The Limerick of Finance for 01/24/16

Twitter shake-up comes into our view
Different leaders must bring something new
Independence at stake
User growth hit a brake
Radical change is long overdue

The Haiku of Finance for 01/23/16

Bad money choices

Spend now what could grow later

Losers waste it all

The Haiku of Finance for 01/22/16

Resource downgrade watch
Hit energy and mining
Clobber the ratings

The Haiku of Finance for 01/21/16

Demand oil meeting
OPEC members are crying
Tiring of low price

Ultimate Lessons From JP Morgan Healthcare Conference 2016

The end of the JP Morgan Healthcare Conference invites reflection on lessons for investing. The legions of investors populating the Union Square hotels - almost all white, male, and wearing pale blue neckties - will face challenges finding value in the health care sector's long bull market. Bears have already come out of hibernation in the larger US stock market's first two weeks of 2016. They wait to pounce on the health care sector.

Investors could have thrown a dart at the universe of stocks and funds in the large-cap health care sector after 2010 and come away winners. The bull case made sense up until mid-2015. Consider the price trajectory of one very broad health care ETF, iShares Nasdaq Biotechnology ETF (ticker IBB).

iShares Nasdaq Biotechnology ETF (IBB) from Yahoo Finance

Here we see the 5-year price chart for IBB from Yahoo Finance as of January 19, 2016. Its valuation peaked in July 2015. Note that Amgen (ticker AMGN) is one of the top ten holdings. That one stock is off its 52-week high by about 17% even though Motley Fool reports that Amgen had phenomenal things to say about itself at the JP Morgan Healthcare Conference. Of course, a sector's performance is more than the financial health (pun intended) of one of its widely-held leaders.

The health care sector's long-term performance is very much dependent on the Affordable Care Act (ACA). FactCheck noted in 2014 that the ACA may be contributing to a moderation in the growth rate of per-capita health care spending. The per-capita growth since at least the 1990s has driven the profitability of drug makers and insurers, so any moderation means the sector's companies must seek more customers (i.e., plan enrollees) to sustain their earnings growth. The Economist noted in 2015 that more people are enrolled in health insurance plans even as costs per patient decline. The tradeoff of more customers for less costly coverage was always the grand bargain that the health care sector expected from the ACA to maintain its financial success.

Several CBO reports note that federal health spending continues to grow. We can find one cause for this hidden in FactCheck's 2012 discussion of cuts to growth in Medicare spending. The estimated $716B in growth savings designed to prolong the Medicare trust fund's life covers the issuance of Treasury bonds the trust fund will own. The Treasury's borrowing through such bond issuance will subsidize the ACA health plan exchanges for years. The CBO's March 2015 baseline update on the ACA's fiscal effects shows just how expensive those subsidies will become. The estimated net cost of ACA coverage, including exchange subsidies, totals over $1.2T by 2025. That total more than overtakes the original estimate of $716B Medicare savings. The ACA's effects on health care affordability are an unsustainable burden on the federal government's finances.

The ACA exchanges themselves are facing financial trouble. Premiums from healthier people are not offsetting the tax credits for poorer and sicker people. Twelve of the ACA cooperative health plans have now closed. Insolvent entities cannot continue to operate, and their closure means the surviving eleven co-ops will face more financial stress as sicker people enter their risk pools. The ACA risk corridors are underfunded. Insurers' premiums did not keep up with cost increases for those risk corridors, so either a federal bailout replenishes them or insurers raise their premiums even more. Insurers participating in ACA exchanges are facing unprofitable growth. The ACA's rules and structures force every participant in the health care sector's revenue chain - individual plan subscribers, insurers, and government transfer payment programs - to participate in an increasingly insolvent regime. The financial implications of a collapse in support for the health care sector's revenues would be disastrous for investors.

Watching The Big Short before the JP Morgan conference began offered an indirect lesson in the warning signs of an overheated sector. Only a handful of major investors anticipated the housing market's crash through 2008 by watching how adjustable-rate mortgage rates destroyed the value of pooled securities. The canary in the coal mine to watch is always whether a payment stream is sufficient to support asset valuations. Health care payments are a convoluted jumble of insurance premiums and government reimbursements. Collapsing intermediaries will obstruct such payment streams and endanger the valuation of any security tied to the health care sector. Investors will eventually have an opportunity to make their own big short in health care, much like the home mortgage big short. Analysts can someday decide which short is bigger.

Full disclosure: No positions in any securities mentioned.

The Haiku of Finance for 01/20/16

Fear drives stock selling
Oil still finding bottom price
No final crash yet

The Haiku of Finance for 01/19/16

Trust in modern life
Perverse change from ancient world
Time to change it back

A Post-Modern Interpretation Of Trustworthiness

I made my usual rounds through San Francisco's intellectual circles of influence today. One aspiring philosopher claimed that trustworthiness is the fulfillment of a promise, especially one that is in accord with publicly professed values. The naivete in that expression was striking. Life would be so much kinder if only the modern world worked that way. The real world has a different definition of trustworthiness than the one held in the effete imagination of progressives.

The classical age's virtues gave the Judeo-Christian West a baseline for understanding trustworthiness. The baseline disappeared in the modern era as a semblance of material prosperity became accessible to the uneducated, unenlightened lower classes. The most postmodern definition of trustworthiness has a different formulation from the classical understanding. In antiquity, moral actors earned trust by fulfilling duties, especially civic ones. Today, amoral actors earn trust by providing economic advantages, regardless of how said benefits are attained. Demonstrating integrity by keeping promises is not part of that equation.

Consider how modern politicians typically earn trust. Election winners promise to give their constituents free things. Greedy, selfish, stupid voters flock to the polls and hand them victories purely from self-interest. The question of trustworthiness becomes "What will you do for me?" The answer is some variation of "I will make you prosperous." How the prosperity comes is irrelevant. Voters tend not to link their personal prosperity to abstractions like the rule of law, property rights, enforceable contracts, and incorruptible regulatory bodies. The modern electorate prefers cold, hard cash. It cuts out the middleperson that way. Benefits and bailouts are the order of the day. Politicians who try to do honorable things like balance budgets, end wasteful programs, curtail entitlements, and enforce accountability are the kinds of politicians that voters simply will not trust.

I have always tried to earn trust the old-fashioned way by telling the truth, showing loyalty, and sharing my work. I always fail because my personal values are out of step with the times. Feel free to scold me for my own naivete. My colleagues in financial services lacked personal integrity but outperformed me anyway, and their clients rewarded them for their exertions. Bernard Madoff lied and cheated all the way to prison, while the SEC and his well-heeled clients could not have cared less. In a perverse sense, vile people earn a kind of trust by violating values a philosopher from antiquity would have held dear. The Alfidi Capital solution is to be a lone voice in the wilderness raging against the onrushing dark age.

Trustworthiness is no longer earned in post-modern America. It is a commodity to be traded rather than a virtue to be demonstrated. It is highly ironic that a nation founded by serious intellectual students of the English Enlightenment and ancient Rome has devolved to this state. A reset to pre-modern definitions of trustworthiness and virtue is a pressing national need. Resetting national values is always an election year issue, whether we realize it or not.

I am Anthony James Alfidi, and I approve this message.

Inca One Gold Turns Its Wheels

Inca One Gold Corp. (US ticker INCAF) is yet another one of those tiny stocks milling around in precious metals mining. It trades under other tickers but the US listed one is the only one I need to see. There isn't much to see here anyway.

The CEO's bio describes precisely zero experience in mineral processing. Some of these people appear to have mining backgrounds, so maybe they found their way down a hole once in a while. A couple of the people listed here also have zero experience in metallurgy and their bios don't even describe their jobs at Inca One Gold. That just about takes the cake. Investors have cast their lot with people who don't tell the public what they do all day.

Inca One Gold's unaudited quarterly financial statements dated July 31, 2015 show CAD$236K cash on hand and a net loss of -$581K. They burn through the equivalent of their cash reserves in less than a month at that rate. The company does have revenue but COGS eats up a high percentage, and corporate expenses are almost three times their gross margin. This is one very poorly run turkey. Read their own choice of words "material uncertainty" in Note 1 about their going concern prospects in case you don't believe it's a turkey. The shareholders' equity deficit of $15.5M means it has always been a turkey.

The stock's EPS is a negative, losing -US$0.06/share LTM. The closing share price for INCAF on January 18, 2016 was $0.06/share at zero traded volume. That means the company loses the equivalent of its entire public value for an investor who buys now and expects to hold for a year. Some sucker who owns it now and can't sell would love to find someone even dumber. Any trading volume higher than zero means another sucker is born.

Full disclosure: No position in INCAF at this time.

The Haiku of Finance for 01/18/16

Iran oil flood due
Drivers welcome cheaper fuel
Fill up now to save

Oil Slump Leads To Shale 2.0, The Great Crew Change, And COP21

The oil sector's bear attack shows no signs of abating. OPEC's Saudi-led push for huge overproduction is driving the US shale sector to the brink of collapse. The post-crash survivors can benefit from "Shale 2.0" technologies that keep their costs down. They will need every advantage they can get when the "Great Crew Change" makes finding human talent harder and the UN's COP21 protocols make hydrocarbon production less desirable.

High-sulfur US crude varieties are now so uneconomical that they command prices near zero or even negative in refining. You know your sector is in trouble when you have to pay customers to take your worst product away. Large US banks are strengthening their loss reserve allowances as loans to oil producers reach default thresholds. Thank the Federal Reserve for increasing required capital cushions. Some financial players tracking the oil sector have begun clamoring for a federal bailout. The energy sector's financiers did not get the memo that bailouts are political non-starters. Miscellaneous regulatory changes in Washington may make it easier for surviving drillers to market their product. Financial backstops for the entire sector are very unlikely now that regulators have learned lessons from the 2008 systemic crisis.

Oil drillers who survive the slump will contend with more favorable economics, and not just from an eventual rise in market prices. The Manhattan Institute's "Shale 2.0" study argues that Big Data will bring a revolution to oil drilling that dramatically reduces its cost structure. The think tank's longer study is worth reading for technical insights. Lower production costs across North America will make the continent's production less responsive to OPEC production changes.

Another factor working in the oil sector's long-term favor is the need for a "Great Crew Change" replacing the sector's retiring experts. OGFJ's coverage of the Great Crew Change reveals that hiring to replace experts is less of a priority when oil prices are low and producers shut rigs down. Hiring younger Big Data experts will bring the Shale 2.0 cost benefits to financially healthy producers first, giving them market power as they restart exploration. Only the financially healthiest producers can afford to both replace retired talent with new STEM hires and replace depleted fields with new exploration.

One other complicating factor facing oil shale producers is the finalization of the UN's Paris COP21 climate change protocols. The new regime will use both regulatory and financial incentives to discourage hydrocarbon production and favor renewable energy generation. The regime includes financial support for developing nations whose energy exports will suffer as their oil production is rendered uneconomic. US oil drillers who can afford to comply with COP21's controls may have a window of opportunity if some OPEC producers are deterred from production.

The oil sector's pain will pass at some point. US producers who are currently sour on crude (pun intended) will relish the economic advantages they can reap by being first to implement Shale 2.0 tech, first to hire younger engineers in the Great Crew Change, and firs to adapt to COP21 controls. The largest and least leveraged US oil producers should be first in line when the race begins again.

Full disclosure: Long position in USO.

The Haiku of Finance for 01/17/16

Send me to Davos
Elites find me impressive
I could bring a date

The Limerick of Finance for 01/17/16

Davos gathering is on edge
Market turmoil is harder to hedge
Some elites are in shock
Populists broke the lock
Long-held notions are tossed off the ledge

The Haiku of Finance for 01/16/16

Howling bear market
Investors face hard headwinds
Winter should be cold

Winter Bear Markets Start Off 2016

Investors are watching wealth evaporate in the first month of 2016. Major market indexes are down and the CBOE's volatility measure is up. Sleepwalking to easy wealth is no longer the order of the day. Hard winters come with howling winds. Serious macroeconomic headwinds are howling at markets.

Did you think markets would go up forever? Think again. A few decades of consumer overindulgence left developed countries with bloated debt loads. Central bank stimulus was the co-dependent enabler that encouraged consumers, businesses, and governments to load up on cheap credit. Try digging out from under an unmanageable debt load. It's like digging out of a winter snowdrift.

China's economic fictions are now laid bare. Forget the forged official numbers. Australia's declining metal exports to China are real enough. The obvious Chinese recession will become a depression as state-owned funds liquidate shadow holdings and real estate creditors throw urban speculators out of their apartments. The only possible remaining stimulus in a Fourth Turning Crisis era is military spending. Expect Beijing's mandarins to ramp up militarism after a few years of bear market pain become unbearable for China's former middle class.

Live bears hibernate through the winter. Bear markets wake up whenever they feel the urge. Winter is coming, according to people who quote the Game of Thrones saga. Investors' winter is already here.