The Hutch Report

A Day of Carnage in the Trading Rooms

By | Economics, Markets

Thirty-four years ago, on Oct. 19,1987, the Dow Jones Industrial Average plunged 22.6%, its largest one-day percentage-point drop ever.

In comparison, here are five of the worst stock market crashes in US history, based on daily percentage losses (source:

Five Worst Stock Market Crashes in US History

Oct. 19, 1987

Percentage change: -22.61 percent

About: Known as “Black Monday,” this devastating crash began in Hong Kong, spread to Europe and then hit the U.S. hard.

Oct. 28, 1929

Percentage change: -12.82 percent

About the crash: The Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 started on Oct. 24 and signaled the beginning of the 12-year Great Depression. Black Monday, the fourth and worst day of the crash, saw a drop of 12.82 percent.

Dec. 18, 1899

Percentage change: -11.99 percent

About the crash: During the Panic of 1896, the U.S. experienced an acute economic depression caused by a drop in silver reserves and deflation.

Oct. 29, 1929

Percentage change: -11.73

About the crash:  Black Tuesday was the fifth day of the the Wall Street Crash of 1929, also known as the Great Crash or the Stock Market Crash of 1929 that started on Oct. 24 and signaled the beginning of the 12-year Great Depression.

Nov. 6, 1929

Percentage change: -9.92

About the crash: Just a week after the height of the 1929 Stock Market Crash, investors saw another dip.

What were they saying back then?

We were wondering what parallels exist today, not only from an economic standpoint, but also from a human behavioural one. What were they saying back then that we could expect today?

We looked back at a Nightly News Broadcast of that time in order to gain a better understanding of the mindset of the time. You would be advised to watch the broadcast because in the words of philosopher George Santayana, “Those who cannot remember the past are condemned to repeat it.” (See The Nightly News Broadcast October 19, 1987 at the bottom of the post)

The 1987 crash lost much more than the crash of 1929, and although (as they said at the time), “Conditions today are much better than they were then.” According to the broadcast, the sudden sell orders stemmed from big institutional investors to private investors all worried about, “Inflation, rising rates, a declining dollar, and huge budget and trade deficits.”

Because consumption makes up a big chunk of the US GDP, they worried that the market plunge at the time could impact the psychology of even those that didn’t own stocks. They worried the consumer would stop borrowing and spending which could grind the economy to a halt. The difference is that today by comparison, consumers are much more heavily indebted. They are carrying mortgage debts, auto loan debts, student loan debts and credit card debts that are far higher than they were in 1987.

The Reagan administration at the time tried to blame congress for scaring big business by proposing higher taxes. There was also concern about needing to cut the deficit. However, one of the big criticism of the time where directed at Treasury Secretary James Baker for hinting that the US would not defend the decline of the US dollar.

Curiously absent from any of the stock market crash discussion of the time was the elephant in the room, the Federal Reserve Bank of the US. How times have changed, as they have now become the only voice that seems to matter anymore and the last line of defence. They have become the backstop for stock market for the past 20 years, gaining influence with every crisis. Only time will tell what happens when they lose their ability to keep everything a float.

All in all, it is a fascinating 9 minutes to watch. It should give you a pretty good idea of what to expect in the future.

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Where does the stock market and economy meet?

By | Economics, Markets, Psychology

This idea of buying and selling stock in a company was originated by the Dutch in 1602. As the practice spread to other countries the volume of shares increased.  At this point the need for an organized marketplace to exchange these shares became necessary. The modern concept of a stock market took hold in England where traders would meet at a London coffeehouse.  In 1773, the traders took over the coffee house and changed its name to the “stock exchange.” The first exchange, the London Stock Exchange, was thereby founded. The idea made its way to the American colonies with an exchange started in Philadelphia in 1790 and eventually the New York Stock Exchange in 1817. 

The term Stock is used to symbolize an investor’s ownership in a company. Upon purchase of the stock the investor theoretically owns a percentage of everything the company owns or owes. The company’s profitability, or lack thereof, determines whether its stock is traded at a higher or lower price. The practice began as many pioneer merchants wanted to start huge businesses. This required substantial amounts of capital. It was an amount of capital that no single merchant could raise alone. Therefore, groups of investors pooled their savings and became business partners and co-owners with individual shares in their businesses to form joint-stock companies.

Psychological effects

The US economy’s GDP is primarily driven by spending (70%) and investment (18%). The stock market affects gross domestic product primarily by influencing financial conditions and consumer confidence. This confidence spills over into increased spending, which can lead to major purchases, such as homes and automobiles and thereby increase the GDP.  So, when the value of stocks are increasing there tends to be a great deal of optimism surrounding the economy and the prospects of various stocks. In comparison, when the value of stocks are falling, it can have a negative effect on sentiment at which point investors rush to sell stocks to prevent losses on their investments. Those losses typically lead to a pullback in consumer spending, especially if there’s also the fear of a recession (two quarters of negative growth). When GDP rises, corporate earnings increase, which makes it bullish for stocks. The inverse occurs when GDP falls, leading to less spending by businesses and consumers, which drives the markets lower. At least that is the theory. 

Todays reality

Looking at the extraordinary events of today, the stock market looks increasingly divorced from economic reality. The United States is on the brink of the worst economic collapse since the Hoover administration. Corporate profits have crumbled. To date more than 1.8 million Americans have contracted the coronavirus, and hundreds are dying each day. Add to that the death of an unarmed man at the hands of a police officer which has led to daily and nightly protests, widespread anger and looting in cities across the country. You would think that would be enough to destroy consumer confidence. 

However, stocks keep climbing. The coronavirus crisis has cost some 36.5 million American jobs in two months with experts warning that figures could peak above the Great Depression in 1933, yet Nasdaq is less than 1% from its all time highs set back in February and the S&P 500 is down a mere 9 percent from its all time highs.

Economists who have studied the performance of stock markets over time say there’s relatively little evidence that economic growth matters to the outcome of the market at all. According to Ed Wolff, an economist at New York University who studies the net worth of American families, “Stock ownership among the middle class is pretty minimal.” He stated that “The fluctuations in the stock market don’t have much effect on the net worth of middle-class families.” A relatively small number of wealthy families own the vast majority of the shares controlled by U.S. households. According to an analysis by Wolff the most recent data from the Federal Reserve shows that the wealthiest top 10 percent of American households own about 84 percent of the value of all household stock ownership. The top 1 percent controlled 40 percent of household stock holdings.

Ok, this may be true but it still doesn’t take into account the psychological impact of the consumer previously presented. Even if US households own very little stock, the effects of the events we are currently experiencing are putting the brakes on consumer spending. This is already leading to a large number of insolvent businesses. This has a profound impact on GDP and will eventually impact the stock market. Or will it?

Much of the effect of the rising stock market has been explained as the effect of the money printing by the Fed. The theory is the Fed prints money, drives down interest rates which push investment into riskier assets thereby driving up the stock market. There is also the moral hazard effect whereby investors take on additional risk because they believe that no matter what happens the Fed will bailout the markets. 

The Federal Reserve President, Jerome Powell recently explained that in a liquidity crisis, otherwise healthy firms collapse because they can’t access credit. The Fed can resolve such a crisis because it can print and lend unlimited amounts of money. However, in a solvency crisis, companies can’t survive no matter how much they can borrow: they need more revenue. The Fed can’t solve that.

FEBRUARY 12: Federal Reserve chairman Jerome Powell testifies before the Senate Banking, Housing and Urban Affairs Committee on the “Semiannual Monetary Policy Report”
on Wednesday, Feb. 12, 2020. (Photo by Caroline Brehmanl)

So, despite its critical role in the economy, the stock market is not the “same” as the economy. The stock market is driven by the emotions of investors. They can exhibit irrational exuberance which normally occurs during an asset bubble and the peak of the business cycle. Equally we have seen that consumer optimism or lack thereof can impact spending, which makes up 70% of GDP, and also has an effect on stock market performance. So what we essentially have is a situation where investor exuberance is battling underlying deteriorating fundamentals. So far investor exuberance is winning, up until they take Jerome Powell’s words of caution that the Fed has no solution for business insolvency. So the stock market is not the economy but it is influenced by the economy. 

Musical chairs

John Maynard Keynes probably explained it best. According to Keynes, the stock market is not simply an efficient way to raise capital and advance living standards, but can be likened to a casino or game of chance. “For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs–a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops.”

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Mind the GAAP!

By | Finance, Markets

With the earnings season upon us we now go through the same dog and pony show. Companies report earnings, then the success of those earnings are based mainly on whether or not they beat consensus analyst’s estimates. Curiously enough, many often beat by one penny. What methods do they possibly use to beat by a penny per share? 

Prior to earnings, analysts tend to be busy estimating what earnings they think will be reported. Their estimates are based on guidance from the company itself, economic conditions and their own independent models and valuation techniques.

Companies prepare their accounting using generally accepted accounting principles, also referred to as GAAP. GAAP, are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. GAAP are controlled by the Financial Accounting Standards Board (FASB), a non-governmental entity. The FASB creates specific guidelines that company accountants should follow when compiling and reporting information for financial statements or auditing purposes. GAAP is not law, and there is nothing illegal about violations of its rules unless those violations happen to coincide with other laws. Today, all 50 state governments prepare their financial reports according to GAAP. While a little less than half of them officially require local governments to adhere to GAAP.

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However, more and more, companies are finding that by following a standardized set of GAAP rules, their earnings often come out less than attractive. So, over the years corporate accountants have become more and more creative through the use of “non-GAAP” methods to improve their bottom lines. 

A study published by Audit Analytics noted that 96 percent of S&P 500 companies used non-GAAP measures in earnings releases during the fourth quarter of 2016. In addition, a study published by FactSet indicated that for the first quarter of 2017, 63 percent of the companies in the Dow Jones Industrial Average reported non-GAAP earnings per share and that, on average, the difference between the GAAP and non-GAAP earnings per share was approximately 54 percent. The most common adjustments were found to be restructuring charges, acquisition-related items, stock compensation costs, and, to a lesser extent, debt costs and legal costs. 

As companies battle to present themselves as profitable, non-GAAP measures are becoming the norm as the disparity between GAAP and non-GAAP results grows larger and larger. So if you think you are going to get the true story from a company’s statements or earnings reports, think again. 

Off-balance sheet financing is another method of non-GAAP financial engineering. A business tries to keep certain assets and liabilities off its balance sheet in order to present to the investment community a cleaner balance sheet than would otherwise be the case. It does so by engaging in transactions that are designed to shift the legal ownership of certain transactions to other entities. The transactions are designed to sidestep the reporting requirements of the applicable accounting framework, such as GAAP or IFRS. So, therefore, considered non-GAAP.

Off-balance sheet financing played an important role in the Lehman Brothers bankruptcy. Through the use of off-balance sheet entity ‘Repo 105’, Lehman was able to move $50 billion of debt off of their balance sheet, making them appear more financially stable before the end of the quarter. Since it was classified as a repurchase agreement, it was ‘bought back’ after the reporting period. When the debt was originally moved off-balance sheet, the bank recorded the debt as a ‘sale’ and booked the $50 billion as revenue. This type of accounting manipulation contributed to the largest bankruptcy in U.S. history, wiping out the life savings of thousands of employees of the bank. 

Adjusted EBITDA is another non-GAAP financial measure that has gained a lot of popularity. Speaking on Jim Grant’s Current Yield Podcast, Adam Cohen, founder of Covenant Review, stated, “Some version of adjusted EBITDA is quite common, but we are seeing things turn into absolute fantasy land.” He took a recent example using the company WeWork, currently valued at roughly $47 Billion, with a stated annualized revenue of $2.5 billion. Cohen explained that the WeWork 2017 income statement started with a net loss of $933 Million. Once they got themselves to adjusted EBITDA, they reduced that to a loss of $193 Million, however since they wanted to sell a bond yield, this wasn’t good enough, so they invented something called “adjusted EBITDA before growth investments” but that still wasn’t good enough, so they invented a third version called “Community adjusted EBITDA,” which at what point they achieved a positive $233 Million community adjusted EBITDA. That is a $1.1 Billion swing from net loss to profit, which is more than the amount of revenues they booked that year. 

As an update to this example, the Financial Times just reported on March 26th, 2019, “WeWork bond prices slipped on Tuesday after the provider of shared office space said that its losses had more than doubled from a year earlier, as the company ploughed money into a breakneck expansion that has captivated the real estate industry.”

So, as a word of caution to those investing in the next potential Lehman, as all these fairy tale companies go public, and as the earnings season takes off,  “MIND THE GAAP.”

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The Great Gold Consolidation

By | Markets

It seems that the merger activity amongst gold miners is continuing. On Monday, January 14, 2019, gold miner Newmont Mining said that it would buy smaller rival Goldcorp in a deal valued at $10 billion. Newmont will offer 0.3280 of its share and $0.02 for each Goldcorp share. According to the company’s statement, the combined company’s reserves and resources will represent the largest in the gold sector and will be located in favourable mining jurisdictions in the Americas, Australia, and Ghana.

The latest merger falls on the heels of last year’s mega merger between Barrick Gold and Randgold Resources. Trading in the shares of the new company started at the opening of business on the New York and Toronto Stock Exchanges January 2. The new company is still known as Barrick but its trading symbol on the NYSE has been changed to GOLD, the ticker formerly held by Randgold on NASDAQ. On the TSX, the ticker remains ABX.

The merger created a gold company which now owns five of the industry’s Top 10 Tier One gold assets1 (Cortez and Goldstrike in Nevada, USA (100%); Kibali in DRC (45%); Loulo-Gounkoto in Mali (80%); and Pueblo Viejo in Dominican Republic (60%), and two with the potential to become Tier One gold assets (Goldrush/Fourmile (100%) and Turquoise Ridge (75%), both in the USA). 

Overshadowed by the Barrick merger was the acquisition of Beadell Resources and its Tusan Gold mine in Brazil by Great Panther Silver. In a telephone interview with Kitco News, Jim Bannantine, president and CEO of Great Panther Silver (NYSE: GPL, TSX: GPR), said that he thinks investors are only seeing the start to more mergers within the mining space as companies are beginning to take advantage of low valuations in the marketplace.

According to a new report by Fitch Solutions, Gold miners are expected to remain committed to cutting costs and capping expenditures in 2019. Gold prices are predicted to average $1,300/oz and it is believed that most major miners’ cash costs of production should remain comfortably below $900/tonne. The largest firms are expected to remain committed to spending cuts in order to reduce debt loads, and continue to follow a strategy of improving both operational and cost performance. Fitch also stated that, “Capital expenditure estimates for 2019 indicate that although gold companies may have turned a financial corner in 2016, spending will not return to the heights of the past decade. As such, priority will be given to reinvestment in brownfield assets rather than the development of greenfield projects.”

Following the Barrick – Randgold merger (completed in January 2019), and now the Newmont – Goldcorp merger, we should expect more M&A activity to filter through the industry in addition to and increase in joint ventures as a strategy to reduce risk, especially in unstable countries. An example of notable joint venture activity in 2018 include Gold Fields & Asanko Gold’s 50/50 deal in the Nkran and Esaase gold deposits in Ghana and Indiana Resources and Cradle Arc’s 65/35 deal in the Kossanto West Gold project in Western Mali.

Not surprisingly, as an added measure to further reduce risk in these volatile areas, miners are expected to invest in blockchain technology. According to Fitch, such a system would allow them to effectively track the sourcing of minerals across the supply chain in order ensure they abide by ethical and sustainability standards.

Gold prices have been consolidating since the previous move up in 2016. If the price of gold moves up above the resistance level of $1,400 it could help propel the miners who have gained the greatest operating efficiencies. 

Previous to today’s takeover of Goldcorp by Newmont, articles of the past few years were focused on who Goldcorp would takeover, disregarding Goldcorp as the target. So now in light of that, the question is, “Who is the next prime takeover target?” The top 10 in the industry according to current market capitalisation levels are now Barrick Gold, Newmont Mining, Franco-Nevada, Agnico Eagle, Kirkland Lake, Royal Gold, AngloGold Ashanti, Kinross Gold, Goldfields and B2Gold. Will we see consolidation amongst the 10 largest as we have just witnessed or are the juniors ripe to be taken over? Either way, the current consolidation activity should create some strong valuation plays for the future should the price of gold finally make its move upward. 

Kirkland Gold has broken away from the pack.

The FED – Are We Being FED Bullshit?

By | Finance, Markets

Did the market reaction after last week’s 25bps rate hike announced by Janet Yellen and the FOMC (Federal Open Market Committee) leave you scratching your head? The dollar went down, Wall Street rallied with the S&P spiking near all-time highs, commodities including gold rallied … was this what you were expecting? Well, if not and if you are scratching your head, be comforted that you are not alone. Many others are also scratching their heads, from amateur investors to seasoned industry veterans.

As typical with post game couch side review, explanations are being created to match with what happened. One of the explanations that is being repeated is that this was a dovish event on the part of the Fed. A bit surprising because in the recent past, this would most likely have been considered a hawkish move from the Fed, as with most rate hikes, along with the maintained position on a forecast of three hikes this year. Apparently for this latest FOMC meeting to have been considered hawkish the Fed would have had to announce an increase in the anticipated number of rate hikes and there would have had to have been a change to the notorious dot plot of Fed member positions.

If you do not buy the explanation that the announcement was dovish, another plausible explanation is that this is the kind of behavior just driven by ongoing euphoria of the late stage bull market. Jan Hatzius, chief economist of Goldman is quoted as saying that this market reaction does not really make sense and was more akin to what you would expect if it was a 25bps move in the other direction – in other words how the market would have reacted if the Fed had announced a rate cut.

Another dynamic at play here is the bullish rhetoric of Trump, decreasing corporate taxes and regulation, infrastructure spending, US dollar repatriation which would lead to a stronger dollar but also more difficulty for the US economy versus the Fed who want to be sure they have enough powder to keep inflation in check. Another elephant in the room is all of the outstanding US debt which would become impossible to service if rates get too high.

Nothing is ever in isolation and another event with a side-effect impact to the dollar was that the Dutch elections were on the same day as the Fed announcement and there was a boost to the Euro exchange rate due to the non-populist outcome of the Dutch elections. Next month will see additional events outside the US that will have side effects towards the US dollar. Sentiment towards the Euro will surely be impacted as the French elections start heading towards a climax over the next two months as well as the UK’s self-imposed deadlines for Brexit talks next week. In addition, both the ECB and BOJ will be convening towards the end of April and these sessions will surely add to the exciting things to watch out for next month. The next FOMC session is not scheduled until June 13-14 and that session will also be associated with a Summary of Economic Projections and a press conference by the Chair.