The stock market has hit a high.  At the same time, corporate profits are stagnant.  When numerator is divided by denominator, what you get is a record high number showing stocks as expensive, rivaling the peaks recorded in 1929, 1972 and 2000.  The current recession in corporate earnings is expected through at least the end of the year, as evidenced by second quarter results.

Meanwhile, measures of manufacturing activity are contracting, purchases of cars and trucks are in decline and rail shipments are slipping across the U.S.  The ISM New Orders index is 50, a number that means zero growth in the industrial sector of the economy, down from 63 in 2018.   Auto sales are on a steady descent, down -3% this year (only Subaru is achieving sustainable growth).  Trucking is down -5%, rail transport fell even more, to a level last recorded in 2014, reversing five years of growth.  While 2018 was marked by strong economic growth, 2019 so far shows gravity is pulling the economy towards the ground.

The Trump Administration has pushed foreign trading partners to revise long-standing agreements, arrangements which have arguably benefitted consumers and corporations despite numerous loopholes sacrificing labor and environmental conditions (yet the Trump Administration hasn’t targeted improving these two areas of concern).  If you can make sense of Trump’s logic on trade, beyond his headline-grabbing tactics, then congratulations.  Trade dislocations mean price increases and production relocating to other countries, away from China.

The Federal Reserve, although its members were split, signaled future reductions in short-term interest rates at its last meeting.  They’d be supportive of economic growth to calm market worries – these monetary magicians hope to achieve the trick of “look away, nothing to see here”.  It’s been working, until it doesn’t.  Longer-term interest rates have declined to nearly record lows. 

Worries fuel the stock market.  The ability to push worries aside levitates stock prices.  Gathering worries are pressures that, once the container breaks, cause investment prices to cascade lower.

It takes time for lower interest rates to spur economic growth.  It might have the opposite effect.  Worries over the health of the economy might further suppress spending.  The Fed might not deliver dramatically lower interest rates.  I question whether the U.S. would ever join the club of countries with negative interest rates, ex. Germany, Japan, Switzerland, along with several other European countries.  The 10-year government bonds of even somewhat dodgy credit Italy are yielding the same as those of the U.S. (shorter 1-year Italian bonds are more notably paying investors an interest rate of 0%).  Remarkably, over $17 trillion of bonds currently trade at negative interest rates, an absurdity only logical when you stand reason on its head.  This means investors could expect to be repaid less than what they paid to buy their bonds.

I’m not throwing in the towel, just giving perspective on how we live in interesting times.  I’ve erred on the conservative side, meaning that we invest in stocks for growth, bonds for income and retain reserves to not only meet your upcoming cash withdrawal needs but also add a cushion of cash that’s ready to invest if and when prices decline to levels more in sync with opportunities.
​
Ready to invest across a range of possible future scenarios, I believe that’s a better way of investing for the long run.     

​– poet Clive James

Enron in the year 2000 was a fraud hidden in the plain sight of public disclosure.  The professional investment experts who recommended buying the stock couldn’t explain, or understand, how the company made its money.  In short answer, it didn’t make any money.  Enron made itself look like it was making billions, until it came crashing down.  Its CEO, Jeff Skilling, was later sentenced to 24 years in prison, later reduced, so that at age 65 he’s just been released.

Of note, Enron fooled the nascent socially responsible investing community.  Every environmentally managed mutual fund owned the stock.  Enron was the electric and gas utility that didn’t pollute: it traded only financial claims on energy.

Lehman Brothers was a similar sort of bad deal, on Wall Street. During the financial crisis of 2008. Lehman masqueraded as a bank worth saving.  It actually wasn’t a bank and so they didn’t save it.  Lehman became the poster child for, financially, making something out of nothing.  In the end, it was a nothing.  And yes, anyone paying careful attention could have seen it coming.

Over the past couple of years, Theranos, the medical testing startup once highly acclaimed, was also revealed a scam, with lawsuits in progress to prove it.  Promising a new diagnostic test based on a single drop of blood, in reality, the test Theranos claimed to have developed wasn’t accurate.  That didn’t stop some big corporate names from buying into the myth, as did its all-star board of directors, including the former CEO of Wells Fargo bank, former Secretaries of State and James Mattis, former Secretary of Defense.  It was Wall Street Journal’s reporter John Carreyrou who first broke the story, as was recently told in HBO’s documentary The Inventor.  In March 2018, the U.S. SEC filed fraud charges against Theranos and its now 35 year-old former CEO Elizabeth Holmes, who awaits trial and could face 20 years in prison.

Tesla, I expect, will meet a similar fate.  The company operates a business, in automobiles, solar installations and batteries, that we all hope might bring a brighter future for our world.  In reality, we can’t overlook Tesla’s many burdens despite its pioneering role in bringing electric cars to market in a big way.  Tesla’s funding needs are large, its competition strong and numerous managers have departed.

What Tesla has going for it are customers who are fanatically loyal and goals dramatically ambitious, aiming to overthrow the fossil fuel-based economy.  Its leader is Elon Musk, a modern-day P.T. Barnum who fakes it until he makes it, while the harsh reality is billions of dollars in losses, kept afloat by a free-spending investor base.  However, as I write on the cusp of Tesla’s two billion dollar stock offering, needed to keep the business going, operations aren’t going well and poor finances are finally catching up with it, in the form of vendors who demand payment in the courts and sales falling at a double-digit percentage rate.

The truth in these cases is that they became frauds hidden in plain sight.  At first, we might have an investment theory.  We might wish for it to be true, about how it will work.  And it might seem to be working for a time and we feel good to be associated with a good cause or what goes up – the perpetrators of frauds rely on investors’ perceived indicators of success to be proof of success.

When I was an auditor at the U.S. SEC, I helped uncover many frauds where everyone, victims included, were happy with the situation right until the very end, when something happened to derail the fantasy.  In our analysis, if we can’t find fundamental truth in what’s wished for, your wishes probably won’t turn out true after all.