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The Market Is Surging Like Never Before

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Where the Market is Headed From Here

The market is surging like never before…

So far this year, the S&P 500 is up over 7% (as of August 2.) It’s risen almost 6% since the United Kingdom’s vote to leave the European Union June 23 (“Brexit.”)

The reason: the Federal Reserve (Fed.)

Take a look at the annual returns of the S&P 500 since the Fed dropped interest rates to near zero… And bought $4 trillion worth of U.S. Treasury bonds.

S&P 500 Annual Returns:

2010: 16%

2011: 2%

2012: 15%

2013: 20%

2014: 12%

2015: 2%

2016: 7.1% year-to-date (12.6% annualized)

The gains we’re seeing this year don’t add up.

This business cycle is long in the tooth. We just started the 7th year of the cycle. Not only is the stock market’s growth slowing, the slowdown is accelerating faster than any other year since the recession ended.

Wait – maybe it does make sense. This is almost exactly what happened right before the Great Recession. The market surged one last time before collapsing.

Check out the previous business cycle prior to the Great Recession:

2003: 35%

2004: 5%

2005: 9%

2006: 13%

2007: -4% (but was up 8% before plunging starting in October)

The last cycle behaved as normal: up strong as the economy regained its footing – about 10% per year. Then it dropped 4% in 2007.

However, this cycle is moving to a different beat… And the drummer is the Fed.

For instance, note the size of annual growth in this cycle – on pace to have five double digit return years in a seven year cycle (about 11.3% per year.)

You can thank the Fed’s easy money.

But notice the abrupt drop in 2015. The Fed ended its quantitative easing policy by the end of 2014. And raised interest rates December 2015.

The spigot got turned off by 2015… and it resulted in just 2% gains.

This year’s gains – up over 7% (12.6% annualized) – defies both underlying fundamentals AND the Fed’s loose monetary policy.

First, growth was already artificially driven by the easy money.  Second fundamentals are terrible: revenue growth is low and has declined for four straight quarters. Meanwhile, global economies are slowing. Talk about divergence.

The S&P 500 price-to-earnings (P/E) ratio is now at 25, the highest it’s been since the recession.

The Schiller P/E – which averages the P/E ratio over the past 10 years – is at 26.  It previously peaked at this level in early 2015.  The market stayed at that level before plunging 8%. 

Immediately before the last recession, it hit 27 and then the recession started.

KEY POINT: The market is richly valued.  Every time the Schiller P/E reaches these highs, the market stalls… and eventually drops. Given the lack of growth factors (outside of a Middle East and Asian arms race), this divergence won’t last. I expect the market to begin falling by the end of the third quarter (I’ll explain why in a future post.)


Andrew Zatlin

Editor of Moneyball Economics

P.S. Recently, Bloomberg ranked me the 8th most accurate forecaster of US private payrolls.

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Did China Just Buy One of the World’s Most Important Companies?

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Did China Just Buy One of the World’s Most Important Companies?

This company holds the keys to the future of electronics.

It’s not hyperbole.

Like a spider sitting in the middle of the web, this company sits firmly at the heart of the future of electronics.

I’m talking about ARM Holdings (ARMH).

ARMH’s microprocessors power more than 95% of the world’s smartphones. They have a 65% share of the computer accessory market. And a 90% share of the hard drive and SSD market.  Their reach and dominance extends far beyond the world of the internet. For example, they have a 95% share of the auto processor market. (Full disclosure: They are also the only stock I still own.)

ARMH‘s business model is simple: they specialize in the design of microprocessors and they license the designs to other semiconductor companies. For $10M a year, any company can go through the ARMH library and choose any of ARMH’s designs. The advantage of being a design house means that everyone uses them: Samsung, Intel, Apple.


It has been said that ARMH is the biggest consumer product in the world. 

I agree: In 2015, 20 billion chips shipped using ARMH technology. Their designs are the core of the critical components of virtually all consumer electronics: smartphones, tablets, TVs, and so on. For example, most of today’s tablets and phones run on Qualcomm chips: they did $26 billion in sales last year. These chips re-package ARMH designs.

And it is for this reason SoftBank offered to buy ARM Holdings for $32 billion last week (July 18) – a 42% premium to its previous day’s closing price.

Meanwhile, Softbank’s acquisition of ARMH will deliver a huge blow to Intel (INTC) for two reasons.

Intel was interested in buying ARMH. And in this post-PC world, Intel is struggling.

Their first problem is that they have the wrong type of products. Intel specializes in large, powerful and power-hungry semiconductor chips. But the future lies in small, application specific, energy-thrifty chips. 

The second problem is that Intel does everything in-house and they don’t “play well” with others. 

Compare that to ARMH which deliberately makes their technology available to anybody.

The easy solution was to buy ARMH. ARMH would’ve been its life preserver. And a way to buy their way back in. Unfortunately, anti-trust issues were likely a major factor preventing Intel from purchasing ARMH.

It might not be game over yet. With ARMH in play, perhaps Intel will field an offer of their own. Or, as I will discuss in a moment, Intel may be part of the ARMH deal after all.

But the real question is: Who is Softbank?

Who is Softbank?

One thing stands out when reviewing Softbank’s business… there is absolutely no synergy between the two companies. That is exactly the point.

Softbank comes out of the 1990s Internet boom. Its history is long… 

Based in Japan, they started as a mobile phone telecom company. They then bought the big annual computing conference COMDEX. And also partnered with Yahoo! to establish Yahoo! Japan.

Using massive debt, Softbank then embarked on a series of investments, mostly focused on the telecoms and internet space (They recently bought Sprint.) 

Today, they carry $89 billion in debt… and have always had cash flow problems which affect their ability to pay off that debt.

However, one of the investments was to a start-up by Jack Ma – called Alibaba. Leveraging the Yahoo! partnership, Softbank and Yahoo! each took a 1/3 share of Alibaba.

Softbank’s investment in Alibaba is where things get interesting. 

Today, Softbank’s stake in Alibaba is single-handedly saving them from bankruptcy.

Why? Because Alibaba isn’t just an “internet company.” It dominates China’s internet economy. They’ve spent approximately $35 billion in various (mostly Chinese) companies in the last two years alone. Investments ranging from e-commerce to travel to shipping.

Alibaba is everywhere.

Alibaba didn’t get to dominate the internet economy today because it is the “best.” It dominates the internet economy because it got China’s official blessing.

If you know China, then you know relationships matter.

And where Alibaba dominates the Chinese economy, Softbank is behind the scenes as a controlling shareholder.  Softbank may be based in Japan, but it is absolutely a Chinese company.

It is a clear indication that hardware and semiconductors are no longer a part of Softbank’s current business focus.

The China Angle

I believe that ARMH is China’s way to become a dominant semiconductor player.

You see, semiconductors are a major capital outflow (expense) for China. China spent approximately $100 billion last year on semiconductors. And it’s a major capital inflow for South Korea and Taiwan, whose economies are driven by semiconductors. Beyond economics, semiconductor strength enables national security strength (think: super computers). And it’s also a point of pride: developed economies tend to have strong domestic semiconductor industries.

The Chinese government want to bring that in-house. It has made the development of a domestic semiconductor industry a major strategic goal.

It used its leverage as the major customer of semiconductors to squeeze semiconductor designers and manufacturers into doing more business in China. It has even earmarked $10 billion for intellectual property development.

But the fastest path to become competitive with its Asian neighbors is through acquisition.

Last year in July, a $23 billion offer was made by Tsinghua Unigroup to buy Micron Technology (MU). Micron sells memory (DRAM) which is, like ARMH processors, a fundamental product used everywhere. The U.S. government blocked the offer for national security reasons.

Of importance is that Tsinghua Unigroup is a semi-government entity – set up and funded by the government as part of the drive for building a semiconductor industry. And speaking of Intel and Tsinghua, Intel just invested $1.5 billion in Tsinghua for a 20% stake. (I’ll come back to this very important point in a moment.)

So let me paint the picture. The Chinese government has an industrial policy to jump-start a domestic, world-class semiconductor capability. They have – through shell companies like Tsinghua – been putting their money where their mouth is.

Having tried to buy a major core semiconductor company and been rebuffed, buying ARMH (through a state-owned enterprise) would’ve struck a nerve. Buying the crown jewels of the internet would’ve ruffled feathers with the Western world.

It also would’ve come at a hefty price.

So instead, it used SoftBank as its proxy.

SoftBank = China

Recall that SoftBank specializes in telecommunications and the internet. Same with their key asset, Alibaba. Why would they want to buy a major semiconductor company? Why, with $89 billion in debt, is Softbank adding another $31 billion? And who would be willing to lend them that type of money?

The answer: Softbank is not buying ARMH for themselves.

One possibility is that Softbank on its own is front-running a bigger China budget. That $10 billion budget is not even table stakes at the big tables. Perhaps, with its strong insight into the Chinese business and political world, Softbank is anticipating that more funds will be made available – which they want to be able to take advantage.

Or perhaps Softbank was tapped to be the buyer, but not the ultimate buyer. After all, who is lending them the $31 billion to close the deal? Especially when they can’t come close to servicing their current debt load. 

The Chinese banks have the money.

Softbank will earn a lot of political credits for doing the Chinese government a favor in its effort to ramp-up a semiconductor company.

Don’t be surprised if we see an announcement in a year or two that ARMH is up for sale and the buyer is a major Chinese company.

This was a brilliant move by the Chinese. They are making a play to buy the most important company in the world.

It is a death-blow to Taiwan. Literally. 

If ARMH goes to China, Taiwan’s semiconductor economy will rapidly unwind because China will have all the leverage to force more on-shoring (domestic business.)

How to play this: This deal likely won’t happen. Far too many players in the ecosystem want to block it.  While ARMH is based in the U.K., Silicon Valley has a strong and vocal lobbying group.  And given the impact on Taiwan’s future, perhaps the Ambassador to the U.K. is meeting with his counterparts to review the deal. (Which will be interesting in and of itself – whose leverage is strongest with the U.K.)

This sets up two possible and opposing scenarios:

1) ARMH price drops because the deal gets blocked. Or;

2) ARMH price surges because a competing offer gets placed.

Personally, I am selling and booking profits now.  Any counter-offer will be only slightly above Softbank’s whereas there is a real risk of watching the whole deal fall apart.

KEY POINT: China is making a stealth play for ARMH – one of the most important companies in the world. It is using SoftBank as a proxy to catch up to its Asian neighbors – Taiwan and South Korea – to compete in the semiconductor industry. Don’t be surprised if ARMH is up for sale in the next two years… and a Chinese company sweeps it up. But it is also likely that the deal won’t go through in the first place. Too many “players” are at risk if the Chinese get hold of ARMH.


Andrew Zatlin

Editor of Moneyball Economics

The Consumer is Weak… But You’d Never Know

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The Consumer is Weak… But You’d Never Know

If Retail sales are a proxy for consumer spending, then it’s being overstated.

Not by a little… but by a lot.

Retail Sales figures are mistakenly including a thick slice of non-retail corporate business.

You see, non-store online retail sales (aka Amazon) began to accelerate in July. Meanwhile, big-box (aka Nordstrom and Macy’s) store sales fell.

The casual reader would assume that this was just another step in the cannabilization of brick-and-mortar stores.  From one pocket to the other.

But something much different is taking place. Retail sales include Amazon.

Instead of swapping one sales channel for the other… they’re mixing apples-and-oranges.

Consider Amazon’s cloud services business (Amazon Web Services or AWS.)

Thanks to achieving the highest level of federal security clearance, AWS has picked up over 2,300 government agencies using its cloud services. Amazon’s AWS business is increasing its share of the government’s $70 billion annual budget for IT spending.

On top of that, there is the basic business use of the AWS offerings.

Business is booming:


Amazon’s AWS sales (monthly avg.)

2013:  $260 million

2014:  $390 million

2015:  $650 million

2016 (Q1): $900 million

Amazon is on track to do about $12 billion in annual cloud services – $5 billion more than last year.

That is likely being included in Retail sales, although it is essentially government and business spending.

Now factor in Microsoft’s cloud service sales (approximately $3 billion per year).

You can see Amazon and Microsoft are distorting the retail sales figures.

Retail vs Nonstore

Simply remove non-store sales from retail spending and the annual growth in spending falls from 2.5% to 1%.

However, it’s impossible to really isolate out how much cloud services contribute to non-store retail sales. The Census Bureau only goes by a company’s reporting. So if the Census Bureau includes Amazon in the survey, they’re surely including its AWS revenues. (Its probably safe to say Amazon is included considering its the biggest contributor to U.S. non-store retail. And today, all retailers now have a strong online presence while mobile shopping is no longer a novelty number.)

Based on this adjustment, the already mild consumer spending growth is barely positive.

To net it out, the addition of Amazon and Microsoft’s cloud services overstates the consumer spending numbers… by billions of dollars.

Lots of retailers cater to both business and consumers: Costco, Office Depot, and so on.

But very few have added ~$5 billion in annual revenue that is essentially corporate spending on IT.

With U.S. gross domestic product (GDP) and retail spending already anemic, any interest rate increase or uptick in inflation will significantly hurt consumer spending. 

KEY POINT: The consumer is weaker than reported. They’re not spending as much as perceived. Once consumer spending contracts (which we see it’s beginning to), businesses will forego investments. And even cut jobs. We’re close to that inflection point. A main reason it hasn’t happened already is because retail sales include “cloud services.”


Andrew Zatlin

Editor of Moneyball Economics

A Framework for 2016 Global Macro

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“I call China the mystery meat of emerging-market countries. Nobody knows what’s there and there’s a little bit of bologna.” -Bill Gross, 2014



The story of 2015 and 2016 has been about discovering genuine physical demand.

China Domestic Demand and the Global Supply Chain

Everything you want to know about macro today is in the iron ore import chart above.

  • Severe Global Excess Factory Capacity: Factory capacity has been built for a Chinese demand that never existed. For years China was on a super cycle of infrastructure build-out that drove domestic consumption of commodities like iron. Eventually speculation took hold and commodities were ironore2imported and stockpiled, simply on the assumption that prices would continue to rise. Cheap credit fueled the speculation. When the real demand was exposed in 2014, commodity prices collapsed. 2016 global demand growth won’t mop up the excess capacity.
  • Lunar New Year Distortion: A boom followed by bust. Every year factories race to complete work before the holiday shut down.
  • Short-Term Bounce: The bump in production is not sustained.

The basic message is this: China marginal demand sits at the epicenter of the global supply chain and macro. It’s sending some false signals.


Discount recent rebounds in commodity prices.

Stability: Not a Rebound or Recovery

key point 1

A frequent theme on recent earnings calls is a lack of clarity about Chinese demand. Depending on the expectation (aka hope) of a return of Chinese domestic demand growth, most companies are guiding for stability (aka no more contraction) or even 2H growth.


In 1Q, three waves combined to create the illusion of rising demand:

  • Wave #1: Lunar New Year
  • Wave #2: Inventory Restocking
  • Wave #3: Central Government Budget Cycle

Lunar New Year Calendar: The global supply chain follows a basic rhythm. Factories ramp up in the 2Q to produce and ship product to get on the shelves in time for 3Q back-to-school and 4Q holiday shopping. More recently, the importance of China in the supply chain is reflected in the way the Chinese Lunar New Year shifts the production cycle.

A lot of factory activity gets pulled into January in advance of the long holiday in February. Even March is somewhat distorted by the January/February gyrations. It isn’t until April that underlying trends re-assert themselves.

Inventory Restocking: 4Q 2015 saw a lot of inventory drawdown. Part end-of-the-year window dressing and part genuine drop in demand. Some inventory rebuilding is underway.

Central Government Budget Cycle: April kicks off the Central Government’s fiscal year. Speculators jumped into the market in March in anticipation of strong infrastructure stimulus. They have good reason to be hopeful: government stimulus has been surging. According to the People’s Bank of China, government spending in March surged 20% month-over-month.

Speculative demand outpaces physical demand… again.

Speculation frenzy has returned and is turbo-charged. Iron ore prices are up 50% since December. According to Hudson Lockett (reported by the Financial Times), trading on the Shanghai exchange for steel rebar futures hit 1.3 billion tons, enough to build 178K Eiffel Towers.

Again, in response to the fake demand, Chinese factories are ramping up production. The macro signal distortion hits everyone. Australia is enjoying the increase in prices and ore shipments.

It won’t last. Short-term stimulus only goes so far. Chinese steel production vastly exceeds domestic demand, and the US has already signaled that it won’t be a dumping ground for the surplus. Plus, the government lacks the ability to create big-ticket infrastructure projects to soak up the excess. The days of big dams are over.

By the 3Q, surplus inventories will again lead to price drops.

Most Companies Not Buying the China Bump

US companies are discounting the recent bump in Chinese demand.

Most industrial companies are waiting to see if the China story has legs. That wait-and-see attitude seems appropriate. Recently released data from China shows stimulus over, the impact is already fading.

  • China Manufacturing PMI fell from 50.2 in March to 50.1 in April.
  • China Non-Manufacturing PMI fell from 53.8 in March to 53.5 in April.

Plus they aren’t seeing any relief in the form of US demand:

  • US ISM fell from 51.8 in March to 50.8 in April.

Service Sector: Lower Costs Today, Lower Sales Tomorrow?

Everybody knows that the US industrial sector is in trouble. The question is when the service sector will slide.

The impact of commodity deflation can’t be overstated. In the US economy, 70% of all goods are shipped by trucks. That’s the mechanism by which fuel costs get translated into lower costs for restaurants and hotels and other service industry participants. Service sector margins have been strong.

On top of that, topline growth has remained stable thanks to the consumer sentiment aspects of deflation. But that’s reversing: deflation has ended, and it will sour consumer spending and cut margins. That always leads to layoffs.

Consumer Spending and Inflation


Commodity disinflation was bound to end. Some uptick in inflation is in the cards, even if Chinese over-production edges it down again over the summer.

The impact on CPI is slight when compared to the massive Obamacare- and rent-triggered inflation.

But the impact on consumer sentiment is huge. Like a frog in a frying pan, households are conditioned to expect healthcare inflation. Yet they have only recently started to expect deflation in commodities. As that reverses, consumer spending will slow down.

key points 2