It was a good week for Flabby but what does the future hold for the market. I told you last week that I didn't expect the 200DMA on the S&P to hold and when it didn't we would get a technical sell signal. Bingo down to 1821 or a 9.8% drop from the 2019 top. That is a 198 point drop. We rallied back to 1898 or 77 points or about 38.9%. Close enough in this market. 1906 is now resistance as former support turns into resistance. In Siri land we hit 3.33. The move down was 41 cents from 3.65 to 3.14. The recovery was within 1 cent of a 50% retracement. Close enough.
I told you the structure of the decline would tell me a lot about what to expect in the future. First, I'm expecting a second fall that will take us below the 1821 semi bottom but given the massive BTD performance this week I expect the next leg down to be less than the first which means the overall decline will be in the 15/20% range rather than 20/25% I originally predicted. Secondly, the first leg down took about four weeks to complete which means the second leg down should be completed in the same time frame or less. That leaves us with about 6 weeks until the end of the year when we will get a feel good rally to repair the damage.
As for SIRI, 2.38 is now off the table. Much will depend on the CC and whether we get the much anticipated headline about the 5% dilution that will occur on 12/1. There is always conflicting forces driving the PPS in SIRI land. For now I will stick with my $2.74/76 call.
Friday brought another legal loss for SIRI. We talked about the Turtles case in Federal Court a few weeks ago but there was also a similar case pending in a California state court where various record labels had sued SIRI for royalties on pre 1972 recordings. The law involved the same statute as the Federal case. But in the state court the judge backed SIRI's interpretation of the law and had agreed to use a jury instruction favorable to SIRI. The record companies asked the State Court judge to reconsider her ruling in light of the Federal Court ruling. This is akin to asking God to change the Bible. Never going to happen except it did so SIRI is going to lose that case also. Great week.
Two other issues we have been following reared there ugly head. I told you to watch the rate on the 10Y and if it broke 2.30 there was trouble ahead. It broke it a few weeks ago but on WEN we got as low as 1.86% before going back above 2%. These are recession levels or worse. Then over in sub prime land we hit 38.93 in JNK on WED. We have to go all the way back to 6/24/13 or 17 months to find JNK that low. What it means is that junk bonds imploded AGAIN and people pulled new offerings because there is NO MARKET FOR THEM NOW.
So did anyone figure out why SIRI rallied on WEN when the market was down 400 and why it moved from 3.19/3.20 at 3:00 PM all the way to 3.28 before the close? It has to do with the way long/short hedge funds are structured. The fund is usually 80% long, 20% short and SIRI is a favorite short. These funds got clobbered in the sell off because they are leverage 10 to 1. They were facing margin calls so the quick way to meet the margin call was to cover the short they had in SIRI and other stocks. The money in their short account was IMMEDIATELY credited against their margin call and they weren't forced to sell any more stock. Of course, the MM knew what was going on and took them to the cleaners...hence the 8 cent pop in an hour.
First, the banks continued to do some direct sub prime lending on their own so they could collect the full 20% interest but not at such high aggregate levels so as to attract the attention of the regulators. The next step was to fund the newly created finance companies with their Triple A rating. If the finance companies were truly Triple A they should have been able to borrow at 5/6%. But the banks were really a partner of the finance companies in this little subterfuge so they charged them 12% and the finance companies then lent the money at 20%. Everyone made money and the banks successfully hid their true exposure. You see when the sub prime borrowers don't pay, the finance company would be able to repay the banks, and the banks will write off the loan. Bad business you say, but if things really get bad the fed will step in and bail out the banks with your money. The banks are running a casino and they can't lose. So you are saying how does The Duke know this? Dumb question. Who do you think did some of the legal work to set up the finance companies?
So what does the Chrysler IPO have to do with this. If you looked closely at the monthly auto sales figures you would notice that although sales are up 5% YOY only three companies have increased their sales, Toyota, Nissan and Chrysler. Toyota and Nissan because of the drop in the yen and redesigned products. C is different. Their auto sales are DOWN YOY but Jeep and Ram Trucks are way up. It has been fueled by sub prime because Jeep and trucks have huge profit margins. Chrysler wanted to show big profits before their IPO and so they made loans to any one with a pulse if you bought the high profit truck. They will lose millions but they just got billions in their IPO so who cares?
Midweek brought news that HBO would offer it shows on line at a monthly rate. What this means is that it will bypass cable and keep all the profits for itself. Cable is doomed and Malone had a heart attack that wasn't reported. ESPN next?
With all the triple digit moves in the DOW this week to capture your attention, you may have missed some of the headlines that will impact SIRI and Liberty so I thought it appropriate to review them and offer my views. Monday brought a pair of headlines that were seeming disparate but were actually related. The first was an issue that is near and dear to The Duke's heart. Federal banking regulators announced that they were opening an investigation into the explosion in sub prime lending in the auto industry so that they can better assess the risks to the banking system. Maybe they should have read The Duke four months ago to know there was a big problem brewing. The second headline was that Chrysler went public with much fanfare and thus they successfully traded millions for billions. Do you see the relationship between the headlines?
Let start with the sub prime issue, the banks exposure and what the bank regulators will find if they UNDERSTAND BASIC MATH. The regulators are concerned because sub prime debt has gone up 50% since 2011, the numbers of accounts 60 days in arrears is up 7% over last year and repossessions are up a mere 70%. They have just realized that there could be a problem to the banking system since 30% of new car loans are sub prime.
Here is what they don't understand at this moment. Banks make a ton of money off of the higher sub prime interest rate. But it was sub prime that caused much of the melt down in the housing market in 2007. The banks knew that they couldn't do as much direct lending to sub prime in the auto industry post 2007 because the regulators were watching. So what they did was to encourage people to set up finance companies which would act as an intermediary to facilitate the sub prime loans. Here is how it worked.
I think you may be over thinking this thing. The trend is down and this could last for a few more weeks. If you want to go long, think about 2.98, 2.88 or 2.76. SIRI was due for a bounce which is why I cautioned every to stay short which was another way of saying don't buy here.
You are correct. It would make more sense to start from the bottom up but Bernutty was appointed by a Republican and Obama did not dare to put in his own appointee during the crisis. The trickle down theory goes back to Reagan/Stockman era.
For those of you who are not math challenged, you may want to start watching something called the M2. It tracks the money supply in circulation. It is an old 1970's tool that the Fed uses to control liquidity into the banking system and into the market. The Fed has been draining money supply from the system and that shows up in the weekly M2 report. Last week the M2 turned negative for the first time in several years. You don't need any fancy math skills. As long as M2 is falling the market is going down...because the fed wants to let the air out of this balloon.
The key is to figure out what the fed will do next. Early this week we will get a test of the 200MA. The bulls should try and hold the 200 day or try a rebound if we gap down in the morning. I expect that since we are only 5.6% from the high that the bears will win this battle. If this occurs, you should look at the sell off. If we get a waterfall, panic selling then the fed is likely to step in with a liquidity injection after the third day. If we get a more restrained, constant sell down then look for a longer term market correction before the fed acts.
What this means is that it much too early to predict Flabby levels or how long the market will sell off. We need to see how this plays out this week and then we can determine time and price.
As to SIRI, I predicted in 10/13 that SIRi would decline in 5 waves. During the fourth wave down I told you to go long and that the stock would retrace to 3.60. We hit 3.65. I told you to short at 3.60. If you did you need to be patient. I still expect the $2.90 gap from 12/31/12 to close and SIRI to hit 2.74/76. The issue is whether we go to 2.38. a 61.8% retracement of 1.27 to 4.18. What happens in the next week or so should give us the answer. We called the top. You need to let it play out and not cover too early. Follow the minnow, he will get it wrong every time.
So far the market has been acting exactly as I predicted it would. The S&P is down 5.6% from its 2019.26 top and I see that my readers are doing all sorts of Flabby computations to figure out the bottom, where to cover their shorts or asking me whether they should buy at 2.75. Fear and greed are running rampant. On the Street the very people who said there would be no correction and that stocks were fairly priced are now saying we needed this correction because valuations were frothy and the correction will bring those on the sidelines into the market. These guys can't change their stories or come up with a new set of lies fast enough.
My suggestion to everyone is to take the emotion out of this and look to the math. If you have been following The Duke for a while then you know that in JANUARY I predicted the market would have a 20% correction late in the third Q or early in Q4. Back then I thought the top would be 1925 but by Feb. I said that number was too low. On 8/31, I told you the top would be 2020. So far both predictions look pretty good.
The market moves in a series of waves that are defined by time and price. This is not the Eliot Wave #$%$ you have heard about but the ebbing and flow of credit and liquidity into the market. It has its own defined cycle and if you understand the cycle you can predict market tops and bottoms or at least fool yourself into thinking that you can. It works until it doesn't and right now I'm on a hot streak so I'm allowed to indulge any fantasy that I want.
As you all know the S&P is sitting right on its 200 MA and the index has not been below the 200 day since 2011. What you don't understand is that Yellen has been trying to engineer a soft landing to the market. Her comments that some biotechs and social media stocks were overpriced, the creation of a Fed committee to study bubbles in the market, and the refusal to stop reducing QE were all signs to the math challenged.
Last week an article appeared entitled "Why One Analyst Sees SIRI Rising To $5.00". My first inclination was that the disease that gripped Wrongway is spreading through the analyst community and it is just a matter of time until the CDC launches a search to find patient zero and eradicate the disease before it spreads any further. It would be a public service and money well spent.
It seems that Jessica Cohen's $5.00 call on SIRI was ill timed to say the least, but if you read it closely and understood the math implications you would have shorted SIRI rather than rushing out to buy it. So what did she say that carried such negative implications for the stock. First, she said that SIRI probably bought 700M of its shares under the BB program. At the last CC, SIRI had announced that it had purchased $3.54B in shares and we had expected the second BB would be completed in mid Sept. If Cohen is correct SIRI completed the second BB in Sept., even though it did not file an 8K, and the third BB is being done out of current FCF (good) or using its revolving line of credit (VERY BAD). We know the company has not gone back to the bond market as I predicted (good) since they have not filed an 8K. What this all means is that instead of buying 220M in stock each month, the purchases have dropped to about 80M. With the artificial buying reduced the price would drop and you saw what happened...the shorts came out to play.
But Cohen's report contained even worse news. She lowered Q3 FCF from 308M to 264M and 2014 FCF from 1.2B to 1.1B. If you are not totally math challenged, she cut FCF in Q3 by 44M and Q4 FCF by 56M. Since all you guys want to argue that SIRI's PPS is a multiple of FCF the report was devastating. The report was a wolf dressed in sheep's clothing. People who understood the math shorted, while the math challenged on this board said why is the stock falling? Basic math if you can do the analysis.
One of the problems in America is that no one under 35 can do simple math calculations in their head. You could take it one step further and say that people under 35 can not simple math problems without a calculator. Without the ability to do simple math, most investors have lost the ability to comprehend mathematical equations or understand more complex math problems.
For instance, all you need to do on this board is to say SIRI is doing a buyback and every math challenged long is salivating at the prospect. In past posts I have shown that when the BB ends the artificial price caused by the BB quickly evaporates and secondly, that it would take the purchase of billions of shares to move the SIRI's profit. But BB are even worse than that...they rob long term holders of value even though these people are the ones cheering the BB.
Let's look at THE MATH. On 5/1 SIRI sold 1.5B of 8 year notes at 6%. It will pay 720M in interest over those 8 years. Let's say it took the 1.5B and bought SIRI shares at 3.50 per share. It would buy 428,571,143 shares. For the math challenged that may look good but when you add the 720M in interest costs the real cost of each share is $5.18. Would you pay $5.18 for SIRI today? Excluding the minnowtrader who would pay any amount.
But it is worse than even what you see. The 90M in interest will reduce FCF by that amount each year and hurt the PPS. Each quarter SIRI will report 22.5M in interest and this will cut earnings 3/4 cents a year. All to pump up the price for people who don't understand simple math.
The better way to have done it would have been to use current FCF and slowly buy back the shares, like paying off a 30 mortgage. You avoid the interest and the PPS goes up faster and the price doesn't collapse like last week.
This week brought to fruition many of the themes that I have touched on in the past month. First, we saw Ford lower its full year profit from 7-8B to 6B. It cited two reasons, weakness in the European economy and problems with currency conversion as the strong dollar is eating into profits when weak foreign currencies have to be exchanged for the greenback. You will be hearing that a lot in the next three weeks.
Most commodities declined again this week. Base metals like copper and nickel were down. They tell me the world economy is improving. Somehow we are manufacturing more goods with less raw materials, you know like building more houses with less lumber.
The market dropped this week but everyone focused on the recovery rally on FRI. The bulls are focused on the year end rally and the selling is just mutual funds taking profits before they close their books on 10/31. No one noticed a case of mistaken identity...Flabby has reappeared to the downside. The top was 2019 on the S&P. Thur we hit 1925 or a 94 point drop. On Friday we hit 1971. No one noticed that that was almost a perfect 50% flabby retracement. 94 divided by 2 equals 47. 1925 plus 47 equals 1972. People saw rally, I saw Flabby and a mistaken identity.
SIRI did the same thing. The bottom was 2.98 and the top of the retracement was 3.65 or 67 cents. 50% of 67 is 33. SIRI declined to 3.32 (3.65-.33) before it started to rally. How many people saw Flabby or correctly identified him.
Markets crack slowly. The DJ WORLD INDEX has corrected 10%, as has the Russell 2000 and the NYAD. Some small markets in Europe are down 10% but no one notices. BTD is still in vogue. A case of mistaken identity. Little has changed in the Land of the Duke, I still see SIRI headed to 2.74/76 with the market correcting 20%. Yellen was right about one thing. The rest is just noise or maybe a case of mistaken identity.
Okay, so you are thinking auto leasing has always been reported as a sale of a new car, even though ownership does not change hands, so unlike your other examples this a comparison of apples to apples. In theory, that would be the correct analysis but leasing has changed over the past five years and this portends changes in the future.
Leasing used to be an arena for well off person who wanted to have a new car every 3 years without a capital outlay. Coming out of the recession leasing changed. The average lessee is likely to have subprime credit, no downpayment and a questionable work record. Why the change? Auto dealers needed to move the metal. Bernutty lowered interest rates to zero and yield starved pension funds were willing to hold their nose and take subprime to boost their return. Let's see how it works. First, the auto finance company says this is not a sale but a lease so credit scores are waived or reduced in importance. The dealer sells the car at full price so he is fat and happy. The lessee is happy because he got a new car at a low rate because Bernutty's ZIRP policy allowed him to pay only 14% interest but the payment is something he can afford and no downpayment. He has also been told that making the payments will improve his credit score. The yield starved pension funds buy the bundled lease payments in the hope that Mr. Subprime will keep his job or the losses will be off set by the yield. That is why leasing has doubled in the last five years and why subprime now dominates leasing.
Everything is fine, right, except all those three year leases are starting to end and those leased cars are filling up used car lots and can't be sold. That is why the Manheim index is headed down..too much supply and we just hit the tip of the lease return iceberg. Used car prices will crater leading to poor trade in pricing and lower new car sales. It is all part of the credit cycle and the credit cycle can never be repealed, even by central
The United States is filled with people who take things at face value. They think they understand the statistics that are spewed forth on CNBC but behind the scenes the government is changing the definitions to make things seem better than there are at the moment. It is a case of mistaken identity but few people realize what is happening. It is meant to be that way. Back in the 1970's the federal deficit was exploding higher and people were getting worried about the deficit. Social Security was a cash cow taking in much more than it was paying out. So someone came up with the idea of a CONSOLIDATED BUDGET. They added the social security inflows and outflows to the federal budget and it masked the ever expanding federal deficit for a while...this was before they stole all the money in SS and replaced it was government bonds.
CPI was redefined so that the government computes product improvements to offset price increases. Maybe the price of an I phone goes up but the government looks at the technological advancement, puts a price on the improvement and magically the price for CPI has gone down. We recently changed the definition for GDP. It now includes the value of intellectual property. The number does not really exist in the market place. The government estimates it (makes it up) and GDP goes up. Over in Europe countries are estimating illegal activities such as drug sales and prostitution and adding it to GDP. My hope is that they are doing field research and sampling the products before making up the numbers. Don't you need quality tests before you change CPI?
So this week it was reported auto sales were up 9.4% and you believed it. Another case of mistaken identity. Suppose I went and rented a condo. Would the realtors report that as a sale? No, they separate out rentals from sales and report separate stats. But what about autos. We call it leasing. Someone RENTS (leases) a car for three years but that rental is magically recorded as a sale of a new car.
It is called the Manheim Used Car Value Index and it tracks wholesale used vehicle prices. Most autos that you trade in at the dealer are resold at auction to used car dealers and the price that they are willing to pay shows the underlying health of the industry. While you focus on the 16.5M new cars sold, there will be 35M used cars sold this year and what happens there will be translated to new car show rooms.
Here is what Manheim said about its Aug. Index. Wholesale used vehicle prices declined 0.7% in Aug. This was the fourth consecutive monthly decline. The recent downward movement in wholesale prices reflects: 1. A reversion to trend levels after an extended period of exceptionally strong pricing, 2. Increased wholesale supplies and 3. Moderating retail demand. Translated that means more supply than demand in the market.
So how does that translate to retail. When a dealer takes your car in trade, he resells it at a higher price to a wholesaler who resells the car at retail in the used car market. It is a profit center to the dealer. As used car prices fall and channels clog, the dealer can offer you less for the trade in meaning a higher net purchase price for the new car buyer and higher monthly payments. High volume dealers can eat the loss, low volume new car dealers can't.
This week we saw heightened volatility in the market. We are 2% below the 2020 S&P top I predicted. Not much and a buy the dip mentality still exists. What should you be looking at as the key level. If and when we get a CLOSE below the last bottom in the market, 1904.8, it will send a technical SELL signal to even hard core bulls and things will get interesting very quickly. Right now we are in happy land, where WRONGWAY can still dream of $5.03 by mid Jan.
This week brought some interesting news in the auto world. CarMax the largest used car dealer in the country had its stock lose about 10% of its value when it reported weaker than expected earnings and sales on 9/23. Here is what one article said, "The Virginia based car dealer reported a 0.2% increase in same store sales in the quarter...as SUBPRIME LENDERS kept financing tight...This is what I have been writing about since July and so the question is why did it hit CarMax but not the new car dealers yet.
The difference is the way autos are financed in the new vs. used car market. If you go to a new car dealer you can get credit through a loan company set up by the manufacturer. Ford Motor Credit Co. or HMC Credit Co. They package up the loans and sell them to pension funds. The key is that they fund three months in advance and set the lending requirements. They control the process from start to finish and are funded through 9/30. Next quarter will be a challenge because the subprime market imploded this week so new cars will be impacted in Q4. Used car dealers don't issue much in the way of subprime debt. They rely on the SPOT MARKET a group of small lenders who CarMax can call to get quotes. These small lenders are impacted daily by the fluctuations in the subprime market since they sell resell the loans on a weekly basis. As the subprime market changes on a daily basis they feel it and have to change the rates and terms daily otherwise they will be stuck with the loans. But what happens in used cars will ultimately spread to new cars.
Last week I wrote about commodity indexes, the lumber and copper index as a harbinger of things to come. Wouldn't it be nice if there was such an index that could predict weakness in the new car market before it happened? There is such an index but few people outside the auto business have ever heard of it and most of those people don't know how to use it. Part 4 will tell you the secret.
What that means is that the 9th Circuit has a long and storied history of protecting the rights of the little guy from the predatory practices of large corporations. You guys didn't know you had invested in a predatory company...at least SIRI isn't creating any toxic waste sites. Given the liberal make up of the 9th Circuit it is highly unlikely that they will reverse the lower Court judge. SIRI will make its appeal. The 9th Circuit may grant SIRI an oral argument but since the case did not involve any dispute as to the facts and revolved around the interpretation of state law, it is likely that the Court will review the briefs and oral argument in the lower Court and the appeal papers and render a judgement without the benefit of oral argument. This can be done in a one sentence report saying the Court has reviewed and affirms the decision of the trial court. No one has a right to a hearing before the Appeals Court. It has to be granted. From there SIRI could appeal to the Supreme Court in DC. The Court has thousands of cases appealed to it every year but hears about a hundred. This is not an important case so the chances that the Supreme Court would hear it are less than zero.
SIRI will lose its appeal, so put a year from now on your calendar and expect a negative decision. I expect SIRI to pay out about 60M in royalties and 20M in legal fees. CN doesn't see this impacting the stocks price. I don't agree with that assessment. The 80M will knock 1.33 cents OFF of earnings in the Q in which it is paid. SIRI investors did understand what the debt extinguishment would do to earnings so why would they understand this? Another negative surprise at earnings..like that never happens.
In May SIRI issued bonds at an interest cost of 90M (1.5B X 6%). In Dec. the CB will disappear and save 35M in interest. The Turtle lawsuit could cost 80M. The net of these three is 135M. 2015 FCF is gone. If people figure this out SIRI's PPS will plummet. Better hope no one sees this.
By now everyone knows that SIRI lost its Turtle suit, and likely will have to pay royalties on songs recorded before June 15, 1972. Certifiably Nuts did a good job describing the lawsuit in a post entitled Alvin & The Chipmunks take a bit out of Sirius XM over on SA.
I thought it would be important to correct one factual error in CN's post, take a look at the timeline for appeal and then take a look at CN's conclusion that the "decision on the impact of SIRI's share price ....and that the market overreacted by sending the shares tumbling below $3.50."
The factual error in the piece is that SIRI may be able to alter its play lists to circumvent or reduce its liability under the ruling. That is a misunderstanding as to what the Court ruled. This was a class action lawsuit and if it is upheld on appeal all members of the class would immediately be entitled to monetary damages under the ruling. The question then becomes what about artists who didn't join the lawsuit but whose songs were played by SIRI during the last six years (the applicable statute of limitations). They would be covered also. The Turtle suit sets a precedent that Courts will follow so each and every artist could file their own lawsuit. SIRI knows this so you can expect SIRI to pay out to all the artists rather than those just in the class. That will mean that henceforth every song played on the 40s, 50s and 60's channel will be subject to a royalty. There is no way to just change the playlist to get around the ruling and SIRI is not going to drop the channels to save the fee. This is a classic case of a non lawyer trying to practice law without a license.
The case was decided in Federal District Court in CA and so SIRI will be appealing to the 9th Circuit Court of Appeals. This Circuit along with the 2nd Circuit in NY have a decades long record as being the most liberal circuits in the Federal System.