Hussman Economics has some nice succient points on CASH FLOW and it's different variations at the end of this missive, Thanks to George Cole for posting.
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Hussman Economics:
The Market Climate remains on a Warning condition. The simplest way to change this would be for the S&P 500 to advance by about 3% further on a
weekly closing basis, without any fresh breakdowns in other internals. Bond market action has been quite threatening in this regard, but we still have not
had enough negative action there to prevent a positive shift in our measures of trend uniformity.
I want to emphasize that a positive shift in trend uniformity would not be a signal that stocks are a "value." Favorable trend uniformity implies only that
risk premiums are in a persistent and relatively robust downtrend. This has nothing to do with value. A favorable shift would imply only that investors
had become sufficiently attracted to risk-taking that their preference should not be fought aggressively. It would not be a signal that stocks have
investment merit, in the sense of prices being reasonable in relation to the present discounted value of future cash flows. Rather, favorable trend
uniformity speaks only to speculative merit - the likelihood of positive average market returns driven by falling risk premiums.
The goal of our approach is not to time or forecast the market, nor to generate "buy signals" and "sell signals", nor to catch bottoms or tops. Quite simply,
we believe that there are several identifiable Market Climates, and that each Climate is associated with a particular probability distribution (or "bell curve")
of market returns - some positive, some negative. Our only interest is the average expected return/risk of each particular Climate. We believe that the
average return to market risk varies significantly across Climates, but that it is impossible to predict whether the next move will be a rally or a decline. This
is where we differ from market timers.
Again, shifts in the Market Climate are not forecasts about future returns, except in the broadest terms of average return to market risk. A positive shift in
trend uniformity, if it occurs, should not be confused with a forecast that the market will go higher immediately following the signal, or that any particularly
important low has been registered. A positive Market Climate says nothing except that the average return to market risk tends to be favorable while that
Climate is in effect. We make absolutely no forecast as to how long a given Climate will persist, when it will shift, or whether the next specific move will be
up or down.
For purposes of our investment stance, the Market Climate remains in the most negative possible condition here and now, and we remain fully hedged at
present.
Among the most interesting aspects of market action, I continue to be struck by the failure of trading volume to confirm what we're seeing in price action.
Stocks that rally tend to be on lighter volume, produced by thin but very eager buying, combined with a backing away by sellers. This is "short squeeze"
type action. In contrast, stocks that decline tend to be on heavy volume, which smacks of "distribution" by large interests.
This pattern seems to be confirmed by the sentiment figures. The latest survey of the American Association of Individual Investors shows just 15.6% of
these investors bearish. In contrast, Vickers reports a sharp spike in recent sales by corporate insiders, with sells outpacing buys by over 3-to-1. Mark
Hulbert of the Hulbert Financial Digest reports that the top risk-adjusted market timers over any time frame are uniformly bearish here. This contrasts with
Investors Intelligence figures that show a much smaller overall level of advisory bearishness, at just 29.2%. Finally, the CBOE volatility index has declined
to just 21.6%, a level of complacency among options traders that has typically marked intermediate tops in the market. In short, there is a clear contrast
between investor groups that are buying and those that are selling, and the ones with the best records are on the sell side.
None of this will prevent us from becoming constructive if the Market Climate shifts to a positive condition, but it does feed into the amount of market risk
we would be willing to take, particularly with valuations still extreme.
As for fundamentals, I have a built-in aversion to saying "this time it's different." That said, with regard to the economy, this time it's different. That opinion
doesn't affect our investment position, but I do find it disturbing that investors, economists, and politicians are all so eager to call the recession over.
Frankly, I think that the current bounce is a misleading calm before the storm, much as the strikingly short 1980 recession was. That recession, you may
recall, was over within 6 months. Between the end of the recession in mid-1980 and November of that year, the Dow advanced about 6%, and that was the
end of it. Stocks turned back down, and within 12 months, the U.S. was in a new, separately identified recession - one of the worst economic downturns
since the Depression.
The failure of the 1980 recovery was certainly not predictable from the Purchasing Managers Index, which had soared from 29.4 in May to 58.2 in
November 1980, while the New Orders Index surged from 25.6 to 65.3. Consumer confidence had soared from 50.1 to 87.2 in the same time span. The
telltale warnings in 1980 were the failure of capacity utilization to surge higher, as it typically does after recessions, while the Help Wanted Advertising
Index also stalled, increasing only from 76 to 84. Both of these failures were informative - one indicated an excess of capacity leading to a lack of strength
in capital spending. The other indicated a lack of underlying hiring interest, driven by strong downward pressure on profit margins and a reluctance to
increase payroll costs. Needless to say, both capacity use and the Help Wanted Index are worth watching here.
I note in passing that January Capacity Utilization came in at 74.2%, down from 74.4 in December. The January Help Wanted Index came in at just 47 - a
negligible change from the deep trough of 45 in November. In this light, one also has to interpret the recent employment figures with skepticism. This is
particularly true given that the Labor Department still adjusted January and February employment numbers strongly higher, even though unseasonably
warm weather argues that these upward seasonal adjustments were unnecessary.
On the subject of accounting, I notice the phrase "cash flow" being discussed more often by guest analysts on CNBC and the like. Unfortunately, this is
almost entirely lip-service. The focus remains squarely on operating earnings, and when cash flow is discussed, it is painfully clear that these people have
no idea what they're talking about.
Probably the best examples are the ridiculous assertions by various companies, including General Electric, that "the quality of our earnings is supported by
our cash flow", and that "Cash is cash. You can't lie about cash."
Look. There is a difference between the cash position of a company, and the cash flow of a company. The cash position is cash on hand, in the bank.
And yeah, you can't really lie about that unless, you're actually lying about it. But "cash flow" is not the change in the cash position. Cash flow is simply
earnings, adding back depreciation and amortization. "Operating cash flow" or EBITDA also adds back interest expenses and taxes while excluding
extraordinary charges. If earnings are misrepresented, it invariably follows that cash flow is being misrepresented.
If you look at the Statement of Cash Flows in any annual report, you'll see three sets of numbers: Operating Activities, Financing Activities, and Investment
Activities. This is where the rubber meets the road. As long as you can classify certain costs as "investments" rather than expensing them, you can keep
them from reducing your operating cash flow, and of course, boost your operating earnings as well. Meanwhile, debt service shows up in the financing
activities, so the more debt you take on, the more you can mislead shareholders by reporting huge operating cash flow (EBITDA) that is actually the
property of bondholders. A stock is not a claim on EBITDA. It's a claim on free cash flows that can actually be delivered to shareholders after all other
claims have been discharged, such as debt service and investment to replace depreciation and provide for growth.
Of course, it's common practice to mislead investors by focusing on operating earnings. But this is a regulatory, accounting, and ethical lapse. Common
practice doesn't make it proper or informative. When investors allow incentives such as stock options that compensate executives for managing earnings
announcements rather than compensating them for delivering free cash flow to shareholders, what can they expect? We routinely vote against such
programs when they are presented on proxy ballots. Employee stock purchase programs (say, at a 15% discount from market value) are a reasonable
employment perk. Stock options are a different matter, particularly when managements simply lower their strike prices if the stock price declines. This is a
"heads I win, tails you lose" game against shareholders.
I visited the local Barnes & Noble over the weekend. At the bottom of one of the shelves, I noticed an audiobook copy of "Investing for Dummies", loosely
covered in half-torn shrink wrap. Curious, I peeked inside and discovered that one of the tapes had been stolen. Apparently, the thief failed to notice that it
was a two-tape set.
One has to wonder what kind of desperation would lead someone to steal "Investing for Dummies." But it's clearly a sign of the times. |
