Juggling Dynamite

Rising precious metals stocks this summer have, so far, managed to hold the Canadian stock market (TSX) above the 16,000 level where it has languished, flat since 2017.  Material stocks, however, make up just 10% of the index overall.

Energy stocks, the second-largest sector weight at 19%, have been losing since oil prices hit a secular peak in 2008, and are down another 24% in the last three and a half months.

Oil companies are suffering from both a cyclical fall in demand as the world economy heads into its next contraction, as well as a secular ‘evolve or die’ phase where they must reinvent themselves into renewable energy and storage conglomerates.  See Power to the People–How Renewables and Batteries are Reshaping the Utility Industry.  This is not an easy transition and will take a lot of money.

At the same time, lawsuits for increasing environmental and health damage will be a drag on oil sector cash flow, profits and shareholders for years to come.  This CNBC report reviews some of the recent price impacts.

Something interesting has been happening in the oil patch: Crude oil has fallen the last few months both here and around the world. But the American oil stocks have fallen a lot more, and now there is real concern about where the industry may be headed. Here is a direct video link.

In the process, countries, states and provinces which came into this secular downturn heavily dependent on fossil fuels are behind the curve and will struggle with their current low tax, high spending policies.  For example, see Behind Alaska’s Big Fight Over Oil Money:

Instead of paying taxes to fund state government, Alaskans have since the early 1980s been able to rely upon taxes and royalties from North Slope oil and gas production to pay for both (1) state government and (2) a sort of universal basic income for residents, with “dividend” checks averaging an inflation-adjusted $1,718 a year since 1982. Alaska levies no statewide property, sales, or personal income taxes, has the lowest state and local tax burden of any state, spends more per resident than any other state government and has over the past four decades relied on oil and gas for 83% of the unrestricted state general fund revenue with which most state operations are funded. But since 2015, the oil revenue hasn’t been nearly enough to pay the bills.

To try and make ends meet, an increase in consumption taxes is inevitable as incomes fall. Tough times in Alberta are reflected in the steadily rising mortgage defaults over the past ten months, see Mortgage Arrears in Alberta hit the highest rate since 2013.

All of this is setting up for a triple whammy for Canadian banks who are levered on rising defaults in the highly indebted oil patch, realty markets and households as well as tumbling capital markets.

Make no mistake:  as the energy and realty sectors stumble, so do the banks.  Down over 4% this month, Canadian financial shares are finally repricing for the compounding strains at hand.  Since financials are the largest weight in the TSX (34% of its market cap), the broad market will have to follow suit.  It’s just math.

After a year-long investigation, renowned Madoff whistleblower and financial analyst Harry Markopolos and company have released a 175-page report to regulators declaring General Electric guitly of the largest insurance fraud ever.  The report alleges that GE has a “long history” of accounting fraud, dating back to as early as 1995 when it was run by Jack Welch.  See GE Fraud.com:

The Fraud Investigators have been researching General Electric’s financials and accounting practices for more than one year. The result is the discovery of an Enronesque business approach that has left GE on the verge of insolvency.

GE has been running a decades-long accounting fraud by only providing top-line revenue and bottom line profits for its business units and getting away with leaving out cost of goods sold,

To make it impossible to compare GE’s numbers across multi-year time periods, GE changes its Financial Statement reporting formats every few years. This is only detectable by reading at least 10 years of 10-K’s back to back. We read 17 years from 2002-2018.

The report centers around GE’s long-term care insurance unit, which the company had to boost reserves for by $15 billion last year. By examining the filings of GE’s counterparties, it alleges that GE is hiding massive losses that will only increase as policy-holders grow older.  Separately, he goes on to find issues with GE’s accounting on its oil and gas unit Baker Hughes. See:  GE shares drop after Madoff whistleblower calls it a ‘bigger fraud’ than ENRON.  Here is a direct video link.

Like so many other big companies in the last decade, GE has resorted to financial engineering tricks to boost short-term share price at the expense of longer-term investment and prudent management, as I explained here in GE: bellwether sees zero revenue growth and more buybacks:

Ironically, in continuing to buyback shares rather than pay down debt and expand long term R&D and investment plans, GE is perpetrating the self-defeating circle which is plaguing itself and other companies today. A fixation on financial engineering to keep shareholders placated in the short run, means less funds for long term investment and restructuring that will grow the productivity, innovation, and revenues of the future.

All of this could lend more momentum to proposed new laws seeking to rein in share buybacks.

After making the dumb business decision to crush its much loved ahead-of-the-pack electric cars (EV1) in 2002, GM, along with emission-fraud leader VW, finally, see where the puck is going.  Chinese regulations requiring companies to sell a minimum number of zero-emission vehicles to avoid financial penalties are a huge catalyst.

Ford and Toyota are, so far, still doubling down on much-less efficient hybrid models that require batteries and gas-powered engines. Other auto companies are spending an estimated $225 billion to develop more than 200 new purely electric plug-in vehicles through 2023.

With internal combustion engine sales slumping globally, auto companies are in for a tough transition where they must reinvent business models away from reliance on higher-margin internal combustion engine (ICE) sales to EVs with 90% fewer parts and service needs.  First, manufacturers will have to give–in terms of investment and fewer near-term profits– to get a viable longer-term business. The race is truly on.  See GM, Volkswagon say goodbye to hybrid vehicles:

GM plans to launch 20 fully electric vehicles world-wide in the next four years, including plug-in models in the U.S. for the Chevy and Cadillac brands. Volkswagen has committed billions to producing more battery-powered models, including introducing a small plug-in SUV in the U.S. next year and an electric version of its minibus around 2022.

“If I had a dollar more to invest, would I spend it on a hybrid? Or would I spend it on the answer that we all know is going to happen, and get there faster and better than anybody else?” GM President Mark Reuss said in an interview.