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DANGER AHEAD: Wall Street / Main Street Pattern Shifts by Lynette Zang

Blog Apr 4, 2018

This year started out with a bang as stock markets hit historic highs and became the most expensive stock market in history. More expensive than 1929 and more expensive than 1999. Most people believed the central banks had the markets backs. I suppose they didn’t believe the bankers when they said it was time to remove a tiny bit of “accommodation.”

There were signs (pattern shifts) that things were shifting; extreme levels of insider selling, flattening of the yield curve, federal reserve raising rates and slowing dividend and principal reinvestment into treasuries etc. But the markets zoomed on with nary a 1% decline.

Tax cuts almost guaranteed the appearance of 20% earnings gains for wall street and corporations have announced a tsunami of stock buybacks with all the repatriated cash coming back. That should hide how over-valued stocks are, at least for a while.

Then the correction began. Is this the big collapse we’ve been waiting for? Only time will tell us for sure, but there are significant pattern shifts occurring that could be warning of danger ahead.

Here are just a few.

How Wall Street (Banks) Invents Market Value and Gets Main Street to Buy-in

Wall street propagates the myth that losses have nothing to do with company valuations. This gave birth to “Unicorns.” Companies with expected losses well into the future that have extremely high market valuations. If they say it, you will believe. Spotify is one such unicorn.

As a global music streaming company Spotify dominates that space. Apple is a deep pocketed competitor, but Spotify seems to be a venture capitalist favorite with funding rounds that began in 2008. In March 2016 they raised $1 billion in a convertible bond offering funded by TPG, Dragoneer and Goldman Sachs. I wonder who wrote the bond contract?

They must have really needed the money since the terms were very aggressive. The coupon on debt started at 5%, but then went up 1% EVERY SIX MONTHS until they list their stock on a trading exchange (Interest caps at 10%). In addition, the bonds are convertible into stocks STARTING at a 20% discount to the IPO price. This percentage increases by 2.5% EVERY SIX MONTHS after the first year, until it goes public. That means that after March 31, 2018 the interest rate would reset to 7% and the discount to IPO price would be 25%.

In September, based on private stock trading, the market value was $8.8 Billion ($50 per share).  In December, in a private transaction, Tencent bought shares that then valued Spotify at $20 billion ($115 per share). On May 3rd, Spotify did a direct listing on the NYSE. The first share traded at $165.90 which would put the market value above $29 Billion!

Now let’s look a little deeper. Spotify has not been profitable yet. Nor can anyone anticipate when they might become profitable. Interestingly, they did a direct listing because they said they did not need funding, so this was likely a way to provide access to main street.

I also find their timing interesting. Direct listing is a much faster way to go public, so it would seem that they would list PRIOR to March 31st when they would have locked in 6% interest and given a 22.5% discount to the IPO price. Wonder who negotiated that?

After March 31st the terms would remain intact for another six months. Perhaps the markets would resume their rise. Or perhaps they thought that the markets were turning unfriendly to unicorns so it was now or never.

Risk Shift Completing

Of course, in any market where there are sellers, there must be buyers. Wall street insiders have been and continue to be, big sellers. Typically, that would drive prices down, but is easily covered up by corporate buybacks. In fact, thanks to the repatriation, announced corporate buybacks have hit $82 Billion, a historic high. We’ll have to see if companies follow through with their plans, but just the announcement can influence market moves.

Looking back at announced vs. actual buybacks an interesting pattern emerges. Since 1997, in most cases, market breakdowns were anticipated by less actual buybacks than were announced. That holds true in 2004, when leverage rules were loosened and 2007 as the subprime derivative market began to unravel. Since 2013 there have been three times when announced buybacks have been higher than actual buybacks, the last time was 2017.

Today, volatility is back as markets struggle to find firm footing.

Listening to Wall Street, this is a buying opportunity. But financial elites are not buying so who is? According to a CNBC “All America Survey”, mom and pop hold wealth in the markets and that began spiking during the “Trump Rally”.

Insiders out, mom and pop in. We all know who is NOT too big to fail.

So what is causing all this turmoil? There are so many these days, but one reason is the threat of a trade war with china. President Trump has threated tariffs.

China Announces Retaliation, Markets Respond

The threat of a trade war threatens corporate profits and wall street does not like this at all. Because even though Unicorns do not need profits, the rest of wall street does. Trade wars could hurt profits.

All major markets are breaking down and no stock is immune. Both the S&P and the Dow Jones have now broken below their 200-day moving average and the 50 day moving average has turned down. Both indicators are telling us that it is most likely that more pain lies ahead.

Today China announced additional retaliation and US stocks plunged on the open for yet another volatile day. Where can we find safety in this storm?

How Some Safe Haven Assets Respond

Typically the US dollar and US Treasuries are considered safe, but with lower highs and lower lows, they are both in negative trends. But spot gold is in a positive trend with higher lows and higher highs. Spot gold is just a wall street product too and much unloved to boot, but it would not be moving up without heavy buying since the main focus of the central bankers is to hold its market price down. In the short term there is resistance at $1,360.

Of course, that does not reflect its fundamental value, which is way north of $9,000 an ounce at this writing, you’ll likely have to hold the physical and be a bit more patient for that. But if this is start of the final market collapse, hold physical gold and silver in your hands is the safest place you can be.

Slides and Links:

 

 

http://fortune.com/2017/07/31/spotify-ipo-direct-listing-2/

https://www.wsj.com/articles/spotify-rule-would-help-new-york-stock-exchange-woo-unicorns-1495791000

https://techcrunch.com/2018/02/28/heres-what-spotify-shares-will-be-worth-when-they-start-trading/

http://money.cnn.com/2018/03/29/investing/spotify-ipo-valuation/index.html

http://fortune.com/2017/04/07/spotify-ipo-direct-listing/

http://fortune.com/2017/07/31/spotify-ipo-direct-listing-2/

https://www.nasdaq.com/markets/ipos/company/spotify-technology-sa-967774-86175?tab=financials

https://www.musicbusinessworldwide.com/spotify-raises-1bn-convertible-debt/

https://www.cnbc.com/2018/02/27/insider-buying-not-picking-up-along-with-buybacks.html

http://money.cnn.com/2018/02/16/investing/stock-buybacks-tax-law-bonuses/index.html?iid=EL

 

https://stockcharts.com/h-sc/ui?s=compq

http://stockcharts.com/h-sc/ui

https://stockcharts.com/h-sc/ui?s=spx

https://www.voanews.com/a/china-announces-50-billion-in-retaliatory-tariffs-on-us-goods/4331805.html

https://stockcharts.com/h-sc/ui?s=Gold

https://stockcharts.com/h-sc/ui?s=usd

 

Thumbnail Photo We believe that everyone deserves a properly developed strategy for financial safety.

Lynette Zang

Chief Market Analyst, ITM Trading

Sources & References In This Article

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