalityorg) June 19, 2018

Facebook also benefits by roughly 100 ETFs that have somehow tweaked their algorithms such that they can overweight the shares. One such fund claims to invest only in companies with a positive ESG (environmental, social and governance) impact. As for the "E" there's not much I can say but when you are charged with fomenting violence and even death in places like Myanmar and others around the world and you have also become the poster child for some of the worst governance practices in corporate America it's hard to see how these can fit within a "positive ESG impact" framework.

'The idea that there should be an autocrat in charge of a gigantic public company is an anachronism. It harks back to the 19th century when you had these robber barons who were autocrats and dictators.' https://t.co/w1TjKvBcMh

— Jesse Felder (@jessefelder) June 27, 2018

Netflix has a very curious holder of its own among the more than 100 ETFs that choose to overweight the shares. The stock currently pays no dividend and, to the best of my knowledge, never has. It might be difficult for the company to do so while it sustains losses in terms of free cash flow into the billions of dollars per year. Still, one "dividend advantage" fund not only owns Netflix shares but also in a size that is triple the index weighting.

Finally, Nvidia can be found as an overweight position in fully 140 different ETFs. By this measure it wins the popularity prize even if it isn't an original FANG stock. One of these funds carries "ecological strategy" in its title. I assume it seeks to invest only in companies that meet some ecological test yet Nvidia chips have powered the Bitcoin mining boom, perhaps the single greatest waste of energy in human history. It's very hard to call cryptocurrency or anything associated with it ecologically friendly. Still, this fund sees the core of the cryptocurrency mining mania as supporting a sound ecological strategy.

' Ifind it interesting that most of the people in bitcoin are climate people... I don't quite get the connection. We've got this rogue currency that we're all going to support that's destroying the climate[?]' https://t.co/uRo3D2ojlu

— Jesse Felder (@jessefelder) December 13, 2017

The point of all of this is simply to demonstrate the absurd extremes of the current mania in the stock market. The only way to explain any of it is to chalk it up to shameless performance chasing. Own these stocks in your ETF or suffer outflows that put its existence in jeopardy. Offer a dividend or a socially conscious or low volatility fund that beats the market via oversized FAANNG weightings and watch the inflows make you rich.

It's the very same sort of insatiable greed on the part of Wall Street serving the insatiable greed on the part of investors that has driven every speculative mania throughout history. Only this time it comes in a brand new, shiny wrapper that people can use to call themselves 'passive investors'...

Fed Test Fails Deutsche Bank, Forces JPMorgan, Goldman, Four Others to Limit Payouts

Tougher Federal Reserve stress tests forced six U.S. banks to scale back proposals for doling out more cash to shareholders, while failing Deutsche Bank's US unit on "qualitative" grounds:

• The Fed failed the U.S. subsidiary of Deutsche Bank AG, citing "widespread and critical deficiencies" in its planning, limiting the unit's ability to send capital home to Germany.
• Goldman Sachs Group Inc. and Morgan Stanley -- agreed to freeze payouts at previous years' levels. Both banks were required to rein in their dividend and stock buyback plans after the Fed warned their initial, more bullish, proposals would have left them with inadequate capital buffers.
• JPMorgan Chase, American Express, KeyCorp and M&T Bank Corporation also rethought their original plans for payouts to shareholders, although they got the thumbs up after submitting more modest plans in the past week, the Fed said.

Twenty-eight other firms can proceed with their original proposals to boost stock buybacks and dividends after the Fed found they'd still hold enough capital to weather a hypothetical economic shock.

As the FT notes, given the disappointing results on Thursday for some banks, the industry's overall payout ratio — capital distributed as a proportion of earnings — was expected to remain roughly unchanged from last year at about 95 per cent.

Even with the more conservative capital plans, Goldman and Morgan Stanley fell below some required capital thresholds. Yet the Fed gave the less punchy payouts the go-ahead anyway. Officials said weakness in the stress test partly reflected the accounting impact of landmark tax reforms that Mr Trump signed into law last year. Randal Quarles, the Fed's regulatory chief, said they had created "one-time challenges".

The results overall were weaker than last year, although Fed officials noted that the regime had become stricter this year. They also said the tax reforms reduced banks' capital ratios just as the stress tests were beginning, because the cut in the corporate tax rate from 35 per cent to 20 per cent cut the value of deferred tax assets. Furthermore, Trump reforms eliminated a beneficial tax treatment that had enabled banks to smooth their earnings by carrying losses forwards or backwards from periods of crisis.

And here are select banks' capital plans announced in response:

• Wells Fargo to Buy Back Up to $24.5b Shrs, Boosts Div to 43c/shr, up from current 39c/shr
• JPMorgan Chase to buy back up to $20.7b of shares, raises dividend to 80c/shr from 56c/shr;
• Bank of America to buy back up to $20.6b of shares, raises dividend to 15c/shr
• Citi to Buy Back Up to $17.6b Shares, boosts dividend to 45c/shr from 32c, est. 41c.
• Goldman Sachs to Buy Back up to $5.0b Shares, Boosts Div to 85c from 80c
• Morgan Stanley to Buy Back Up to $4.7b of Stock, Boost Qtr Div to $0.30/shr from $0.25/shr
• American Express To Buy Back Up To $3.4b Shares, boosts qtrly dividend to 39c/share, from 35c/share
• U.S. Bancorp to Buy Back up to $3B Shares, Boosts dividend to 37c/shr from 30c/shr
• PNC Financial to Buy Back up to $2.0B Stock, boosts dividend to 95c/shr from 75c/shr
• Capital One to Buy Back up to $1.2B Stock, keeps dividends at 40c/shr
• Ally To Buy Back Up To $1b Shares, Boosts Dividend to 15c/shr from 13c/shr

And the market response, no surprise, is favorable as has been the case after every prior CCAR result:

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The Full Fed statement is below (link):

As part of its annual examination of the capital planning practices of the nation's largest banks, the Federal Reserve Board on Thursday did not object to the capital plans of 34 firms and objected to the capital plan of one firm.

Due in part to recent changes to the tax law that negatively affected capital levels, two firms will maintain their capital distributions at the levels they paid in recent years. Separately, one firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Comprehensive Capital Analysis and Review, or CCAR, in its eighth year, evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms' planned capital actions, such as dividend payments and share buybacks. Strong capital levels act as a cushion to absorb losses and help ensure that banking organizations have the ability to lend to households and businesses even in times of stress.

"Even with one-time challenges posed by changes to the tax law, the CCAR results demonstrate that the largest banks have strong capital levels, and after making their approved capital distributions, would retain their ability to lend even in a severe recession," said Vice Chairman Randal K. Quarles.

When evaluating a firm's capital plan, the Board considers both quantitative and qualitative factors. Quantitative factors include a firm's projected capital ratios under a hypothetical scenario of severe economic and financial market stress. Qualitative factors include the strength of the firm's capital planning process, which incorporates risk management, internal controls, and governance practices that support the process.

This year, 18 of the largest and most complex banks were subject to both the quantitative and qualitative assessments. The 17 other firms in CCAR were subject only to the quantitative assessment. The Board may object to a capital plan based on quantitative or qualitative concerns.

The Board objected to the capital plan from DB USA Corporation due to qualitative concerns. Those concerns include material weaknesses in the firm's data capabilities and controls supporting its capital planning process, as well as weaknesses in its approaches and assumptions used to forecast revenues and losses under stress.

The Board issued a conditional non-objection to the capital plans of both Goldman Sachs and Morgan Stanley and both firms will maintain their capital distributions at the levels they paid in recent years, which will allow them to build capital over the next year. Each firm's capital ratios, under the capital plans they originally submitted and with the one-time capital reduction from the tax law changes, fell below required levels when subjected to the hypothetical scenario. This one-time reduction does not reflect a firm's performance under stress and firms can expect higher post-tax earnings going forward.

The Board also issued a conditional non-objection for the capital plan from State Street Corporation. The stress test revealed counterparty exposures that produced large losses under the hypothetical scenario, which assumes the default of a firm's largest counterparty under stress. The firm will be required to take certain steps regarding the management and analysis of its counterparty exposures under stress.

The Federal Reserve did not object to the capital plans of Ally Financial, Inc.; American Express Company; BB&T Corporation; BBVA Compass Bancshares, Inc.; BMO Financial Corp.; BNP Paribas USA; Bank of America Corporation; The Bank of New York Mellon Corporation; Barclays US LLC.; Capital One Financial Corporation; Citigroup, Inc.; Citizens Financial Group; Credit Suisse Holdings (USA); Discover Financial Services; Fifth Third Bancorp; HSBC North America Holdings, Inc.; Huntington Bancshares, Inc.; JP Morgan Chase & Co.; Keycorp; M&T Bank Corporation; MUFG Americas Holdings Corporation; Northern Trust Corp.; The PNC Financial Services Group, Inc.; RBC USA Holdco Corporation; Regions Financial Corporation; Santander Holdings USA, Inc.; SunTrust Banks, Inc.; TD Group US Holdings LLC; U.S. Bancorp; UBS Americas Holdings LLC; and Wells Fargo & Company.

U.S. firms have substantially increased their capital since the first round of stress tests led by the Federal Reserve in 2009. The common equity capital ratio--which compares high-quality capital to risk-weighted assets--of the 35 bank holding companies in the 2018 CCAR has more than doubled from 5.2 percent in the first quarter of 2009 to 12.3 percent in the fourth quarter of 2017. This reflects an increase of more than $800 billion in common equity capital to more than $1.2 trillion during the same period.

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PREVIEW

After 13 days straight down, bank stocks staged a very modest comeback today ahead of tonight's hope-strewn Comprehensive Capital Analysis and Review (CCAR). However, given the performance since the last CCAR, investors better hope it's different this time...

As a reminder, all 35 banks passed the stress test last week as The Fed confirmed they would all be fine if stocks crashed 65% and VIX spiked to 60.

That test examined hypothetical losses with dividends continuing as before. The second phase (results announced today) looks at requests for future stock buybacks and higher dividends.

There's technically two ways to "fail" the stress test -- quantitatively and qualitatively. But no one has failed on a quantitative basis since 2013 because the Fed allows banks to take a "mulligan."

The stress tests showed Goldman Sachs and Morgan Stanley potentially at risk, and as a reminder, Wells Fargo is under Federal Reserve restrictions and all eyes are on whether Deutsche Bank is allowed to do anything.

Specifcally analysts have grown more skeptical that GS/MS can increase their payouts-- or in Goldman's case, that it can even maintain last year's level.

"We don't get to see all the details of how the Fed gets to its numbers, but it's still hard to fathom how they can meet pre-test expectations," said Brian Kleinhanzl at Keefe, Bruyette & Woods."The math just doesn't work."

And analysts aren't confident that Deutsche Bank AG's U.S. holding company can pass a key part of the test: the qualitative review of risk controls, internal oversight and other aspects of management. The bank's U.S. unit already was placed on a Fed list of troubled lenders because its systems were deemed insufficient.

"It's pretty hard to expect a positive surprise for the state of Deutsche Bank's controls," said Markus Riesselmann, an analyst at Independent Research in Frankfurt. "Sadly, we're all pretty much used to bad news around Deutsche Bank, so a negative result won't necessarily hurt their share price."

For now, most banks' dividends are well above their previous peak, but some still lag...

So what were the results?

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Minutes before the official release time, BB&T filed an 8-K saying they passed the Fed's annual stress test. They boosted their quarterly dividend by 3 cents to 40.5 cents. They're also doing $1.7 billion in share repurchases.

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MS,GS are modestly lower; JPM, BAC, and C are higher...

China is Done Playing "Tariff Tag"... It's Now Looking to Crash the Markets

China has gotten tired of playing "tariff tag" with the Trump administration. It's now playing a new game called the "devalue stock dump." It consists of China aggressively devaluing the Yuan in an effort to crash the US stock market.

If you think I'm being overly dramatic here, have a look at the below chart. This current devaluation is already on par if not worse than those of August 2015 and January 2016.

By the way, those last two devaluations (red boxes) resulted in the S&P 500 dropping 11% and 12% in less than one week.

Put simply, China is done messing around. It is actively trying to crash the US stock market to send a message to the Trump administration. China knows that President Trump views the stock market as a "report card" on his performance as Presidency.

Bear in mind, most Emerging Markets (including China) are already in bear markets, having dropped ~20%. If the US stock market follows suit, we're talking about the S&P 500 down in the 2,3-00-2,400 range.