The stock market rally faltered last week as signs of economic weakness shook the resolve of the bulls.
The Dow Jones Industrial Average dropped 33 points, or 0.2% to 17,740.63, while the S&P 500 fell eight points, or 0.4% to 2,057.14. The Nasdaq Composite Index fell 0.8% to 4,736.16.
More telling, after a disappointing 160,000 new jobs were added to the economy in April, the yield on the benchmark 10-year Treasury closed the week back down to 1.78%.
The U.S. economy has produced new jobs at a 192,000 per-month clip in 2016, down from 2015's average of 229,000.
This is not the stuff that dreams are made of, and in fact, it's about to get a whole lot worse…
Debt and Overregulation Are Choking Growth
The debt burden is well-known, but less publicized is the regulatory burden that makes it more difficult for businesses to grow.
Last week, the Competitive Enterprise Institute released its annual report card on federal regulation and the results were nothing less than appalling: Beltway rules imposed $1.9 trillion of annual costs on American businesses last year. Coupled with sluggish wage growth and rising healthcare costs, it is little wonder that Donald Trump's incoherent bluster resonated with voters feeling increasingly disenfranchised by their government.
The real message from the jobs report was that the Fed is not going to raise interest rates for a very long time. I have been maintaining that the Fed will at most raise rates once this year.
The Fed added propping up stock prices to its twin mandates of price stability and full employment based on a flawed assumption that high stock prices would lead to higher spending and economic growth.
That hasn't happened – there was no reason to think it would outside the textbooks that guide economics professors – and these policies leave us with over-inflated stock prices and trillions of dollars of debt borrowed by corporations to prop them up through ill-advised stock buybacks and dividend increases.
Remember, the so-called huge amount of cash on which U.S. companies are sitting is concentrated among a small number of large companies, like Apple Inc. (Nasdaq: AAPL) and Microsoft Corp. (Nasdaq: MSFT), while the vast majority of U.S. companies today are highly leveraged and generating insufficient levels of cash flow to service their debt.
This is why the recent rally in the high-yield bond market is a trap that should be avoided at all costs by investors interested in avoiding losses as the corporate default rate sharply rises over the next two to three years.
That's not the only trap out there right now, though.
Commonwealth of Crippling Debt
We also have the sad and stupid case of Puerto Rico, which last week started the first in what will be a series of defaults on various pieces of its $72 billion of debt (which doesn't include the $40 billion of future pension obligations it can never hope to pay).
While Congress fiddles over a plan to help the island, the island burns. The truth is that those investors dumb enough to own Puerto Rican debt do not deserve one whit of sympathy or relief from U.S. taxpayers for their plight.
Puerto Rico's insolvency was one of the worst-kept secrets in the municipal bond (muni) market for the last few years. Municipal bonds require very little skill or knowledge to manage; anyone who pays a manager more than a couple of basis points to invest his/her money in municipal bonds is throwing money down the rat hole.
If your manager bought you Puerto Rican debt at par, you should fire them and then sue them. But the one thing you should not expect is a bailout from the U.S. government. Something on the order of $50 billon of the $72 billon of the island's aggregate debt needs to be written off to fix the problem, coupled with radical pro-growth reforms.
Anything else is a political sideshow and total waste of time. Sure, distressed investors will fight over the scraps but that will do nothing to help Puerto Rico have a chance for a viable economic future.
And worse, Puerto Rico is only a preview of coming attractions in Illinois (particularly Chicago) Atlantic City, N.J., and other cities and states that spent and borrowed themselves into insolvency.
Finally, two investors speaking at different conferences last week demonstrated just how much of a bubble mentality still exists in today's markets…
The Big Difference Between Apple and Amazon Stock
At the Ira Sohn Conference in New York, Chamath Palihapitiya of Social Capital argued that Amazon is headed toward becoming a $3 trillion company, ten times its current market cap, by 2025, while analyst Robert Luna told investors that Amazon stock is headed to $1,000 a share by the end of 2017.
The latter is at least plausible (though it would render the company absurdly overvalued) while the $3 trillion number is ludicrous.
These bursts of hysteria were triggered by Amazon's impressive first quarter profit, which was largely driven by the company's cloud storage business that is going to face shrinking margins in the years ahead.
Among other things, these enthusiasts ignore the lesson of large numbers that investors are currently learning about Apple.
You see, it wasn't long ago that similar things were being said about Apple becoming the first $1 trillion company.
When companies get that big, the revenues and earnings they need to generate to move the needle and maintain their valuations are enormous and increasingly difficult to maintain. Just as Apple is finding it virtually impossible to maintain its phenomenal growth rate, Amazon will no doubt do the same.
There is one difference, however, that flashes a bigger warning sign for Amazon than Apple: Apple has never been an expensive stock. When you back out its huge cash hoard, it trades for under 10 times earnings.
Amazon, on the other hand, trades for over 100 times earnings and has much thinner margins than Apple, as it is primarily a distribution company rather than a manufacturer of high margin must-have consumer goods. That suggests that the road ahead for Amazon should be harder than it was for Apple.
Investors should ignore these modern-day P.T. Barnums and avoid Amazon's ridiculously expensive stock.
Investing legend Stanley Druckenmiller offered the wisest advice at the Sohn Conference: Sell your stocks and buy gold.
Readers of my columns know, like Mr. Druckenmiller, that central bankers have destroyed the financial world – it is only a matter of time before investors figure that out and react.
The world's economies are quite literally borrowing themselves to death right now. Growth is being crushed by debt on all fronts, but Wall Street and the press are ignoring it.
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.