Markets have no memory. So once again they are rallying based on false hopes that central bankers will save them from themselves.
Despite a stealth bear market in many stocks, the major indices have recovered all of their 2015 losses in October. They've been boosted by several factors – large cap tech stocks, expectations for a delay in Fed tightening, more European QE, and further interest rate cuts by an increasingly desperate China… Such are the stuff that dreams are made of in the terminal stages of one of the biggest bull markets in history.
As I've written before, I believe that bull market is over and we are now likely entering a bear market. There are too many macroeconomic headwinds to sustain further stock market gains. The Chinese economic miracle is over. Commodity prices are not going to recover any time soon (indeed, while stocks were rising last week, oil prices were dropping again).
U.S. economic growth remains tepid while the rest of the world is downright weak. And the geopolitical situation continues to fracture while America is facing a highly divisive election. We could end up electing either a far left liberal, hell-bent on spending the country deeper into insolvency, or a wild card Republican whose sheer unpredictability could scare the bejesus out of markets.
Bloated Large Caps Buoy The Indices
With the exception of large tech stocks and McDonald's Corp. (NYSE: MCD), third quarter earnings have been disappointing. But in a world dominated by cap-weighted indexes and central banks promising more goodies, all it took was great earnings reports from Microsoft Corp. (Nasdaq: MSFT), Amazon.com Inc. (Nasdaq: AMZN), and Google – now Alphabet Inc. (Nasdaq: GOOG, GOOGL) – to move the market higher. These three behemoths alone were responsible for half of the S&P 500's 1.1% gain on Friday.
Overall, the S&P 500 added 2.1%, or 42 points, last week, to move back into positive territory for the year at 2,075.15. The Dow Jones Industrial Average jumped 2.5%, or 431 points, to 17,646.70. And the Nasdaq Composite Index, home to these tech giants, soared by 3% to 5,031.86.
Away from technology, however, earnings were generally poor with energy companies and terminal underperformer CAT coming up short again.
Credit spreads have rallied along with the market but remain much wider on the year. The average yield and spread on the Barclays High Yield Bond Index have rallied by roughly 50 basis points in October – suggesting that investors' risk appetites have increased again. There has, however, been little improvement in actual credit conditions.
The troubled energy sector has seen an increasing number of defaults due to distressed debt exchanges and the overall default rate continues to creep up. The two big high yield bonds ETFs – iShares iBoxx $ High Yid Corp Bond (NYSE: HYG) and SPDR Barclays Capital High Yield Bnd (NYSE: JNK) – saw huge inflows last week after months of outflows and losses. The sector remains vulnerable to further declines if the economy doesn't improve in the months ahead.
A Pharma Failure Shows Wall Street's Sickness
I spent much of the week writing about Valeant Pharmaceuticals Intl. Inc. (NYSE: VRX) for Sure Money. VRX has come under pressure for its predatory business model of buying other drug companies using huge amounts of debt, firing their workers and raising their drug prices. The stock had dropped from its all-time high of $263 per share last summer to $164 last Friday.
On Monday, I warned that VRX could hit $100 per share and by mid-week. And that's just what happened after Citron Research, a short-focused publisher, issued a research report questioning the company's sales practices. Citron revealed that the company was selling product to an affiliated pharmacy company that it had not previously disclosed, raising questions about VRX's disclosures and financial results.
The stock ended the week at $116 per share after the company announced that it will hold a press conference on Monday morning at 8am New York time to try to clarify matters.
VRX is interesting in itself, but it is worth paying attention primarily for what it teaches us about how poisonous Wall Street and the financial media can be. Part of the reason VRX had been successful was that it convinced Wall Street that pharmaceutical R&D is wasteful.
Unlike other drug companies that spend 15% to 20% of revenue on research, VRX only spends 3% and considers this a necessary evil. Instead, it would rather buy old drugs and raise their prices. It has raised prices by an average of 66% per year over the last five years.
The fact that Wall Street analysts and hedge funds bought into this illustrates their moral obliquity. Lest they forget, they or their loved ones may themselves someday require these same drugs to survive life threatening illnesses.
It is downright disgraceful that VRX was celebrated in the media and the markets when it was preying on the weakest among us – people who are suffering from serious illnesses. The fact that much of the cost of these medicines is paid by insurance companies and the government doesn't absolve them.
In the end, those costs are passed through to the American consumers and taxpayers. Watching corporate executives and hedge fund managers enrich themselves in such a manner is simply disgusting.
The company has already announced that it will stop raising prices by such large amounts in the future, which raises questions about its business model. Investors should avoid VRX (or sell it short). This story isn't over and it isn't going to end well for the company and its fat cat shareholders.
About the Author
Prominent money manager. Has built top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.