The One Thing About Tax Reform That NO ONE is Talking About

The markets have been gunning higher on the notion that the Trump Administration is about to unveil a huge tax reform plan.

However, the devil is in the details. And thus far the plan is focusing on corporate tax reform, with the notion that an employer will somehow "pass on" their savings to employees via raises.

First off, while the phrase "corporate taxes" is a great political prop, the reality is that nearly 50% of large corporations pay ZERO corporate income tax.

That is not a typo.

In 2012, the Government Accountability Office performed a study in which it discovered that 43% of companies with $10+ million in assets pay ZERO corporate income tax.

It's not as if the other 57% are picking up the slack either.

It is well known that large corporations go above and beyond to avoid paying the full, required tax rate. As Forbes noted earlier this year, Apple pays a 25% tax rate (the official US corporate rate is supposed to be 35%). Microsoft pays a 16% tax rate. Alphabet (Google) pays 19%. General Electric and Exxon Mobil appear to have paid no corporate income tax in 2016.

The point is this: pursuing corporate tax reform is a pointless exercise. Few if any corporations pay anywhere near the official corporate tax rate of 35%.

So what tax reform should we be talking about?

Individual tax reform.

And why aren't we talking about it?

Because any discussion of individual tax reform eventually leads to the elephant in the room: entitlements.

The US currently spends 65% of it budget on entitlement spending. Nearly half of American households receive some kind of Government assistance/outlay. Those households that DO pay taxes cover only some of this (which is why the US is running $500+ BILLION deficits every year).

The bond bubble is financing the rest of this. Anyway, politicians promise, but bond markets deliver.

Put simply, the bond bubble is what has financed the enormous entitlement spending of Governments around the world.

Take away the bubble in bonds, which permits Governments to issue debt at rates WAY below the historic average, and most major countries are bankrupt in a matter of weeks.

Well guess what? The bond markets are already beginning to revolt. As I write this, the bond yields on FOUR of the largest economies in the world are rising, having broken out of their downtrends of the last few years. The bond markets for US, Japan, Germany and the UK are all in revolt.



And guess what is triggering this?

INFLATION.

Inflation forces bond yields higher as the bond markets adjust to compensate for the fact that future interest payments will be worth less in real terms.

Bond yields higher= bond prices lower. Bond prices lower= the bond bubble is in serious trouble.

The above chart is telling us in very simple terms: the bond market is VERY worried about rising inflation. And if Central Banks don't move to stop hit now by ending their QE programs and hiking rates, we're in for a VERY dangerous time in the markets.

American's Consumer Confidence Highest Since The Peak Of DotCom Bubble

The animal spirits among American consumers has not been this 'high' since the year 2000...The only time in US history that confidence was this high... was the dotcom bubble... but it's different this time...

With the Mountain Region surging to Dec 1999 record highs...

"Consumer confidence increased to its highest level in almost 17 years (Dec. 2000, 128.6) in October after remaining relatively flat in September," said Lynn Franco, Director of Economic Indicators at The Conference Board.

"Consumers' assessment of current conditions improved, boosted by the job market which had not received such favorable ratings since the summer of 2001. Consumers were also considerably more upbeat about the short-term outlook, with the prospect of improving business conditions as the primary driver.

Confidence remains high among consumers, and their expectations suggest the economy will continue expanding at a solid pace for the remainder of the year."

Interestingly, consumers' outlook for the job market, however, was somewhat less favorable than in September.

The proportion expecting more jobs in the months ahead decreased marginally from 19.2 percent to 18.9 percent, however, those anticipating fewer jobs declined from 13.0 percent to 11.8 percent.

Regarding their short-term income prospects, the percentage of consumers expecting an improvement decreased marginally from 20.5 percent to 20.3 percent, however, the proportion expecting a decrease declined from 8.6 percent to 7.4 percent.

However, not everyone is exuberant, while the rich have never been richer and more confident (green), the poor (income <$15k) are seeing confidence collapse to the lowest since Aug 2016...

The rich-poor divide in confidence has never been higher...

What Makes a Good Economic Model?

In order to make the data "talk," economists utilize a range of statistical methods that vary from highly complex models to a simple display of historical data. It is generally held that by means of statistical correlations one can organize historical data into a useful body of information, which in turn can serve as the basis for assessments of the state of the economy. It is held that through the application of statistical methods on historical data, one can extract the facts of reality regarding the state of the economy.

Unfortunately, things are not as straightforward as they seem to be. For instance, it has been observed that declines in the unemployment rate are associated with a general rise in the prices of goods and services. Should we then conclude that declines in unemployment are a major trigger of price inflation? To confuse the issue further, it has also been observed that price inflation is well correlated with changes in money supply. Also, it has been established that changes in wages display a very high correlation with price inflation.

So what are we to make out of all this? We are confronted here not with one, but with three competing "theories" of inflation. How are we to decide which is the right theory? According to the popular way of thinking, the criterion for the selection of a theory should be its predictive power. On this Milton Friedman wrote,

The ultimate goal of a positive science is the development of a theory orhypothesis that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed.1

So long as the model (theory) "works," it is regarded as a valid framework as far as the assessment of an economy is concerned. Once the model (theory) breaks down, we look for a new model (theory). For instance, an economist forms a view that consumer outlays on goods and services are determined by disposable income. Once this view is validated by means of statistical methods, it is employed as a tool in assessments of the future direction of consumer spending. If the model fails to produce accurate forecasts, it is either replaced, or modified by adding some other explanatory variables.

The tentative nature of theories implies that our knowledge of the real world is elusive.

Since it is not possible to establish "how things really work," then it does not really matter what the underlying assumptions of a model are. In fact anything goes, as long as the model can yield good predictions. According to Friedman,

The relevant question to ask about the assumptions of a theory is not whether they are descriptively realistic, for they never are, but whether they are sufficiently good approximation for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.2

Why the Predictive Capability for Accepting a Model Is Questionable

The popular view that sets predictive capability as the criterion for accepting a model is questionable. Even the natural sciences, which mainstream economics tries to emulate, don't validate their models this way. For instance, a theory that is employed to build a rocket stipulates certain conditions that must prevail for its successful launch.

One of the conditions is good weather. Would we then judge the quality of a rocket propulsion theory on the basis of whether it can accurately predict the date of the launch of the rocket? The prediction that the launch will take place on a particular date in the future will only be realized if all the stipulated conditions hold.

Whether this will be so cannot be known in advance. For instance, on the planned day of the launch it may be raining. All that the theory of rocket propulsion can tell us is that if all the necessary conditions will hold, then the launch of the rocket will be successful. The quality of the theory, however, is not tainted by an inability to make an accurate prediction of the date of the launch.

The same logic also applies in economics. We can say confidently that, all other things being equal, an increase in the demand for bread will raise its price. This conclusion is true, and not tentative. Will the price of bread go up tomorrow, or sometime in the future? This cannot be established by the theory of supply and demand. Should we then dismiss this theory as useless because it cannot predict the future price of bread?

Or consider a situation when a stock market is following an "up" trend over several years. As a result, an analyst has established that it is possible to outperform the stock market by following the barking of a dog.

If the dog barks three times it is a buy and if he barks once it is a sell. Should such a framework be accepted as a valid theory because it makes good forecasts?

Contrary to the popular way of thinking the criteria for selecting a model is not how well it worked in the past — i.e. passed the criteria of back testing and a life test — but whether it is theoretically sound.

1.Milton Friedman, Essays in Positive Economics, Chicago: University of Chicago Press, 1953.

2.Milton Friedman, ibid

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The secret to the current recovery is that American households are up to their eyeballs in debt once again! Consumer credit hits a record $3.7 trillion.

Do you notice more credit card offers hitting your mailbox? Are you noticing more "easy financing" for purchasing a new car? Welcome to the new recovery where spending is being fueled by consumer credit. Once again people are spending beyond their means. In an economy driven by consumption you need to keep people spending and splurging to keep the machine moving. Yet this recovery is being driven by massive consumer debt. We now have record credit card debt, record student debt, and record auto debt. None of these sources of debt really builds wealth in the long run. And banks are once again going into the subprime trenches just to find consumers to lend to. The Great Recession was really the Great Credit Crisis and here we are going deep into debt again.

Consumer debt hits a record level

Consumer credit has now hit a record level at $3.7 trillion. This segment of credit is not really beneficial in building long-term wealth especially if you look at credit card debt or auto loans. This is simply spending future earnings today.

Take a look at consumer credit:



Total consumer credit is now at $3.7 trillion. That is an $800 billion increase in merely five years. People are yanking out those credit cards, personal loans, and signing away years of work for new cars. This is a big problem especially with households already deep into debt in multiple forms:



Credit card debt is now at a record level surging over $1 trillion:

"(Bend Bulletin) The amount of debt owed by American consumers, which receded in the wake of the financial crisis, is again on the rise.

Outstanding credit card debt — the total balances that customers roll from month to month — hit a record $1 trillion this year, according to the Federal Reserve. The number of Americans with at least one credit card has reached 171 million, the highest level in more than a decade, according to TransUnion, a credit-reporting company."

This is problematic because stagnant wages are simply adding fuel to the flame and Americans are using credit cards as a stop-gap measure:

"That business model is increasingly lucrative. Many consumers, their wages stagnant and their costs rising, are growing reliant on credit cards for essential goods and services, including medical and dental care. Across the industry, profits rose in the latest quarter."

What you have are people simply trying to keep up with a shrinking middle class base. This is fine when you can make the minimum payments but what happens if we have a minor recession? What happens when an inevitable correction hits? The house of cards comes crumbling down again.

The recovery is largely looking like one built on debt spending. We are now in a phase where even a tiny recession will send the system into a severe shock. The credit craze is back again, just look in your mail.

Second Crash Warning From The IMF – This Time It's About Vol

Another week, another warning regarding financial crash scenarios from those keen minds at the IMF.

In "Here Is The IMF's Global Financial Crash Scenario" last week, we highlighted the institution's surprisingly candid discussion hidden away in its latest Financial Stability Report "Rising Medium-Term Vulnerabilities Could Derail the Global Recovery"…or as we paraphrased the IMF's "politically correct way of saying the financial system is on the verge of crashing".

In the section also called "Global Financial Dislocation Scenario" because "crash" sounds just a little too pedestrian, the IMF uses a DSGE model to project the current global financial situation, and ominously admits that "concerns about a continuing buildup in debt loads and overstretched asset valuations could have global economic repercussions" and - in modeling out the next crash, pardon "dislocation" - the IMF conducts a "scenario analysis" to illustrate how a repricing of risks could "lead to a rise in credit spreads and a fall in capital market and housing prices, derailing the economic recovery and undermining financial stability."

This week the IMF has gone a step further, courting the mainstream financial media to publicise its warning about the dangers of historically low volatility and related short volatility strategies.

As The FT reports, The International Monetary Fund has warned that the increasing use of exotic financial products tied to equity volatility by investors such as pension funds is creating unknown risks that could result in a severe shock to financial markets. In an interview with the Financial Times Tobias Adrian, director of the Monetary and Capital Markets Department of the IMF, said an increasing appetite for yield was driving investors to look for ways to boost income through complex instruments.

"The combination of low yields and low volatility facilitates the use of leverage by investors to increase returns, and we have seen rapid growth in some types of products that do this," he said.

It explains some of the short vol strategies that we've been expressing concern about for several years. To wit.

Mr Adrian's warning comes amid increasing evidence that pension funds and insurance companies are venturing into riskier types of investments to gain income.

Some are also effectively writing insurance contracts against a market crash to pocket premiums. Last year the $14bn Hawaii Employees Retirement System said it was writing put options to boost its income, while other US pension schemes such as the South Carolina Retirement System Investment Commission and Illinois State Universities Retirement System have also hired outside managers to use option writing strategies. The IMF estimates that assets invested in volatility targeting strategies have risen to about $500bn, with this amount increasing by more than half over the past three years. Marko Kolanovic, head of macro, derivative and quantitative Strategies at JPMorgan, last month warned of "strategies that sell on 'autopilot'", and how risk management models that use volatility could be luring investors into taking on too much risk.

 

"Very expensive assets often have very low volatility, and despite downside risk are deemed perfectly safe by these models," he wrote in a note to clients.

While we applaud this warning from the IMF, it's absurdly belated and the short vol "horse" has long since bolted. Moreover, we think that the IMF is seriously under-estimating the magnitude of short vol risk in financial markets. Indeed, the IMF's research department would do well to read the recent report from Artemis Capital Management which we drew investors' attention to.

Artemis estimates that financial engineering strategies that are short vol, either explicitly or implicitly, amount to more than $2 trillion. However, both Artemis and the IMF are "on the same page" when it comes to what would unfold if there was a sustained spike in volatility. The FT continues...

The IMF believes that sustained low volatility increases incentives for investors to take on higher levels of leverage while causing risk models that use volatility as an important input to understate real levels of risk participants may be taking on.

"A sustained increase in volatility could then trigger a sell-off in the assets underlying these products, amplifying the shock to markets," Mr Adrian said…

With equity implied volatility continuing to drop over the course of this year, investors who have bet that markets will remain tranquil have been rewarded. Yet the true quantity of complex products being sold that are linked to volatility of various assets is hard to ascertain due to such deals mostly being done in private. Regulators therefore find it difficult to map out the risks in the event of an unexpected market shock.

Rationality Versus The Market - 2

The late stages of financial bubbles are always tough for rational analysts. Focused as they are on the numbers, such analysts are relatively immune to the emotion that drives the action at market extremes, so they find themselves making predictions that turn out to be "wrong" for months and sometimes years.

Then the cycle turns and the rational analyst is vindicated – though often far too late for his bruised ego and diminished client base to easily recover.

[Recall the scene in The Big Short where hedge fund manager Michael Burry, after suffering months of abuse from his clients for shorting the 2006 housing bubble a bit early, is lambasted by a client who can't believe Burry has, after the crash, gone long equities — because they're clearly going to zero. In both cases Burry was right and his clients wrong, but he nevertheless closed up shop and quit the business.]

Anyhow, we're there again, with governments manipulating all major markets to valuation levels at which previous crashes have occurred. This is leading analysts who focus on historical norms to issue warnings, which turn out to be wrong (stocks are setting new records as this is written), which draw derision from people who see no reason why the party ever has to end.

A good example is John Hussman, whose eponymous family of funds has been on the wrong side of this market for an uncomfortably long time. Yet he persists, because the numbers don't lie. From his most recent report to clients:

So the mindset, I think, goes something like this. Yes, market valuations are elevated, but, you know, low interest rates justify higher valuations. Besides, there's really no alternative to stocks because you'll get what, 1% annually in cash? Look at how the market has done in recent years. There's no comparison. Value investors who thought stocks were overpriced in recent years have been wrong, wrong, and wrong again, and even if they're eventually right, being early is just the same as being wrong. The best bet is just to invest in a passive index fund for the long-term, and ignore the swings. There's really no alternative.

What's notable about this mindset is its excruciating reliance on three ideas. The first is that low interest rates "justify" rich valuations. The second is that market returns simply emerge as a kind of providence from a higher power, perhaps magical gnomes, or the Federal Reserve if you like, and that those returns have no particular relationship to valuations even in the long-term. The third is that market returns during the recent advancing half-cycle are an accurate guide to future outcomes.

In effect, stocks are viewed as good investments because they have been going up, and the evidence that stock prices will go up is that stock prices have gone up. Every additional market advance makes stocks look even better, based on past returns. Indeed, the more extreme valuations become, the more convinced investors become that extreme valuations don't matter.

And that's why we're all gonna die.

A few insights may help to deconstruct this mindset. First, if one is going to invest one's financial future in the stock market here, it's worth making at least a cursory study of 5, 10 or even 20-year growth rates in population, labor force, productivity, S&P 500 revenues, earnings, real GDP, nominal GDP, and virtually every other measure of fundamentals. That exercise will quickly inform investors not only that the growth rate of fundamentals has persistently slowed from post-war norms in recent decades, but also that the underlying drivers of growth (primarily labor force demographics and productivity growth) are now running at rates that are likely to produce real GDP growth on the order of just 1% annually over the coming decade, while even a sizeable jump in productivity would likely result in sustained real GDP growth below 2% annually.

Unfortunately, this has implications for how one responds to interest rates, because the argument that "low interest rates justify higher valuations" relies on the assumption that the growth rate of underlying cash flows is held constant. Any basic discounted cash flow analysis will demonstrate that if interest rates are low because growth is also low, then no market valuation premium is "justified" by the low interest rates at all. Indeed, if both growth rates and interest rates are x% lower than their historical norms, then even a historically normal level of market valuation would be associated with subsequent market returns that are x% below historical norms. No valuation premium is required to produce this result.

The most reliable valuation measures we identify (those most strongly correlated with actual subsequent market returns) are about 2.5 to 2.7 times their historical norms here. Paying a valuation premium in this case simply causes prospective future market returns to collapse.

In order to provide the longest perspective possible, and also to offer a measure that can be easily calculated and validated should one choose to do so, the chart below shows my variant of Robert Shiller's cyclically-adjusted P/E (CAPE), which has a correlation near 90% or higher with actual subsequent 10-12 year S&P 500 total returns in market cycles across history.

What investors presently take as a comfortable environment of pleasant market returns and mild volatility is actually, quietly, the single most overvalued point in the history of the U.S. stock market.

Hussman's conclusion is, obviously, that a horrendous crash is coming. The problem is that this – and most other valuation measures – started flashing red in 2013, so warnings based on them now have a hollow ring.

Will they end up being be right? Without a doubt. And the longer the current exuberance goes on the bigger will be the subsequent crash. Somewhere out there is the perfect moment to short the hell out of this and pretty much every other country's stock market. But only a tiny handful will nail it.

The Real Peak Complacency

Stocks are at record highs while volatility is at a record low. Which is another way of saying that investors aren't as worried as they probably should be about the coming year.

That's okay. Price corrections (with their attendant volatility spikes) are normal and natural ways for markets to teach overconfident investors a little humility. Think of them as the financial word's forest fires, clearing out the underbrush of misconception, malinvestment, and hubris.

But there's another area of Peak Complacency that is neither natural nor benign. And that's cyberspace. Americans – and Europeans and Japanese – have moved most of their financial lives online just as hackers and other cyber-enemies get the upper hand. Recently:

• Credit rating agency Equifax – apparently through its own incompetence – allowed hackers to access and presumably copy and sell "sensitive personal information" of 146 million Americans.
• Online portal Yahoo upped the number of accounts that were hacked in 2013 to – get this — 3 billion.
• The National Security Agency admitted that its state-of-the-art hacking tools were stolen by hackers and are now available for sale on the dark web.
• The Federal Deposit Insurance Corporation (FDIC) suffered more than 50 data breaches between January 2015 and December 2016, exposing "personally identifiable information (PII) of U.S. citizens."

• The U.S. Securities and Exchange Commission EDGAR database of corporate documents was hacked, leading to illegal insider trading that the SEC is still trying to unravel.

And then there's bitcoin, where online exchanges are being hacked with apparent impunity and zero recourse for victims:

Cryptocurrencies: How hackers and fraudsters are causing chaos in the world of digital financial transactions

(Independent) – There have been at least three dozen heists of cryptocurrency exchanges since 2011 and more than 980,000 bitcoins stolen, worth about $4 billion.

Dan Wasyluk discovered the hard way that trading cryptocurrencies such as bitcoin happens in an online Wild West where sheriffs are largely absent.

Mr Wasyluk and his colleagues raised bitcoins for a new tech venture and lodged them in escrow at a company running a cryptocurrency exchange called Moolah. Just months later the exchange collapsed; the man behind it is now awaiting trial in Britain on fraud and money-laundering charges. He has pleaded not guilty.

Mr Wasyluk's project lost 750 bitcoins, currently worth about $3m, and he believes he stands little chance of recovering any money.

"It really was kind of a kneecapping of the project," said Mr Wasyluk of the collapse three years ago. "If you are starting an exchange and you lose clients' money, you or your company should be 100 per cent accountable for that loss. And right now there is nothing like that in place."

Cryptocurrencies were supposed to offer a secure, digital way to conduct financial transactions but they have been dogged by doubts. Concerns have largely focused on their astronomical gains in value and the likelihood of painful price crashes. Equally perilous, though, are the exchanges where virtual currencies are bought, sold and stored. These exchanges, which match buyers and sellers and sometimes hold traders' funds, have become magnets for fraud and mires of technological dysfunction, posing an underappreciated risk to anyone who trades digital coins.

The obvious conclusion is that our bank, brokerage and bitcoin accounts aren't safe from hackers and/or cyber-attacks that shut down settlement systems and power grids.

In the aftermath of Hurricane Maria, for example, much of Puerto Rico is still without power, which means ATM machines aren't working.

So physical cash – always a good thing to have on hand – is a crucial part of disaster planning. And precious metals in the form of small denomination gold and silver coins are if anything even more important, since who knows what a large-scale cyber event and the subsequent central bank money printing will do to fiat currency values

This Bubble Gets Its “Alternative Paradigm”

Towards the end of financial bubbles, asset prices behave in ways that can't be explained with rational/historical metrics. So new ones are invented to make sense of things. In the 1990s tech stock bubble, earnings were "optional" and "eyeballs" – that is, the number of visitors to a dot-com's website – were what determined value. In the 2000s housing bubble, home prices would always rise, which justified pretty much any selling price and asset backed security structure.

Now David Einhorn, a high-profile (and highly frustrated) hedge fund manager, has offered an explanation for today's bubble:

David Einhorn: 'We wonder if the market has adopted an alternative paradigm'

(Yahoo! Finance) – Hedge fund billionaire David Einhorn is struggling to make sense of the stock market. In his latest investor letter, the founder of Greenlight Capital raised an interesting question about valuation.

"Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value," Einhorn wrote in a letter to investors dated October 24. "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?"

Einhorn, who identifies as a value investor, said the market "remains very challenging" for folks like himself as growth stocks with speculative earnings prospects outperform value stocks.

"The persistence of this dynamic leads to questions regarding whether value investing is a viable strategy," he wrote. "The knee-jerk instinct is to respond that when a proven strategy is so exceedingly out of favor that its viability is questioned, the cycle must be about to turn around. Unfortunately, we lack such clarity. After years of running into the wind, we are left with no sense stronger than, 'it will turn when it turns.'"

It's tough being a value investor these days
Greenlight Capital returned 6.2% in the third quarter, bringing the fund's year-to-date returns through September 30 to 3.3%. Meanwhile, the S&P 500 (^GSPC) rose 4.5% during the period, bringing its year-to-date return to 14.2%.

Value investors like Warren Buffett and finance academics would argue that a company's true intrinsic value can be derived by discounting its projected future profits. Of course, it's almost impossible to accurately forecast a company's future profits. Furthermore, it's widely accepted that a company's market price in the short-run is affected by other factors including investor emotions.

One of the most widely-reported signs that the market as a whole is expensive is the cyclically-adjusted price-earnings ratio (CAPE), a measure of stock market value popularized by Nobel prize-winning economist Robert Shiller. CAPE is calculated by taking the S&P 500 (^GSPC) and dividing it by the average of 10 years worth of earnings. It has a long-term average of just over 16. Currently, CAPE is just above 31, which some view as trouble. The only other times CAPE climbed like this was before the market crash of 1929 and the bursting of the tech bubble in the early 2000s.

Einhorn explained that his investment strategy "relies on the assumption that the equity value of a company equals the market's best assessment of the current and future profits discounted at the company's cost of capital." The fund should outperform when it finds opportunities where "the market has misestimated current or future profitability or miscalculated the cost of capital by over- or underestimating the risks."

Unfortunately, that strategy hasn't worked well as momentum stocks have continued to move higher.

"It's clear that a number of companies provide products and services to customers that come with a subsidy from equity holders. And yet, on a mark-to-market basis, the equity holders are doing just fine," he wrote.

Consider Amazon, Tesla and Netflix
Einhorn has placed bets against a handful of high-flying momentum stocks that he's dubbed "The Bubble Basket."

He pointed to Amazon (AMZN) as an example, writing that the company recently revealed "a much lower level of long-term structural profitability, causing consensus estimates for the next five years to drop by 40%, 22%, 18%, 14% and 8%, respectively." Even still the company's stock dipped less than 1% during the third quarter, he noted.

"Our view is that just because AMZN can disrupt somebody else's profit stream, it doesn't mean that AMZN earns that profit stream. For the moment, the market doesn't agree. Perhaps, simply being disruptive is enough."

Next, he brought up electric carmaker Tesla (TSLA), which he described as having an "awful quarter." While shares dipped 6%, Einhorn felt it "deserved much worse."

"So much went wrong for TSLA in the quarter that it is hard to only provide a brief summary," Einhorn wrote. He went on to list numerous issues with the company including manufacturing challenges, reduced gross margins, markdowns on showroom vehicles, and intense competition.

Lastly, he brought up Netflix (NFLX), where he noted that competition has been heating up with Disney pulling their content for its own streaming service plans.

"NFLX continues to accelerate its cash burn as it desperately tries to compensate for its inability to rely longer-term on licensed content. On the second quarter conference call, the CEO stated, 'In some senses the negative free cash flow will be an indicator of enormous success.' To us, all it indicates is that NFLX is capable of dramatically changing the economics of stand-up comedy in favor of the comedians," Einhorn wrote.

These companies have all raised red flags for Einhorn. Unfortunately, the market often doesn't cooperate with what investors consider to be rational analysis.

"Perhaps, there really is a new paradigm for valuing equities and the joke is on us," he said. "Time will tell."

This has been an especially brutal bubble for hedge funds of every type except trend followers. As governments intervene in formerly free markets, historical relationships that drive black box trading models stop working, forcing the closure of a long list of big-name funds. As for value investors, peak bubble is always a time for questioning assumptions, as stocks that are the opposite of value seem to take over the world.

But not once has a new-age, this-time-it's-different bubble rationale turned out to be valid. Fundamentals always win out — eventually. As Einhorn says, time will tell.

Fragmenting Countries: Catalonia Is Just The Beginning

Picture a life where you do most of your shopping through Amazon.com and the local farmers' market, most of your communicating through Facebook and Instagram, much of your travel via Uber, and much of your saving and transacting with bitcoin, gold and silver.

Do you really need an immense, distant, and rapacious central government? Maybe not. Perhaps your region or ethnic group would be better off forming its own independent country.

This question is being asked — and answered — in a growing number of places where distinct cultures and ethnic groups within larger nations now see their government as more burden than benefit. The result: Secession movements are moving from the fringe to mainstream.

In just the past couple of weeks, Iraqi Kurdistan and Spain's Catalonia declared their independence. Neither succeeded, but the fact that they felt free to try illustrates how times have changed.

This is fascinating on a lot of levels, but why discuss it on a gloom-and-doom finance blog? Because secession is about the messiest event a country can experience short of civil war. And few things are more financially disruptive for an already over-leveraged society than potential dissolution.

Today's fiat currencies depend for their value on the belief that the governments managing them are coherent and competent. Let a major region break away and plunge a debtor country into political/civil chaos and the markets will abandon its currency in a heartbeat. Note the sense of panic in the following article:

EU TURMOIL: Finland preparing to go against Spain and RECOGNISE Catalonia's independence

(Express) – FINLAND could be the first country to officially recognise Catalonia as a republic state, in a move that would put the Scandinavian country in direct opposition to the European Union (EU).

The country's MP for Lapland Mikko Karna has said that he intends to submit a motion to the Finnish parliament recognising the new fledgling country.

Mr Karna, who is part of the ruling Centre Party, led by Prime Minister Juha Sipila, also sent his congratulations to Catalonia after the regional parliament voted earlier today on breaking away from the rest of Spain.

Should Finland officially recognise the new state of Catalonia this will be yet another body blow to the the EU which has firmly backed the continuation of a unified Spain under the control of Madrid.

European Commission President Jean-Claude Juncker warned today that "cracks" were appearing in the bloc due to the seismic events in Catalonia that were causing ruptures through the bloc.

Mr Juncker spoke in favour of unity. He said: "I do not want a situation where, tomorrow, the European Union is made up of 95 different states. We need to avoid splits, because we already have enough splits and fractures and we do not need any more."

The Scottish Government has also sent a message of support, saying that Catalonia "must have" the ability to determine their own future.

Scotland, of course, is itself considering secession from the UK, which recently voted to leave the European Union.

The political class, meanwhile, is trying to figure out where it went wrong. See the New York Times' recent What Is a Nation in the 21st Century?

If the combination of long-term financial mismanagement and sudden technological change really has made large, multi-cultural nations dispensable, then some of them are going to fragment. This in turn will contribute to the failure of the fiat currency/fractional reserve banking system that's ruining global finance. Poetic justice for sure, but of an extremely messy kind.

E. Von Greyerz Says This Is Why The Dow Could Lose 97% Against Gold

He says that gold is not going to just outperform the Dow, but all assets. Here's why it will, and what it means for gold investors…

In the last 48 years, since 1969, an investor who put $1,000 into the Dow would today have $33,000. That is a gain of 3,200% or 7.6% annually. On the other hand, someone who put $1,000 into gold in 1969 would today have $37,000 or 7.8% annual return. But if you add dividends to the Dow, the return is far superior at 10.7% with the dividends reinvested.
1969 seems like an arbitrary start year but it happens to be the year that I started my first job. No one could of course have predicted any of those returns. The previous 48 years from 1921 to 1969, the Dow only went up 9X but with higher dividends in that period the total return would still have been 10% annually. Gold on the other hand only had one move up during that period from $31 to $45 in 1933 when the dollar was devalued. That is a meagre 1.5X increase. Due to the gold standard, those 48 years had relatively sound money and therefore limited credit creation with the exception of WWII.
Although history can be an excellent teacher, it tells us nothing about the future. Very few would have predicted a 23,000 Dow 48 years ago. So what will happen in the next 48 years. I certainly will not have to worry about that but my children might and my grandchildren certainly will. If I today gave my grandchildren a gift, would it be stocks or gold?

DOW 1,000 NEXT

During the last 48 years there were four horrendous drawdowns in the Dow of between 39% and 54%. See chart below. Anyone who was invested in the Nasdaq 2000-02 will most certainly remember the 80% drawdown with many stocks going to zero. Looking 30 years at the 1987 crash for example, I remember that day vividly. I was in Tokyo to list a UK company, Dixons (I was Vice-Chairman), on the Tokyo Stock Exchange. Not the best day for a Japanese listing. It was Monday October 19 and became known as Black Monday. Looking back today on the chart, the 1987 41% collapse looks like a little blip. That is certainly not how it felt at the time, especially since it happened in a matter of days.

In spite of major drawdowns during the 1969 to 2017 period, the long term bull market in the Dow has continued until today when the money invested had multiplied 33X.
Back then in 1969 with the Dow at 700, if someone had said that I would experience the Dow at over 23,000 I would of course had said that's ridiculous. Had I looked back 48 years from 1969, I would have found a Dow at 80. So the 48 years from 1921 to 1969 the Dow grew just under 9X or 4.5% per annum.
Thus based on history, the Dow should be 9X higher today than in 1969 or 6,300! So how is it possible that we are now seeing a Dow at over 23,000? Well, we have had the Wizards of Fake Money in the meantime who, with their hocus pocus, have created money out of thin air.

DEBT HAS GROWN 2.5X FASTER THAN GDP

Little did I know in 1969 that Nixon two years later would change the destiny of the world for decades to come as the US came off the gold standard. By throwing off the shackles of a gold backed currency, there was no longer anything stopping the US government and the financial system from creating unlimited credit and printing infinite money.
The consequences have been a US and global credit expansion of gigantic proportions. Just in the US, credit has grown 47X from $1.5 trillion to $70 trillion.

As the chart shows, more and more printed money is needed to grow GDP. The US is now running on empty. No wonder that stocks have gone up 33X since 1969. All this manufactured money has not benefitted the real economy. Instead it has gone to the bankers and the 1% elite.

REAL GDP IS DOWN 8% SINCE 2006

But if we adjust GDP for real inflation based on Shadowstatistics, it looks even worse. As the chart below shows, real US GDP has declined 8% since 2006 rather than the 16% increase that the official figures show.

US total debt in 2006 was $45 trillion and is now $70 trillion, a 55% increase. If we compare that to the Shadowstats real GDP growth, we then have a 8% GDP reduction in the last 11 years against a 55% increase in debt. Thus, however much money the US prints, it no longer has an effect.
Based on the laws of nature, this makes total sense. If you print money which is not a substitute for a service or goods, it has zero value and cannot generate any growth in GDP. This has nothing to do with real money but is a certificate of fraud and deceit. The majority of the $2.5 quadrillion of debt, derivatives and liabilities outstanding today belong to that category.
Once the bluff of the world monetary system is called, all that $2.5 quadrillion will disappear in to a black hole together with all the assets that were inflated by this debt.

GOLD TO OUTPERFORM ALL ASSETS OVER NEXT 10 YEARS

Coming back to the question what the best investment is for the next 48 years, I have no idea. One thing is certain, gold will continue to preserve wealth and maintain purchasing power as it has done in the last few thousand years. It might not be the best investment for the next half a century, but it will certainly be a very safe investment.
But if we take the next 10 years, gold (and silver) is likely to vastly outperform most conventional assets like stocks, bonds and property. The Dow is now the most overbought it has been in over 60 years with gold and silver depressed by a fake paper market.
Gold has been in an uptrend for 18 years from 1999 with a 4 year correction ending in 2015. The uptrend has resumed and will soon accelerate with gold reaching at least $10,000 in today's money. But we are likely to have funny money in the next few years as governments print 100s of trillions or quadrillions of dollars in their futile attempt to save the financial system. This will take the gold price to levels which seem unreal today whether that is $100s of millions or trillions. In real terms those levels are meaningless. What is more important is that gold will preserve purchasing power and save people from a total wealth destruction by holding bubble assets or money in the bank.
So to me it is totally clear that I would advise everyone who has capital to preserve to put it into gold today. This is also the best gift to give to your children and grandchildren as long as they save the gold for at least 5 years or longer.

DOW TO FALL 97% AGAINST GOLD

Finally, the chart which confirms that this is a unique point in history to turn a massively overvalued stock market into the best wealth preservation insurance that anyone can buy.
The Dow / Gold ratio crashed by 87% from 1999 to 2011. After a weak correction, the ratio is still down 60% since 1999. Thus, gold has vastly outperformed the Dow over the last 18 years.
The current correction up of the ratio could go slightly higher but it is now very stretched and the downside risk is massive. I expect the ratio going below the 1980 level of 1:1 and probable overshooting to 0.5. That means a further fall of the Dow against gold of 97%.

Most major stock markets around the world are now more overbought than ever in history. Exponential moves of this nature can extend but when it turns, the move down is likely to come out of the blue, like in 1987, and be very fast and extremely punishing.
Thus, the decision is really easy. The risk of holding bubble assets like stocks, bonds and property is now at a historical extreme. The easy and correct contrarian investment is to hold gold (and some silver). This will not only save investors form total wealth destruction but also create incredible opportunities to buy bombed out assets with the gold at 3 cents on the dollar.

This Stock Market Bubble Is Full Of Fraud Like Every Bubble Before It

Marc Faber says that it will be a series of events that will cause people to panic sell out of the stock markets, which have been inflated by fraud…

Marc Faber interviewed by Greg Hunter

A big difference between the market today and that of the 1987 crash is unfunded pensions. Renowned investor Dr. Marc Faber, who holds a PhD in economics, says, "The unfunded liabilities have gone up. They did not go down. So, if in rising asset markets the pension funds unfunded liabilities go up, can you imagine what will happen when markets fall? So, they will have to print money. . . .

Bear markets do not occur just because of one event. It's a series of circumstances that lead to a loss of confidence with people exiting markets, and then with people exiting markets in a panic. . . .

Fed Head Janet Yellen said if conditions would warrant further measures, the Fed would take further measures. So, she (Yellen) said . . . if the Fed thought the economy was weakening, or their beloved asset markets go down, then she may again ease and introduce QE4 (money printing out of thin air.) . . .

In today's situation, the asset market is less overbought, but the asset bubbles are everywhere. . . .

Each bubble has fraud cases, and I mean massive fraud. That's the characteristic of each bubble. There is fraud."

China's Record Yield Curve Inversion "Spells Disaster"

Overnight we noted that the Chinese stock and bond markets 'turmoiled' as The National Congress came to an end and the forced repression of any weakness ended. Perhaps the most critical aspect of the moves was the push to new record levels of inversion in the Chinese sovereign bond curve.

The Chinese yield curve has now been inverted for 10 straight days - the longest period of inversion ever...

As Bloomberg reports, Qin Han, chief fixed-income analyst at Guotai Junan Securities Co., doesn't mince his words when it comes to the rout in Chinese bonds.

"Considering the pace of the slump, which is very fast, it's fair to say we are likely in a bond disaster..."

The yield gap will widen further, and the cost on debt due in a decade will likely reach 4 percent "very soon," Qin added.

"The yield will become even more inverted as fragile sentiment prevails," he said.

"Yes, this is overselling, but it's not the time to buy yet as the overselling could last longer."

Additionally the pain in bonds is spreading to stocks... (thought it looks like The National Team did step in to stabilize things...

"Pessimism in the bond market is spilling over to the stocks," said Hao Hong, chief China strategist at Bocom International Holdings Co. in Hong Kong.

"Surging yields of the government bonds are resulting in worsened sentiment and higher funding costs for companies, of which smaller ones will suffer most as they rely more heavily on the market rather than bank loans for financing."

"Previously the market was stable because the National Team was there during the Party congress," said Ken Chen, an analyst at KGI Securities Co.

"Now the meeting is over, and October's economic data are expected to be worse than September's, which worries investors."

There are also early signs economic data may weaken, after solid figures for most of this year buoyed equities.