“Never Let A Good Crisis Go To Waste” – And Short AMZN

The “crisis” quote above originated with Winston Churchill. Several U.S. politicians have referenced it since then (most recently Rahm Emanuel when he was Obama’s Chief of Staff). I’m sure the Wall Street snake-oil salesmen and economic propagandists are more than happy to attribute the deteriorating economic numbers to the hurricanes that hit Houston and southwestern Florida.

Retail sales for August were released a week ago Friday and showed a 0.2% decline from July. This is even worse than that headline number implies because July’s nonsensical 0.6% increase was revised lower by 50% to 0.3% (and it’s still an over-estimate).

Before you attribute the drop in August retail sales to Hurricane Harvey, consider two things: 1) Wall St was looking for a 0.1% increase and that consensus estimate would have taken into account any affects on sales in the Houston area in late August; 2) Building materials and supplies should have increased from July as Houston and Florida residents purchased supplies to reinforce residences and businesses. As it turns out, building supplies and material sales declined from July to August, at least according to the Census Bureau’s assessment. Furthermore, online spending dropped 1.1%. Finally, the number vs. July was boosted by gasoline sales, which were said to have risen 2.5%. But this is a nominal number (not adjusted by inflation) and higher gasoline prices, i.e. inflation, caused by Harvey are the reason gasoline sales were 2.5% higher in August than July.

Too be sure, the retail sales overall were slightly affected by Harvey. But the back-to-school spending is said to have been unusually weak this year and AMZN’s Prime Day no doubt pulled some August online sales into July. However, back-to-school spending reflects the deteriorating financial condition of the middle class. I have no doubts in making the assertion that the factors listed in the previous paragraph which would have boosted sales in August because of Harvey offset significantly any drop in retail sales in the Houston area during the hurricane.

Note – John Williams published his analysis of retail sales and it agrees with my analysis above (Shadowstats.com): Net of Hurricane Harvey Effects – Headline Economic Numbers Still Were Miserable, Suggestive of Recession – Hurricane Impact on August Activity: Mixed, Probably Net-Neutral for Retail Sales – August Real [inflation-adjusted] Retail Sales Declined by 0.61% (-0.61%) in the Month, Plunged by 1.24% (-1.24%).

The Fed Continues To Target Stock Prices. The Dow and the SPX continue to hit new all-time highs every week. At this point there’s no explanation for this other than the fact that, according to the latest Fed data, the Fed’s balance sheet increased by $18 billion two weeks ago. This means that the Fed pushed $18 billion into the banking system, which translates into up $180 billion in total leverage (the reserve ratio on high-powered bank reserves is 10:1).

The good news – for Short Seller’s Journal subscribers – is that, despite this overt market intervention, a large portion of the stocks in the SPX are trading below their 200 dma:

The chart above shows the percentage of stocks in the SPX trading above their 200 dma. In March nearly 80% of the stocks were above the 200 dma. By late August the number was down to 54%. Currently 60% are trading above the 200 dma, which means 40% are trading below.

It’s uglier for the entire stock market, as only 43.5% of the stocks in the NYSE are trading above their 200 dma, which means that 56.5% are trading below the 200 dma. This explains why neither the Nasdaq nor the Russell 2000 were able to close at new all-time highs.

Without the Fed’s direct support of the stock market, there’s no question in my mind that the stock market would be crashing. Perhaps more frightening is the increasing amount of debt being added throughout the U.S. financial system. The debt ceiling limit was suspended until December. The amount of Treasury debt outstanding jumped over $300 billion to over $20 trillion the day the ceiling was suspended. John Maynard Keynes’ macro economic model was one in which Governments could stimulate economic growth through debt-financed deficit spending. But once the economy was in growth mode, the Government was supposed to operate at a surplus and pay down the debt. Never did Keynes state that it was acceptable to incur deficit spending and debt to infinity, which is the current course of the U.S. Government.

Trump has suggested removing the debt ceiling. I’m certain it was “trial balloon” to see how vocal the opposition to this idea would be. The Democratic leaders love the idea. I have not heard much resistance from the Republicans. My bet is that by this time next year, or maybe even by the end of the year, there will not be a debt-ceiling on the amount of money the Government can borrow. In truth, this is no different than giving the Government an unlimited printing press.

Corporate high yield debt issuance has exploded globally, as you can see from the chart to the right, which shows the amount of junk bond debt issuance annually on a trailing twelve month basis. Globally the amount outstanding has increased by more than 400%. Close to 60% of this issuance has occurred in the U.S. In conjunction with this, U.S. corporate debt hits an all-time high every month. Most of this debt is being used either to re-purchase stock or over-pay for acquisitions (see the AMZN/Whole Foods deal).

Currently the amount of debt issued to complete acquisitions as a ratio of Debt/EBITDA is at an all-time high, with 80% of all deals incurring a Debt/EBITDA of 5x or higher. The last time this ratio hit an all-time high was, you guess it, in 2007. As an example, let’s look at AMZN’s acquistion of Whole Foods. AMZN issued $16 billion of debt in conjunction with its acquisition of Whole Foods. No one discussed this, but the Debt/EBITDA used in the transaction was 13x. Whole Foods operating income plunged 25% in the first 9 months of 2017 vs the first nine months of 2016.

A 13x multiple outright for a retail food business with rapidly declining operating income is an absurd multiple. That the market let AMZN issue debt in an amount of 13x Whole Food’s EBITDA is outright insane. What happened to all that “free cash flow” that Amazon supposedly generates? According to Bezos, it was $9.6 billion on a trailing twelve month basis at the end of Q2. If so, why did AMZN need to issue $17 billion in debt? We know that the truth (see previous analysis on AMZN) is that AMZN does not, in fact, generate free cash flow but burns cash on a quarterly basis. Currently AMZN is busy slashing prices at Whole Foods, which will drive WF’s operating margin from 4.5% toward zero. This is the same model that is used in AMZN’s e-commerce business, which incurred an operating loss in Q2.

In my view, AMZN continues to be one of the best short ideas on the board – the graph below is as of last Friday (Sept 15th) when AMZN closed at $986, Short Seller Journal subscribers were given some put option ideas as alternatives to shorting AMZN outright (click to enlarge):

The chart above is a 1-yr daily. Technical analysis adherents would see the head and shoulders formation I’ve highlighted in AMZN’s chart. This is potentially quite bearish. Despite the Dow and SPX hitting a series of all-time highs this month, AMZN has not come within 5% of its all-time high on July 26th ($1052 close). It traded up to $1083 intra-day the next day before closing below the previous day’s close and then dropped its Q2 earnings bombshell when the market closed. Based on its $986 close this past Friday, it’s 9% below its July 27th intra-day high-tick. Some might say that’s “halfway to bear market territory.”

AMZN lost $31 last week despite the SPX hitting a record high on Wednesday. This negative divergence is bearish. In addition, Walmart has taken off the gloves and is directly attacking AMZN’s e-commerce business model. WMT offers 2-day free shipping on millions of items without the requirement of spending money upfront to join a “membership.” WMT is also running television ads during prime time which attack some of AMZN’s marketing gimmicks.

Some other bearish technical indicators, a highlighted above: 1) Since the end of July, the volume on down days in the stock price has been higher than the the volume on up days; 2) The RSI has been declining gradually since early April; 3) the MACD (bottom panel) has been declining steadily since early June. All three of these indicators reflect large institutional and/or hedge funds selling their positions.

The stock is sitting precariously on its 50 dma (yellow line above). I would not be surprised to see it test its 200 dma, currently $904, before it reports Q3 earnings. If you want to speculate on this possibility, the October 6th weekly $920 – $930 puts, depending on how much premium you want to pay, might be a good bet. You might also want to out another week to the October 20th series. One caveat is that AMZN will no doubt manipulate its numbers using merger and acquisition accounting gimmicks, which give the acquiring a window in which to egregiously manipulate GAAP numbers. I don’t know if the market will “see” through this or not. But based on the performance of the stock since AMZN dropped its Q2 earnings bombshell, I’d say the stock on “on a short leash.”

The above commentary and analysis is directly from last week’s Short Seller’s Journal. If you would like to find out more about this service, please click here: Short Seller’s Journal subscription info.

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