The real trouble with ‘Bizarro Capitalism’ by Porter Stansberry 7-22-2017

[ I sent out a newsletter to everyone I knew in 1999 about why companies were going to go bust, started warning people in 2002 that there was a housing bubble, and in 2005 that a financial crash was inevitable.  But it always takes longer than I expect for crashes to happen. No one listens to me, sigh. I know another, much worse crash is on the way, a permanent crash as energy declines, but it hasn’t happened yet, thank goodness, I dread the downhill side of Hubbert’s curve.  Nonetheless the signs are there.

Alice Friedemann  author of “When Trucks Stop Running: Energy and the Future of Transportation”, 2015, Springer and “Crunch! Whole Grain Artisan Chips and Crackers”. Podcasts: Practical Prepping, KunstlerCast 253, KunstlerCast278, Peak Prosperity , XX2 report ]

Porter Stansberry. July 22, 2017.  The Real Trouble With ‘Bizarro Capitalism’.


 Today, a quick review of one of my new favorite themes: “Bizarro Capitalism”…
To preview the conclusions, you’ll find below there’s a hidden downside to global central banks’ campaigns of endless credit expansion and zero interest rates: As capital costs disappear, so do profit margins.
Equity investors will surely cheer financial innovations that lead to rapid amounts of revenue growth. But bond investors – those dreary troglodytes – focus on cash flows.
Trouble is, despite wondrous new products, massive investments in research and development, capital expenses (like plants and equipment), share buybacks, and gigantic acquisitions… most of America’s top companies aren’t producing additional cash flows. But they are producing a lot of new debts.
How will this end? That’s the question I (Porter) will attempt to answer today.
 Readers of a certain age may recall Bizarro Superman – the comic villain who was Superman’s polar opposite…
(Truly refined readers will recall the Seinfeld episode “Bizarro Jerry,” which adopted the same metaphor. Seinfeld’s sometimes-girlfriend tells him she has picked a new man who is the polar opposite of him, “Bizarro Jerry.”)
Bizarro Capitalism is my extension of these ideas. It means a system of exchange and property ownership where capital is free and therefore requires zero savings or profits to grow.
 In April, I explained the macroeconomic foundations of Bizarro Capitalism to Digest readers…
In theory, the costs of doing business are limited to capital and labor. Technology has greatly reduced the labor inputs for most businesses. With nearly free capital and greatly reduced labor inputs… the costs of producing a widget or providing a service have plummeted across our economy.
That sounds great, right? Lower costs should equal bigger profits. But of course, there’s also competition. When everyone has access to unlimited capital… and technology limits the per-unit cost of labor… economic theory suggests there will be a race to zero. No one will be able to make a profit because there’s no scarcity of capital, and therefore no ability to increase relative productivity.
And… what has happened?
The last several years have seen the rise of companies that are experts at exploiting technology to reduce labor costs. Free capital and zero per-unit marginal labor costs equals a whole new form of capitalism that’s genuinely unlike anything the world has ever seen before.
These are companies with massive scale, massive sales growth… and virtually zero profits.
 As proof of these concepts, I pointed to Amazon (AMZN)…
Here was a company that had grown tremendously. Since 2013, the online-retail giant’s revenues soared from $80 billion to $140 billion annually. Those are huge numbers.
And profits? There aren’t any in its consumer businesses. Its corporate-services business (Amazon Web Services) makes about $1 billion a year currently.
So over the last three years, on revenues of $320 billion, Amazon made about $3 billion in profit – or less than 1% of sales. Nevertheless, it had invested an incredible $17 billion on acquisitions and capital improvements – before its $13 billion acquisition of Whole Foods Market (WFM). In total, the company has now spent $30 billion on investments in its business… almost none of which are expected to make a profit.
 The stock market loves Bizarro Capitalism…
Stocks in general have virtually never been this expensive before as measured by the ratio of share prices to revenues or profits. Bizarro leaders like Amazon and Netflix (NFLX) have seen their share prices explode.
When Amazon introduced the Kindle e-reader that gutted the profitability of every other book retailer, the stock was trading for around $90 per share. Roughly 10 years later, it trades for more than $1,000 per share – an increase of more than tenfold.
But Amazon wasn’t just targeting book retailers. Even though online retailing today only makes up about 10% of retail sales, the price competition it has engendered makes it almost impossible to maintain a profit margin in the sector.
Finally, investors are beginning to realize the downside to Bizarro Capitalism. As you can see below, the retail sector looks like a war zone…
YTD Performance
Stage Stores
Tailored Brands
Boot Barn
Christopher & Banks
New York & Co.
Chico’s FAS
Urban Outfitters
Foot Locker
American Eagle Outfitters
Finish Line
 This is just the beginning…
All these stocks, and many others, will likely go bankrupt. And the recovery rates on these bonds will not be normal (around $0.45 on the dollar) because no one is going to buy these companies or their assets beyond their inventories.
But the biggest problems from Bizarro Capitalism will occur in the commodity markets. Virtually free capital has led to a huge increase in commodity production, from oil to corn.
Since July 2011, U.S. onshore crude-oil production has essentially doubled. The last time U.S. crude-oil production doubled, it took 25 years, from World War II until the mid-1960s. We’ve done it again in just six years. Corn has seen a growth in production of almost 50% since 2012, from 10.8 billion bushels to 15.1 billion bushels.
 But what about consumption?
Since Bizarro Capitalism doesn’t require anyone to delay consumption (for savings), there’s no pent-up demand for any of this stuff. Oil and corn demand have barely grown.
That’s why prices have fallen so much. Bizarro Capitalism is a recipe for collapsing profit margins (like retail). But it’s also a recipe for collapsing commodity prices. And that sounds good… until you understand more about how Bizarro Capitalism really works.
You see, even though the money doesn’t come from savings, it still has to be borrowed. And the folks who lent all of this capital don’t think of it as funny money. They think it’s real. And they’re going to want it back, with interest.
 Back in April, I pointed to Deere & Co. (DE) as a primary beneficiary (in the short term) from Bizarro Capitalism…
The tractor manufacturer had lent farmers $38 billion to buy tractors and other items necessary for farming. (That explains the huge increase to corn production.)
The Wall Street Journal noticed this, too. This week, it published a well-researched article, noting that John Deere had become the fifth-largest agricultural lender in the country…
[Deere] is providing more short-term credit for crop supplies such as seeds, chemicals and fertilizer, making it the No. 5 agricultural lender behind banks Wells Fargo, Rabobank, Bank of the West and Bank of America, according to the American Bankers Association.
 Does that make any sense?
Should one of America’s most important manufacturing companies be inflating the demand for its products by becoming one of the largest agricultural banks in the world? Isn’t it obvious that these loans are going to lead to far too many tractors being sold, sharply lower corn prices, and eventually, a new financial crisis in America’s heartland?
Deere, like many manufacturers in this credit cycle, has used leasing, even more than lending, to sustain demand for its products. Since 2010, the value of Deere’s outstanding leased equipment has soared, from less than $2 billion to almost $6 billion. The Journal explained…
Deere accelerated its equipment leasing in 2014 when sales plummeted following almost a decade of rapid-fire purchases by farmers flush with cash. The leasing business has kept Deere from having to idle factories and has provided dealers with income from replacement parts and services for leased equipment.
[Leases] provided farmers with machines for one to three years for a fraction of their purchase price, alleviating the need for loans. A new tractor costing $250,000 can be leased for about $30,000 a year. That compares with the cost to buy with a loan, which would require a 20% down payment of $50,000 and more than $40,000 a year in payments for five years.
Trouble is, when you provide leases for equipment that make them much cheaper to own, you make it much harder to earn a profit selling the same equipment. Deere has seen its profit margins on its equipment sales fall from $5 billion to less than $2 billion.
That’s Bizarro Capitalism: plenty of revenue, but no profit.
 Here’s the real trouble…
Eventually, all of those leased tractors get returned. If they can’t be sold quickly, Deere takes the loss. Over the last three years, the amount of equipment leased out by Deere is up 87%. But what have corn prices done? Nothing. So… what do you think will happen next, after three years of booming lease business and no profits from farming?
The stock market couldn’t care less about these risks. Shares of Deere have moved from around $75 to more than $120 in roughly the last year alone. And right now, the bond market couldn’t care less, either. Deere’s long-dated bond (the 5.375% bonds due in 2029) is trading for $24 over par ($124) and yielding 3%.
 How will all of this end?
Will Deere successfully use virtually free money (in the form of endless supplies of credit) to prop up demand for its tractors forever? Will U.S. oil producers be able to lower their operating costs forever? (Recently, the average breakeven price for high-quality onshore production fell from around $50 to around $40, a change that has forestalled bankruptcy for a large number of U.S. oil producers.)
My bet is no. And like I first told Digest readers in April… sooner or later, the gigantic credit bubble that lies at the heart of Bizarro Capitalism will burst.
Of course, I can’t give you a date to put on your calendar. But keep your eye on the market for high-yield debt. The credit market will see these problems coming long before the stock market does.
 In the meantime, the cost of “insuring” against these problems is near an all-time low…
Today, you can hedge your entire equity portfolio with a small number of long-dated put options trading at dirt-cheap prices.
But that won’t be the case forever… When the stock market finally wakes up to these problems, it will be too late. Volatility will return – practically overnight – and put-option prices will soar hundreds or even thousands of percent as investors panic.
In other words, the best time to buy “hurricane insurance” is when the sun is still shining.
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4 Responses to The real trouble with ‘Bizarro Capitalism’ by Porter Stansberry 7-22-2017

  1. RobM says:

    Very good article. Free money has transformed a manageable decline into a catastrophic crash. I note the author makes no attempt to explain why money is free presumably because to do so requires an understanding of thermodynamics and a genetic defect to not deny unpleasant realities.

  2. H Horan says:

    Important to understand Amazon, but it is not the ideal illustration for your larger point. Amazon really could sell books more efficiently than traditional booksellers (not a huge gap, but a real one). Relevant metric here isn’t accounting profit but free cash flow. Amazon invested that cash into developing some real, legitimately profitable(strong cash flow generating) business like AWS. The retail industry collapse has much more to do with destructive private equity deals (pre-Amazon) than the shift to online sales. I’m absolutely not trying to depict Amazon as a wonderful virtuous company–its profits/cash flow and equity appreciation come from exploiting artificial market power. But it is not correct to use it as a poster boy for companies with high valuations that can’t make money in their core business.
    Better example is Uber which isn’t publicly traded, but lost $4.5 billion in its eighth year of operation, and has no hope of earning returns for its investors out of its core taxi service market. It is actually less efficient than the traditional taxis it has been driving out of business. Like Amazon and many others, it is pursuing the hope of eventually exploiting platform-driven market power, but skipped the difficult “figure out how to develop superior efficiency than existing competitors” part.

    • energyskeptic says:

      I should probably avoid articles that mention money and stocks — they’re all going down at some point of energy descent, and there’s so much financial gamesmanship and fraud on Wall Street that the shale drilling and all sorts of unprofitable companies are kept going. Until the energy crunch, I expect the madness to continue.

  3. When a 23000 man/hour in a barrel of crude oil is traded at $50-$150, it effectively makes the man hour priced around 1c.

    Today, individuals and nations are all in deep debt and no one can tell where all fossil fuels extracted are going, despite that 2/3 of the globe is hardly uses fossil fuels and we have almost depleted all the reserves!

    It is the trend these days seeing the media hyping Carl Marx and Socialism over ‘Bizarro Capitalism’ but hardly touches on the root cause of the predicament: Where for a Civilisation to get its Energy from other than human slavery?!

    If we follow Physics and Thermodynamics, human slavery, like never seen before in history, is back to Earth, but hardly anybody is seeing this coming.