For Stocks, a Reality Too Ugly to Behold?

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The magic of Consensual Hallucination.

The simple fact is that corporate earnings data is out there for everyone to see, but no one wants to see it. Instead, everyone wants to see and believe the sweet fairy tale that Wall Street and Corporate America spin with such skill just for us, because if everyone believes that everyone believes in this fairy tale, even knowing that it is a fairy tale, it will somehow lead to ever higher stock prices.

This is part of a phenomenon we’ve come to call “Consensual Hallucination.”

But that fairy tale got spun to new fanciful extremes in 2015.

Revenues of the S&P 500 companies fell 4.0% in the fourth quarter and 3.6% for the year, according to FactSet, with most of the companies having by now reported their earnings. And these earnings declined 3.4% in Q4, dragging earnings “growth” for the entire year into the negative, so a decline in earnings of 1.1%.

While companies can play with revenues to some extent, it’s more complicated and not nearly as rewarding as “adjusting” their profits. That’s the easiest thing to do in the world. A few keystrokes will do. There are no rules or laws against it, so long as it’s called something like “adjusted earnings.” The rewards are huge, in terms of share prices, stock options, bonuses, and for Wall Street, fees. The ultimate target of the magic is earnings per share. EPS is the most crucial term in the canon of the markets.

Turns out, the 2015 “growth” in earnings, and particularly the “growth” in EPS – so a decline – as reported by FactSet and others is a figment of the vivid imagination of Wall Street and Corporate America, called “adjusted earnings,” where everything bad has been “adjusted” out of it.

The reason every developed economy uses standardized accounting rules is to give investors a modicum of insight into what is going on in a company, compare these numbers to those of other companies, and make at least not totally ignorant investment decisions.

In the US, these are the generally accepted accounting principles, or GAAP, the most despised acronym of Wall Street and Corporate America. Yet even these principles offer plenty of flexibility for financial statement beautification. We get that.

Yet they’re way too harsh for Wall Street. So companies file the required financial statements under GAAP for everyone to look at, but then they hype their “adjusted” earnings in their communications with investors. And the gap between the two in 2015 was a doozie.



For example, of the 30 components of the Dow Jones Industrial Average, 20 reported “adjusted” earnings, with 18 of them reporting adjusted earnings that were higher than their earnings under GAAP, according to FactSet. That 18-to-2 relationship alone shows the clear bias of these adjustments: They’re used to inflate earnings, not to lower them to some more realistic level.

These adjusted EPS were on average 31% higher in 2015 than EPS under GAAP. That’s way up from 2014 when 19 of the Dow components reported adjusted earnings that were on average 12% higher than under GAAP.

And yet, despite the soaring portion of fiction, these adjusted EPS of the companies in the DOW still declined 4.8%. That’s bad enough. But under GAAP, beautified as it might have been, EPS plunged 12.3%.

The biggest sinners?

Merck & Co. won hands-down: it reported adjusted fictional EPS of $3.59 for 2015; but under GAAP, its earnings dwindled to $1.56 per share. Its elegant adjustments inflated EPS by 130%! You’d think it would take some balls to somehow get this by keen-eyed Wall Street analysts. But no. Wall Street ate it up. Consensual hallucination.

GE reported EPS of a measly $0.17 for the entire year 2015 under GAAP, but once it got through with excising all the bad stuff, EPS jumped 106% to $0.35. OK, that’s still crummy….

Our tech-darling Microsoft reported EPS of $1.48 under GAAP, and so its financial-statement beauticians set out to do their magic and adjusted them up by 78% to $2.63. Pfizer inflated its EPS under GAAP of $1.24 by 77% to $2.20. And United Technologies, in this elegant manner, raised its EPS by 40% to an adjusted $6.30.

These are among the most established members of Corporate America. Other companies, which were not part of FactSet’s report, were much more extreme.

For example, Twitter lost $0.13 per share under GAAP in 2015, but reported “non-GAAP diluted income per share” of $0.16. Tesla, which is sinking into its own endless sea of red ink, lost $6.93 per share in 2015, but when it got through beautifying the results, its “net loss was $2.30 per share on a non-GAAP basis.”

But there are more layers to this onion. FactSet used earnings from “continuing operations,” when companies provided that number. Companies frequently shed units. GE has gone through a historic binge of that in 2015. And under this “continuing operations” principle, any detrimental earnings numbers that were incurred by a division before it was disposed of would be excluded. So FactSet’s numbers cited here still don’t reveal the true extent of the EPS decline.

And there is another layer to this onion: EPS have been further inflated via adept financial engineering, including heroic share-buybacks with borrowed money at peak prices in 2015. Buybacks reduce the number of shares outstanding, and thus increase earnings per share, even under GAAP. Everyone knows it, and everyone loves it. No one wants to see reality, which is too ugly to behold. Consensual hallucination. And certainly, don’t peel the onion.

So if corporations can’t produce the earnings needed to push this market higher, central banks will have to do that job, at least that’s what Draghi seems to be thinking. But he still doesn’t get it. Read…  Bundesbank Fears “Doom Loop”



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  43 comments for “For Stocks, a Reality Too Ugly to Behold?

  1. Dan Romig
    Mar 13, 2016 at 6:27 pm

    Wolf, are you sure we can’t trust those CEOs that control billions of dollars each day via what they say and/or report?

    Of course, we can always believe the ratings agencies because they get paid to tell us the truth.

    • Mar 14, 2016 at 3:30 am

      Wolf just explained that. People MUST be paid to tell humans the ‘truth’. Humans hate the truth. I can’t believe Wolf would bash the ‘sweet fairy tale’. By the way, fairy tale, is another name for ‘LIE”. Paulo inspired the following article and video.

      Grandfather Lies to Save Child by Bob Miller

      At first, this grandfather confused me with his statement, “My five year old granddaughter is pretty magical. I’d hate to destroy it with ‘reality’”.

      I thought, why would a grandfather tell lies and condone lies being told to his granddaughter? Then, it hit me like a runaway Toyota: if this grandfather is a Canadian, he’d have a hard time explaining reality to a five year old since Canada is No. 6 on the list of the world’s top arms dealers, and far worse than that, these Canadians are selling depleted uranium to the US, which is a violation of Protocol 1 Additional To The Geneva Conventions (1977).

      Now of course, if this grandfather is a US, UK or Australian citizen, then he’d sure need lies. Ever see a map of the countries these Brits have invaded? And who wants to try and explain to a five year old that all of her ancestors were the dregs of society (In England of all places) and were shipped off to a penal colony? I mean, I’d not want the job of explaining the Abu Ghraib pictures to a five year old. Then there are the pictures of little girls just like her lying in the streets and burned out buildings with arms that were blown off by rockets containing this Canadian depleted uranium, especially since there is no such thing as depleted uranium. Uranium, like lies, is still uranium even if you call it Rudolph’s red nose.

      I now totally agree with this grandfather: no five year old should be forced to see who and what we really are. And since we’re paying these communists in Red China to play the bad guy, let them earn their pay, at least until these five year olds get to be 50 and are lying, stealing and microwaving mothers and their children like their grandfathers did.

      • Gary
        Mar 14, 2016 at 7:19 am

        You make a good point but I take exception to your Canadian uranium example. Uranium is just a metal that is abundant in Canada and is used in nuclear reactors (the safest reactors use uranium by the way) and in other civilian uses. If the Americans want to put it to evil use, Canada cannot do much about it against the mighty U.S.

        PS. Americans prefer to use plutonium in their reactors because it’s more dangerous, more toxic, more expensive, and generally more evil.

        • Bob Miller
          Mar 14, 2016 at 7:32 am

          Oh really, ‘cannot do much about it against the mighty U.S.’ So we US are making you Canadians sell us uranium. Did any of you other US know were were doing that to our neighbors in the north? We must surely be the badest of the bad.

          ‘Uranium is just a metal that is abundant in Canada’, oh I get you. It’s like Afghanistan’s largest and fastest cash crop is opium.

        • d
          Mar 14, 2016 at 8:09 am

          Canada also sells lots of it to france, and they know the french, ultimately convert it, and the byproduct of it, to evil purposes.

          With another french supporting, leftist, quebec separatist, flunky, at the top in Canada, that won be changed for a while.

          Realistically until the Russians can be prevented from selling it to anybody who is anti American, through Kazakhstan there is really not much point in the argument, which is why Australia started to allow some Yellow cake mining/sale again.

          Non Proliferation just like non Anything, dosent work, when it only punishes the honest.

      • Eric Patton
        Mar 14, 2016 at 10:18 am

        Would he lie to his five-year-old grandson?

  2. Paulo
    Mar 13, 2016 at 6:29 pm

    Reminds me of the old joke when the guy’s wife holds up her thumb and index finger about two inches apart and says, “I never knew this but this is 6 inches”!

    Fitting analogy to talk about the stock market.

  3. Mike R.
    Mar 13, 2016 at 7:56 pm

    Wolf,
    I don’t think you get it. The Fed and Treasury (with Obama’s approval) have directed most of the CEO’s of this country to ‘stretch the truth’ as it were with respect to earnings. They are convinced the stock market is the #1 indicator of economic health for the public and are intent on holding it up.

    This effort (with CEO’s) is one of many prongs. QE gave cheap money so stock could be bought back. The Plunge Protection Team or whatever it is, buys back after downturns stall. Even CNBC is somehow in the action with some pretty outrageous propaganda designe to keep the average smuck in the market.

    All told, there has been an orchestrated effort to keep the stock market up. Remember, even Bernanke stated at one point that the Fed could buy stocks, when talking about other options including helicopter money. Not only could buy stockes, they are buying stocks; I have no doubt about this. They are manipulating about everything they can, within bounds.

    We are living in perilous times. The economic crisis that came from 2008-2009 timeframe has clear national secruity implications and as such, the government is all in to manipulate and do what it has to to prevent another crisis.

    • Bigfoot
      Mar 13, 2016 at 10:22 pm

      CME Globex had a specific incentive program for central banks domestic/foreign to trade all CME, CBOT, NYMEX, & COMEX futures products, which of course includes many stock index’. They also offered the CB’s reduced transaction costs. That was 2013. Not sure if that particular program is still in play or if something else has taken its place.

    • Thomas Malthus
      Mar 14, 2016 at 2:03 am

      All central banks are buying stocks – they all have Plunge Protection Teams stepping in if markets falter.

      Of course they are also funneling hundreds of billions of dollars to corporations in the form of ZIRP loans that are used to buy back stocks.

      Who knows what else is going on behind the scenes that we are not told about?

      Truly desperate times.

      When we come out of the eye of the storm we’ll be completely exposed this time as the central banks will have exhausted all tools trying to keep us in the eye.

      When this hits this will be epic – it will be the most monumentally disastrous collapse in the history of the world.

      I’m not laughing at Doomsday Preppers – although I do think what they are doing is futile.

      • walter map
        Mar 14, 2016 at 12:17 pm

        “I’m not laughing at Doomsday Preppers – although I do think what they are doing is futile.”

        Once upon a time a man came across a bird, lying in the road with its feet up in the air.

        “Little bird,” asked the man. “Why are you laying in the road with your feet up in the air?”

        “I was told the sky would fall today,” the bird replied.

        “Oh ho!” said the man. “And I suppose your little feet are going to hold up the sky when it falls?”

        “One does what one can,” said the bird. “One does what one can.”

    • Bob Miller
      Mar 14, 2016 at 6:25 am

      No one has to order, direct or coerce humans to ‘stretch the truth’. But why not blame Obama and Congress, that’s close enough since they are elected and reelected by those who blame everyone but themselves. The ‘Someone should do something’ crowd. Right you are, Sir, but we can bet the farm it’ll not be you. God works in mysterious way. I mean that just about covers it. Maybe this is one of those ‘mysterious ways’, whose to say?

    • Ken
      Mar 19, 2016 at 12:18 pm

      Oh, he gets it all right! See his comment below: “That money just disappears quietly. What’s left are lower cash balances and the debt incurred to get that money.”
      The ‘money’ vanishes, but the debt remains. He’s clearly isuggesting that that is the purpose of bank debt in the first place. To get most in so deep that when they crash the system most will lose everything, leaving the banks in charge.
      Having ‘purchased’ all those tangible assets with fiat currecy printed on paper at the cost of six cents per hundred ‘dollar’ bill is an awfully good scam, so long as the scammed stay in normalcy bias(or “Consensual Hallucination”, or whatever other term) and never wake up to the fraud being perpetrated on them.
      Plus, almost all loans are never given in cash anyway. Over 95% are just entries into a computer, with no costs at all, other than a few pennies worth of electricity to run the machines. If one can ‘create’ billions of ‘dollars’ out of nowhere at no cost to yourself, and then loan that out at interest AND also talk the sheeple into putting up everything they will ever have as collateral, that’s a pretty good scam, wouldn’t you say?

  4. Oliver
    Mar 13, 2016 at 8:13 pm

    So, where on the adjusted financials do they put/hide losses on their share buybacks ?

    Does GAAP require them to mark share buybacks to market, and to show a loss (or gain) on the P/L ?

    • Mar 13, 2016 at 8:23 pm

      Nowhere (in terms of income)! That money just disappears quietly. What’s left are lower cash balances and the debt incurred to get that money.

      • chris hauser
        Mar 13, 2016 at 10:03 pm

        maybe trump is the logical continuation result of all this hanky–panky in which the string becomes self-pushing.

        on the other hand, can you do a simple flow chart that explains the following: http://www.bloomberg.com/news/articles/2016-03-14/china-overseas-buys-citic-s-property-assets-for-31-billion-yuan

        but i’m optimistic. i have to be.

      • Jonas
        Mar 13, 2016 at 10:50 pm

        What worries me is the useless debt being entered just to finance buy backs. I couldn’t think of a worse way to spend money, as many formerly healthy companies are now acutely sensitive towards liquidity problems should we have a recession.

        Over the years this has taken I epic proportions to the point where corporate debt May now be a bigger systemic risk factor than the housing fiasco of 2008. The best case scenario is a decade of low earnings as debt it’s paid back. Bizarre.

        • fledermaus
          Mar 14, 2016 at 12:51 pm

          But it’s so easy. Who wants to do all that messy work of creating new products and expanding markets. That requires hiring workers and managing them. Stock buy-backs just require pushing a button and being hailed as a genus by the market.

  5. NotSoSure
    Mar 13, 2016 at 9:48 pm

    We should just rename this country Consensual Hallucination. The stock market is just one its many phenomenons. Soon we’ll all assure one another that the best is still ahead and sing Kumbaya together.

    • LG
      Mar 13, 2016 at 10:21 pm

      Chinas got ghost cities the US has ghost stock markets!

      • NotSoSure
        Mar 14, 2016 at 12:30 pm

        Ghost frack oil too, and don’t forget ghost democracy. As I said, this country’s as delusional as any other major countries so far.

        If the US and China goes to war, both will be exposed as the Ponzi schemes as they are. That whole US military superiority thing does not even stand up to scrutiny if you look at the details. Otherwise why is the US still engaged in Afghanistan, etc.

        Even worse, it took 10 years to find a man with a beard.

        • Toddy
          Mar 14, 2016 at 9:23 pm

          Last I checked, the US went to war because the military contracting business lobbyists sold the idea to congress members as a way to prop up the economy.

          I’m rather certain that the next POTUS is going to be asked to sell voters a war once again.

          China isn’t gonna go to war with the USA, but maybe with Taiwan… As a warm up exercise to see how bad the political fall out would be if they start invading certain parts of India… but by then, NATO will be forced to engage in Europe against IS, and before you know it, the whole mess is a genuine WWIII.

        • d
          Mar 14, 2016 at 9:32 pm

          They shoot at Taiwan they shoot at the US.

          They know this its the only reason they have never attempted to use their manpower superiority to invade Taiwan.

          Look at what is happening on the Borneo and Philippine coast China has effectively brought off the current Malayan Administration, can it buy the people of Malay is another matter.

          china cant buy the Philippines or Vietnam.

        • RDE
          Mar 15, 2016 at 10:30 am

          Might I suggest Dmitry Orlov’s post today eviscerating the myth of US military superiority?

          http://cluborlov.blogspot.com/2016/03/the-wrong-kind-of-victory.html#more

          Although I have a hard time believing that any large bureaucratic organization organized as a command structure is anything but a cluster***k. Including the Russian military.

      • RDE
        Mar 15, 2016 at 10:38 am

        Ghost cities built of ghost concrete, ghost structural steel and ghost drywall will take care of themselves naturally in short order.

        It’s just good business to use all the construction savings to buy hotels in North America or abandoned crack houses in Vancouver.

        Using ghost dollars created by the FED and the other central banks of the world.

  6. Florida Boomer
    Mar 13, 2016 at 10:59 pm

    So, when PE is reported in the Wall Street Journal or other financial news sources, is it the adjusted non-GAAP earnings (fiction) that is reported? If so, all of the manipulated numbers are wildly misleading…is this correct?

    As a middle class senior I live in fear of a financial collapse. I have no idea how to protect my family to have at least modest financial security….the entire financial system appears to be one giant house of cards.

  7. Randy
    Mar 13, 2016 at 11:26 pm

    This is the trickle down theory. Massive corruption at the highest levels of government trickles down to the lowest levels. But, when government is corrupt, so is business. Our big corporations are corrupt to the core.

  8. Michael Gorback
    Mar 14, 2016 at 1:13 am

    Who, exactly, is fooled by this? “Wall Street ate it up”?

    The analysts aren’t anywhere near that stupid. The traders aren’t that stupid. The Managing Directors aren’t that stupid. Anyone who passed the Series 7 exam isn’t that stupid.

    Perhaps Wall Street hyped it and passed it along to the muppets.

    Or maybe everyone realizes they’re playing musical chairs and they pretend there are plenty of chairs figuring they’ll be the one to get the only real chair when the music stops.

    “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” — Lehman CEO Richard Fuld, 2007

    They’re still dancing but the band is starting to look a bit tired, and some of the wind instrument players (the SNB, ECB, BOJ, etc) are sucking instead of blowing.

  9. d
    Mar 14, 2016 at 5:45 am

    “Did I learn Nothing from Richie Apprio, I have to nip this in the bud” Tony Soprano to his “Councilor”.

    It looks more and more, like “America”, learned “Nothing”, from Enron.

    • Mar 14, 2016 at 9:25 am

      We did learn something, quite a bit actually, and then we tried very hard to forget it. Only a few years later, we succeeded.

      • d
        Mar 14, 2016 at 7:53 pm

        Sadly, that ( Your comment ) , seems to be about the size of it (the matter).

        Victors “History” is not “History” at all it is the victors “propaganda” presented as “History”.

        However, the, those who do not study truism, still apples.

    • NotSoSure
      Mar 14, 2016 at 1:00 pm

      Everything gets forgotten, or as Rudyard Kipling eloquently puts:

      Far-called, our navies melt away;
      On dune and headland sinks the fire:
      Lo, all our pomp of yesterday
      Is one with Nineveh and Tyre!
      Judge of the Nations, spare us yet,
      Lest we forget—lest we forget!

      Heck, most people even forget that the whole poem is about forgetting.

      • AsYouLikeIt
        Mar 15, 2016 at 2:49 pm

        We could possibly look to another of Kipling’s stories for the cause of rampant Consensual Hallucination, in other words, they have to believe:

        The Man Who Would be King –

        Peachey Carnehan, “If India was filled with men like you and me, not knowing more than the crows where they’d get their next day’s rations, it isn’t seventy
        millions of revenue the land would be paying—it’s seven hundred million.”

  10. Mary
    Mar 14, 2016 at 9:28 am

    When I recently asked my niece about her high-paying, clearly stressful job, she replied that she’s in “investor relations”. I couldn’t figure out what that involved, and why it came with such a fat salary.

    Now I understand. She is creatively repackaging financial information. thank you Wolf.

  11. Brian Richards
    Mar 14, 2016 at 11:42 am

    I think the Buddhists have it right. All is illusion. We grow up in the US thinking we have some control over things, and with age, rational thinkers realize that we have no control at all. With this comes a bit of wisdom, and serenity. I am going to retreat into serenity today and leave everyone else to worry about the financial world. All excellent comments by the way.

    • Bigfoot
      Mar 14, 2016 at 6:48 pm

      BR, gotta agree with ya, all is indeed an illusion. We are pumped so full of garbage as young ones & then as we age & start asking the tough questions, the illusions begin to unravel & many ugly truths are laid bare. There is no such thing as security.

      Enjoy the day !!

    • DanR
      Mar 14, 2016 at 7:01 pm

      One thing I picked up on esoteric reading regarding Maya is that our brains receive and transmit data so as to support the illusion. I’m not sure the entire brain is involved in this but illusion making is a cooperative project we are all involved in. Trying to take more responsibility for this and see what the next steps are.

  12. Konstantin ks
    Mar 14, 2016 at 12:23 pm

    Sounds like someone is going to lose your pension (already lost I guess) and convince you that you are the only one to blame. It is supposed to keep your society going on values other than saving instead of degrading into a civilian war. #ask a Greek.

  13. Bobster101
    Mar 14, 2016 at 1:09 pm

    Over a period of years I followed the antics of an insurance company that repeatedly got caught fiddling their financial statements. Every time they would change auditing firms and start the same tricks with the new auditor until they got caught again. Accrual accounting, even GAAP, allows tremendous leeway. Entire categories on the balance sheet or income statement can be plug figures and/or made up in order to look good.

  14. Bobster101
    Mar 14, 2016 at 2:19 pm

    Accounting chicanery is common, partially because so few people understand it, also because some accounting standards are so open to “interpretation” (Fasb 157), and because some accounting firms will allow almost anything (Arthur Anderson/Enron). One trick is to count loan proceeds as revenue. There is a strong tendency to trust statements because they were certified by some big audit firm, but standards vary a bit from one firm to another. Bernie Madoff had an outside auditor after all. Besides, companies hide things from their auditors too.

  15. CENTURION
    Mar 14, 2016 at 3:22 pm

    You have the 5 major US banks are stock holders in the FED. You have the worlds most powerful and richest families as stock holders in the FED. Now, since the FED can not be audited, try this on for an idea:

    The FED issues loans (credit entries) to their member banks. Interest rate….0.1%. BUT, the banks know to use these funds to buy stocks and bonds (wink, wink).

    In addition, these member banks give easy loans to corporations and the CEO’s of these corporations know that much of this “credit” is to be used to buy up their own stocks….wink, wink.

    So, the DOW goes up, the people and pensions pile in, the “families” sell into the rally and everybody is happy.

    It is so simple.

  16. Keith
    Mar 15, 2016 at 9:57 am

    Confidence is all there is and when things are going badly you have to lie.

    Imagine if someone from Deutsche Bank was foolish enough to tell the truth?

    We saw it in Wall Street investment banks in 2008 ….

    We are fine.
    We are fine.
    We are fine.
    We are going under now, bail us out now.

    To tell the truth just brings the crunch forward.

    By lying, a few more pay checks and bonuses may be collected.

    Keep on lying, confidence is all there is.

  17. wholy1
    Apr 3, 2016 at 8:15 am

    In the end, will EVERYTHING get ‘consolidated and transferred” to the CB,s?

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