Despite heroic profits reported by two of the FANGs – Facebook, Inc. (Nasdaq: FB) and Amazon.com, Inc. (Nasdaq: AMZN) – stocks had a very rough week.
The Dow Jones Industrial Average fell 230 points or 1.28% to 17,773.64 while the S&P 500 lost 26 points of 1.26% to 2065.30. The Nasdaq Composite Index lost 2.67% to 4775.36 as Facebook and Amazon sucked the air and much of the profitability out of the room in the technology sector.
The other half of the FANGs, Apple, Inc. (Nasdaq: AAPL) and Alphabet Inc. (Nasdaq: GOOGL), took it on the chin after disappointing investors, and Apple in particular is struggling with the laws of large numbers, a phenomenon that Amazon and Facebook will eventually have to deal with.
The overall market is still very expensive and three of the four FANGs (other than AAPL) remain in a bubble.
But here's what I really want to talk to you about today…
Why the Dollar and Oil Are Rising Together
But the real story over the first four months of the year was the pullback in the U.S. dollar and the recovery in oil prices from their lows. The U.S. Dollar Index hit 93 this week, down from 98.85 at the beginning of the year. The drop in the dollar was a major contributor to higher oil prices (remember oil is traded in dollars around the world). West Texas Intermediate (WTI) crude closed the week at $45.99/barrel, up sharply from the mid-$20s earlier this year. This rally is far from enough to save the many oil and gas companies that filed for bankruptcy in the United States (60 and counting) and the many more that will, but it is better than a poke in the eye.
The question, of course, is whether the rally will continue. The answer to that question largely depends on what happens to the dollar. Higher oil prices will lead to more production. The next leg in any sustained rally will require additional dollar weakness.
Of course, the dollar weakened this year because the Fed is weak – weak in mind, weak in will, weak in intellect, and weak in character. Janet Yellen and her confederacy of dunces refuse to normalize interest rates because they painted our economy into a trap. Every level of our economy is buried in too much debt – both the public and private sector.
No doubt higher interest rates will cause problems for overleveraged governments, businesses and consumers. But leaving interest rates at near zero encourages capital to be misallocated to unproductive activities such as consumption, housing, ill-advised M&A transactions that temporarily enrich short-term oriented shareholders and executives, overpriced stock buybacks, and other forms of speculation that do nothing to enhance the productive capacity of the economy.
The Central Bank's Just Aren't "Getting It"
Further, low interest rates do not lead economic actors to spend more money like the Fed's models forecast, but instead cause them to act more cautiously and save. In sum, current policy backfires and produces slower growth and more debt. It must be reversed even though it will cause some short-term pain because that is the only way to produce better long-term results.
But we must take the world as it is, not as we would like it to be. And the world as it is features a feckless Fed that is not going to raise rates aggressively. At most we may see one interest rate hike this year. Investors are foolishly rooting for the Fed and other central banks to chicken out and do nothing. The reaction last week to the Bank of Japan's decision not to take addition action to lower interest rates further below zero is a case in point – markets sold off. Markets want central banks to take additional easing measures even though they aren't working. They should be careful what they wish for.
Central banks lowering interest rates (which in Europe and Japan means lowering them further below zero) and buying assets (which in Europe means buying corporate bonds and in Japan means buying equities) is destroying normal market functions.
The normal functioning of government and corporate bond markets in Europe and Japan has been destroyed by central banks buying trillions of dollars of bonds. These markets no longer send meaningful pricing signals and have no liquidity.
While their influence on equity markets is less direct, sooner or later central banks will corrupt these markets as well. We clearly have a bond bubble around the world (including the U.S.) as a result of central banks buying trillions of dollars of government bonds in their QE programs.
If central banks start buying more equities, we could see a similar phenomenon in stock markets. We know that some central banks like the Swiss own large amounts of stocks like Apple, Inc. (Nasdaq: AAPL). The Bank of Japan owns large chunks of the Japanese stock market. If these practices spread, markets could become even more distorted than they already are. Stock prices might stay high, but at what cost?
Central banks aren't solving the problem of slow economic growth by engaging in these practices – they are corrupting markets and making things worse. They need to stop.
A Quick Word About Our Winning Short
Valeant Pharmaceuticals International Ltd. (NYSE: VRX) finally filed its year-end financials on Friday. As expected, the report revealed a company with serious problems.
In addition to disclosing that two more states are investigating its unsavory business practices, it revealed an even more leveraged balance sheet than expected. The company lost more money in the fourth quarter of 2015 than previously disclosed and reported higher amounts of goodwill and intangible assets than expected.
Valeant is a house of cards that its new CEO, who broke his contract with his previous employer to join the company, will not be able to fix. VRX shares dropped after the report was released
and I believe it is going lower as the company struggles to stay alive.
Investors should buy long-dated puts as a low-risk way to profit from this company's financial and moral carnage.
Michael's Valeant Pharmaceuticals shorts have returned more than 700% to date, and he's planning more. To get in on them, click here to be subscribed to Michael's Sure Money Investor service. Twice each week, he'll tell you what's headed up and what's headed down, and how to make money on both. You'll also get his latest investor briefing on how to profit from "toxic stocks."
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.