Email

This Rally Is an Illusion: Two Market “Magic Tricks” Pushing Stocks Higher

10 | By Shah Gilani

Stocks have been on a tear. After looking weak in February, when the bottom could have fallen out, stocks have soared close to 13% in a matter of weeks, we’re finally here: positive for the year, above the market’s important moving averages, above resistance, and just plain sitting pretty.

So why does it all feel like a magic trick? Why isn’t the market giving investors any solid feelings? Why is everyone so nervous?

The reason it’s hard to get a handle on the market is because the old free market is gone. The free market isn’t free any more.

There are two major forces manipulating markets right now – but it’s nothing more than smoke and mirrors designed to push stocks higher and give the illusion of healthy markets.

I’ll tell you what’s going on, who’s responsible, and what you need to do now.

Let’s get started…

The Manipulation Is Worse Than You Think

Of course, any discussion of market manipulation has to begin with the Federal Reserve.

Everyone knows the Fed and other central banks have been manipulating the markets for years through artificially low interest rates, quantitative easing experiments, and more.

But here’s something you might not know…

Instead of just buying sovereign bonds, central banks now buy everything from mortgage bonds to stocks. They are even contemplating creating their own ETFs to sell to the public so they can then buy them back. Some central banks have even pushed interest rates into negative territory, which is itself proof positive they are completely out of control.

The manipulation is so deep, they’re so out on a ledge, all central banks can do to keep from losing control of markets and global economies is to keep manipulating in the desperate hope that global growth will bail them out of the holes they’ve dug for markets and themselves.

Here’s something else you probably didn’t know.

The real reason the Federal Reserve didn’t raise rates at the last FOMC meeting, even though the Fed’s all about being “data dependent” and the data they’ve been looking for to start “normalizing” rates has been filling up their inboxes, is because they ran into a big problem.

The Fed conducts its “open market operations” – all the buying and selling of securities and bonds they do – through a group of 22 primary dealers – a bunch of big banks that includes Bank of America Corp. (NYSE:BAC), JP Morgan Chase & Co. (NYSE:JPM), and The Goldman Sachs Group Inc. (NYSE:GS).

Well, last month those primary dealers got a ton of U.S. Treasury bonds dumped on them and could have lost billions of dollars if the price of those bonds tanked.

As primary dealers, they have to buy and sell Treasury bonds to maintain prices, keep markets trading, and to facilitate the Fed’s operations.

They ended up with over $121 billion in bonds last month, almost double the average of the past five years. Primary dealers had to buy those bonds mostly from foreign central banks and sovereign wealth funds who were dumping Treasuries to raise money to support their currencies, meet budgets, and liquidate assets they knew wouldn’t go down too much in price as they unloaded them.

If the Fed raised rates while its primary dealers were sitting on all those bonds, the price of those bonds would have tanked and the dealers would have lost billions in an instant. And that would have devastated the $13 trillion Treasury market.

Of course they weren’t going to let their bank constituents lose that kind of money. So they punted on raising rates.

There’s another reason the Fed didn’t raise rates… and it just happens to be the other force that’s goosing stocks at the moment.

And that’s not a coincidence.

These Numbers Are Hiding the Truth About Earnings Growth

Last week, I told you how trillions of dollars of corporate buybacks have boosted stock prices by creating the temporary illusion that earnings per share are increasing, which is what investors want to see (and is something the Fed would like to see before raising interest rates). But those gains are far too often temporary measures to manipulate stock prices higher so executives can cash out their fat options awards.

But there’s more to earnings manipulation.

There’s GAAP (Generally Accepted Accounting Principles) earnings and non-GAAP earnings.

I’m not an accountant, so I have to ask myself, and you have to ask yourself, if GAAP is based on accepted accounting principles, why would companies use non-GAAP accounting methods, which are by definition not generally accepted as being principled?

Because it makes their earnings look better…

Basically, non-GAAP accounting lets companies exclude certain losses from their accounting because they’re supposed to be one-time charges.

Most of these are related to items like costs of a merger or acquisition, restructuring charges, writing down goodwill, asset impairment charges, and other supposed one-time charges.

Of course, there’s a problem with principles when one-time charges keep recurring, as they tend to do too often under non-GAAP accounting.

The difference between GAAP and non-GAAP earnings is material.

For all of 2015, S&P 500 non-GAAP 12-month trailing earnings, also known a pro forma earnings, came in at $118. GAAP earnings, however, were $87 for 2015.

That’s a huge difference.

Looking at non-GAAP earnings, investors would say earnings have been growing nicely. The truth is that GAAP earnings in 2015, after a seven-year bull market, are only about $5 higher than what they were in 2006 before the meltdown.

This is key – because even as the Fed talks up the “recovery,” such as it is, there’s no real, principled data underpinning the surge in stocks and the supposed growth in earnings. It’s all cooked up by creative accounting – and if the Fed were to raise rates in this environment, the entire house of cards would come down.

Want more proof?

The fourth quarter of 2015 saw non-GAAP earnings of $29.49, while GAAP earnings were $19.92. If that’s not manipulation, I don’t know what is.

One Thing You Can Do Now

An increasing chorus of analysts, from Societe Generale’s Andrew Lapthorne, to Deutsche Bank’s David Bianco, to Warren Buffet in his latest Berkshire Hathaway shareholder letter, are worried about the distorted view of earnings investors are being subjected to.

It’s no wonder investors aren’t sure the market rally is real.

They should be worried – and you should be, too.

The best thing investors can do right now is to contact your broker (or hop online if you manage your own investments) and put down stops orders to get out of your winners if a reality check knocks the market back down to earth.

And since the manipulation isn’t going to stop any time soon, and the market can be manipulated even higher, enjoy the ride as long as it lasts.

In the meantime, just keep raising your stops so you can take profits when the markets head back down.

10 Responses to This Rally Is an Illusion: Two Market “Magic Tricks” Pushing Stocks Higher

  1. Phillip Gazzo says:

    Mr Sha Gilani,

    With all this MANUPILATION, is it wise to stay in the game?. I feel like picking up my ball and bat and going home… But it’s people like yourself that keep me in the game.

    Thank you for your honesty.

  2. rusty says:

    great article what is an appropriate level to set stops on big winners say +35% or more. ive already taken out 20% since the first and went to local double tax free munis and utilty funds eg. reaves and gabelli. enjoy your perspective ty for your feedback

  3. fallingman says:

    Here’s my question: If the primary dealers are buying the bonds the sovereign wealth funds are dumping, HOW MUCH of it are they buying?

    It’s hard for me to believe that hundreds of billions of bonds can be dumped and rates would actually GO DOWN without some black hole to vacuuming them up.. Lord knows, I get that the markets are manipulated, but it sure seems as if you could characterize buying by the primary dealers in the face of an onslaught of selling as “taking one for the team.” And with the volumes involved, that’d making them truly self-sacrificing.

    Yeah, right. And lawyers are humanitarians.

    But “taking one for the team” implies that they stood to lose money as they nobly provided the bids no one else would be dumb enough to provide in order to stabilize the market.

    Uh huh, so how is it that bond prices ROSE? How is it that demand somehow spontaneously and mysteriously not only rose up to meet the mountain of supply, but actually came to exceed it? Riddle me that?

    Many suspect, and I find their explanation compelling, that the only thing that can explain rising prices in the face of massive selling is buying by the Exchange Stabilization Fund, using money from a completely dark pool … a pool that was seeded from the proceeds from Roosevelt’s gold revaluation caper in 1933, a large amount that’s been compounding ever since.

    That would make it a very large slush fund … with the kind of money needed to absorb all the selling without negative impact on the markets. And that was a helluva trick to make rates DROP. It’s almost as if they’re saying, “We do do whatever we want with markets. You clowns have no idea who you’re dealing with.”

    Bottom line: I think the rigging of the markets is even more comprehensive and goes deeper than any of us can even really fathom. The whole system is ROTTEN TO THE CORE. And the only thing that’s gonna stop the rigging is a massive phase shift … from overconfidence and complacency to pure panic.

    I’m as ready as I can be for that phase shift and I’m still vulnerable as hell. We all are … but it’s coming regardless.

    Thanks for another really good article.

  4. alex avner says:

    It’s an illusion for sure, but illusions can last a long time, because they feel good. We all know the story of the king going naked while everybody was admiring his new clothes. This illusion suddenly was stopped by a child screaming “but the king is naked”. Now assume for a moment that no such child would have come. Or the child appeared and said what it sayed, but the people could have shouted him down: “what are you talking about, don’t you see the kings clothes? You’ve got an eye problem, go and see an eye doctor”.
    What in fact hampers the central banks from continuing this game endlessly? After all they don’t have to account to anybody. Sure the day will come, when the house of cards has to break. But when is that day. Could still take a while. As John Maynard Keynes had it: “Markets can stay longer irrational than you can stay solvent”.

  5. fallingman says:

    Here’s my question: If the primary dealers are buying the bonds the sovereign wealth funds are dumping, HOW MUCH of it are they buying?

    It’s hard for me to believe that hundreds of billions of bonds can be dumped and rates would actually GO DOWN without some black hole vacuuming them up.. Lord knows, I get that the markets are manipulated, but it sure seems as if you could characterize buying by the primary dealers in the face of an onslaught of selling as “taking one for the team.” And with the volumes involved, that’d making them truly self-sacrificing.

    Yeah, right. And lawyers are humanitarians.

    But “taking one for the team” implies that they stood to lose money as they nobly provided the bids no one else would be dumb enough to provide in order to stabilize the market.

    Uh huh, so how is it that bond prices ROSE? How is it that demand somehow spontaneously and mysteriously not only rose up to meet the mountain of supply, but actually came to exceed it? Riddle me that?

    Many suspect, and I find their explanation compelling, that the only thing that can explain rising prices in the face of massive selling is buying by the Exchange Stabilization Fund, using money from a completely dark pool … a pool that was seeded from the proceeds from Roosevelt’s gold revaluation caper in 1933, a large amount that’s been compounding ever since.

    That would make it a very large slush fund … with the kind of money needed to absorb all the selling without negative impact on the markets. And that was a helluva trick to make rates DROP. It’s almost as if they’re saying, “We do do whatever we want with markets. You clowns have no idea who you’re dealing with.”

    Bottom line: I think the rigging of the markets is even more comprehensive and goes deeper than any of us can even really fathom. The whole system is ROTTEN TO THE CORE. And the only thing that’s gonna stop the rigging is a massive phase shift … from overconfidence and complacency to pure panic.

    I’m as ready as I can be for that phase shift and I’m still vulnerable as hell. We all are … but it’s coming regardless.

    Thanks for another really good article.

  6. Keith says:

    It is hard to remember the old normal.

    Before 2008, we had the “wealth creators” that liked to keep all the rewards from their efforts and pass as little as possible down to employees.

    They were the cause of the boom and they deserved their rewards.

    Markets followed the activity and success of the “wealth creators”.

    After 2008, the easy profits disappeared and so did the “wealth creators”.

    Central Banks had to step into the vacuum and start printing money.

    The markets gradually lost touch with the real economy and started to follow the new “wealth creators”, the Central Banks.

    Later on bad news from the real economy became good news for the markets as the Central Banks would be engaging in new stimulus.

    The markets are now devoid of all reality are inversely proportional to the real economy.

    What was the point of it all again?

  7. Bernie B says:

    Our central bank, the fed, is owned by big banks, who even receive a dividend from their property, the fed. So will the owners of their property, the fed, allow the fed to cause them lose money? Or would you expect smoke and mirrors, for our own good, mind you, as usual. And they tell us to our face, they will devalue our currency. How? Why inflation, we must have inflation. With inflation, everything cost more because your currency is worth less than it was before. Then unions demand raises, which raises the prices, which adds to inflation. And if unions do not demand raises fast enough, no problem, the government just raises the minimum wage, which makes everything cost more, and so on.etc. And they tell us to our face, and the majority does not get it, yet. On a side note, I think Trump will somehow have a fatal accident. Too many want him out of the picture. Democrats, Republicans, the establishment, the PAC money bunch, etc.

Leave a Reply

Your email address will not be published. Required fields are marked *