Friday, August 19, 2016

The Theory of Financial Relativity

The best thing about being a blogger is that I have the latitude to write about whatever piques my curiosity, without concern that some ham-handed editor might ban my musings or worse try to distill them to 140 characters or less, in a misguided effort to maximize "eyeballs" or advertising revenue.  Many of the topics I like to explore are simply too complex to discuss in a few paragraphs.  For example, for this post, to really understand this topic, it's important to take a trip back in time to revisit the work of French Chemist and Physicist, Antoine Laurent Lavoisier, circa 1785.

I'm hopeful I didn't lose too many of you with that introduction, but I believe it's an important preamble to set the stage for what we're going to talk about today.  For those of you unfamiliar, Lavoisier developed/discovered what is now commonly known as the Law of Conservation of Mass (i.e. Matter can neither be created nor destroyed.) This was groundbreaking work and his experiments and methods became a road map for for the modern science to follow.  Unfortunately, for his unique perspective and conflicting political views during the French Revolution, Lavoisier was eventually guillotined in 1794, presumably without recognition, understanding or appreciation of the historic importance of his work.  I'm of course hopeful that my work re: the Theory of Financial Relativity will result is a much less brutal consequence for my efforts.  I've never been one to contemplate giving my life, literally, to science. Thankfully, I need not frame my work to deal with the politics of an impending revolution, nor do I have a guillotine-wielding Robespierre to consider, at least that I'm aware of.

As Lavoisier's theory generally states, in a closed system, Matter/mass can neither be created nor destroyed. It simply changes form.  Mass/Matter is fungible, flowing seamlessly from one state to another when energy is applied.  Matter is Matter.  For example, in economic terms an iPhone and the proverbial "steaming turd on a hot August sidewalk" have roughly the same mass, yet the perceived economic value is vastly different.

This post explores the human experience re: the mechanics of how our global economic systems place a value on various forms of Matter.   Here's a silly little chart to get us started.



Let's say for example, hypothetically of course, that there are only two things on this planet, "Matter" and "money".  Matter is defined as "everything" and "money" is defined as our perceived value of same.  Since Matter is a constant (it can't be created nor destroyed), simple math tells us that the relationship between the price people are willing to pay for Matter (at least on this planet....a closed system) and the amount of money available, is linear.  As our singular, omnipotent, all powerful imaginary central bank increases/decreases the money supply, the price that people are willing to pay for Matter increases/decreases proportionately.

So...Why does the Price of Matter actually matter?

Let's think this through.  If our imaginary money supply stays constant, the aggregate value of all global Matter also remains the constant.   There's a certain level of stability.  There's an expectation of equilibrium.  If the price of one type of matter goes up....another must go down.   People, who ironically are also made of Matter, have an easier time making rational decisions, determining value and allocating their money.

In an economic system, people convert matter to other types of matter through production, construction, marketing, hype, fraud and any conceivable method to create a higher perceived value, and hopefully, create some personal wealth for their efforts along the way. Perhaps they take wood, land, plastic and cement and create luxury real estate, or maybe throw together some aluminum, steel and engineering talent and Eureka! we have a jumbo jet!  In any case the perceived value of the end product should be much higher than the aggregate value of the components, providing of course, in this example, that there is enough "money" available, and people can afford the luxury Real Estate and/or the jumbo jets can actually stay in the air. As all of this activity takes place, it would be prudent for our singular, omnipotent, all powerful imaginary Central Bank to gradually increase the money supply to match the perceived value of what's being created.  Unless there's  a reasonable expansion of the money supply, as people perceive more value in a jumbo jet and they are willing to pay more for travel, compared to say, food or clothes, the relative perceived value (and price) of food and clothing would have to decline without said monetary expansion.  i.e.) There's only enough money to go around.

Here's where it gets complicated 

The above simple example describes the price/value relationship between one (1) currency and one (1) constant, universal economic good/service (Matter).  Today, our wonderful, big blue marble has more than seven billion people engaged in some sort of economic activity (production or consumption).  There are millions of businesses, all attempting to manage a perceived value of tens of billions of SKUs, barters, trades, goods and services. There are hundreds of governments trying to regulate the aforementioned activities for various, and usually conflicting political reasons.  There are 200+ Central Banks and currencies out there, thousands of financial institutions, and hundreds of trillions of dollars worth of "money", financial assets, stocks, bonds, derivatives, off the books IOU's, guarantees and god knows what else, all having their "perceived values" adjusted by Mr. Market nearly every millisecond.

All of this complexity and speed, of course, creates the possibility for mistakes and errors in judgment.  Dr. Richard Thaler, if you are familiar with his work on Choice Architecture, often cites the difference between humans and "Econs".  Humans, of course, are you and I. We make choices based on our own personal biases and limited knowledge, often failing to make the best choices. Econs, as Thaler describes, are people who have no biases, perfect knowledge and an aptitude to always make the best decision in any scenario.  Econ's, of course don't exist....so it looks like you and I (and seven billion of our neighbors) are relegated to the life of a human, muddling through with limited or incorrect information, inappropriate biases and an insufficient ability to analyze most of our daily conundrums.

Central Bank Coordination

Financial globalization has lead us to an unprecedented time in Central Bank history.  Like never before, the FED, PBOC, ECB, and the BOJ (the combined monetary engine for roughly 75% of the planet's economic activity) seem to be operating in a carefully choreographed stimulus dance, with each trying to take the lead and pick up the tempo at the expense of the others.  This waltz began with the BOJ's movement toward  Near-ZIRP in the late 1990's and was further validated by the FED's rate cuts, TARP and stimulus during the financial crisis.  Once the FED opened the door, albeit necessarily, to recapitalize the US Banking system, Central Bankers around the globe had an epiphany....they were born again,  They began implementing policy, which, under the guise of economic stimulus, did little more than support and inflate already bubble-ized asset prices.  It stands to reason that the Central Bankers will reach (if they haven't already) the point of no return.  It would appear that we are on an inevitable, accelerating pace to negative interest rates in every corner of the globe.  (Sweden, Denmark, Japan, Switzerland, etc. are already paving the way)  There is always some "crisis" on the horizon preventing the Central Bankers from "going up" that pesky quarter-point. This phenomenon was unthinkable a decade ago.

The FED Charts below illustrate the odd behavior of US Broad Money (M2) over the last few years.  M2 has nearly doubled in the last decade yet the velocity (defined as the ratio of the number of times one dollar is spent per quarter) continues to decline.




One would think that this relationship would be unlikely, if not, impossible.  Logically, circulation should increase (rather than decline) as the money supply increases.  For an answer to this paradox we need to look to Dr. Thaler's work in Behavioral Economics.  Since the financial crisis, all of this liquidity has been poured into the banking system.  Since the bankers are the gate keepers, deciding who gets a piece of all of this stimulus, we can only conclude that the lions share of this money has been "stuck" in the banking system and financial assets, i.e.) the often discussed "decoupling" of the financial system from the "real" economy. Simply put, the money isn't actually making its way to individuals and businesses which hire workers, spend money, increase consumption and therefore, velocity.  The money is being used to bid up the price of financial assets.  If we think about it for a minute, it makes perfect sense.  Most of us (bankers included) make the best choices available.  If we don't believe that we can expand our businesses profitably, we don't do it.  The folks at the top of the food chain would rather keep the money in financial assets, retirement accounts and savings.  (because they are generating a heck of a return)  They/we/us have no need to consume. Our consumption habits don't change all that much when we have a good year.  On the other hand, working folks, scrimping by on two part time jobs would most likely consume/spend every nickle they could if the money ever made it down to them.  Unfortunately for all of us, it doesn't.   So consumption, prices and wages don't increase....and we can't grow our businesses comfortably/profitably.  So we all hunker down.



Debt continues to grow.  As we can see by the chart below, Non-Financial (Core) and Public (Government) debt has increased significantly (US$ 23 Trillion) since 2010 with no appreciable accretion in GDP. Simply put, businesses and governments are borrowing to spur growth with comparatively little to show for it. Moreover, with China's NBS continuing to report dubious GDP/Growth/Production, and nearly all of the below described debt increase ($20 Billion) is attributable to the Chinese economy, the proliferation of non-productive, low quality (non-performing) debt may be accelerating at a much quicker rate than the traditional ratios might indicate. In other words, despite all of this stimulus, global GDP might actually be declining.      



Here's another chart (below) showing US GDP growth.......bumping along at a half -% or so per quarter.  It looks kind of pathetic when we think about the amount of money that's been deployed to generate this paltry growth.  You'd think that the GDP would be skyrocketing.  Again, the value of Matter that really matters... Matter that's "transformed" and "consumed" (GDP)..... has been flat. 



The FED is starting to rethink what's happening in this "New Economic Era".  Presumably they'll be working toward an increased focus on fiscal policy (which unfortunately is out of the FEDs control) in an effort to get more of the money they print into the hands of people who will actually spend it.   (see Williams - New Orthodoxy)

So What's the Problem?

Central banks can continue to ease, provide credit, roll over bad loans, absorb and recapitalize businesses, and keep money losing, zombie enterprises afloat indefinitely.  With a coordinated effort Central Bankers can support the price of bad Matter, continually breathing new life into an an economy chocked full of steaming financial turds.  So as the Central Banker's dance continues, the global money supply and related debt levels spiral upward.  As an economist, you might ask: Where is the inflation going?  Well, of course the disposition of inflation is government/economy specific.  The perceived value of Matter everywhere is being re-evaluated.  In the US we know inflation isn't going into wages or raw materials.  We've learned long ago that trickle down economics doesn't always trickle.  Sometimes the trickle gets diverted by Mr. Market.  I've postulated for a while now that we shouldn't be seeing a doubling in US equity prices (since 2009) with an anemic (2% +/-) annual growth in GDP, but that's where the inflation is hiding.  The US Stock Indexes just keep busting through record high after record high.  In China the inflation is "stuck" in vacant real estate and excess capacity.  I'm sure we can look at every economy participating in the global money supply expansion and make a "Where's Waldo" guess as to where they are storing their inflation.  As an aside, for those of us who work for a living, there doesn't seem to be much inflation showing up in our paychecks anywhere on the planet.  Yet, the retirement (income) assets we're hoping to buy with our savings are continually priced higher. The yield declines, until we will all eventually pay a fee  to save (negative rates).  This math, for a Central Banker, is apparently a fair trade for the avoidance of a systemic default

The Theory of Financial Relativity:

The cornerstone of the theory is:

"Central Bankers, acting in concert, expanding the money supply, funding, guaranteeing and recapitalizing debt, regardless of quality, can prevent the decline of the perceived value of the planet's aggregate Matter."

Everything is indeed..."Relative".  The proposed Theory, to be tested over time (Like most Macro-Economic Experiments there is unfortunately no test-lab available) is comprised of Five Underlying Banking/Accounting Rules (FUBAR):

  1. The aggregate value of Matter has a linear relationship with the supply of money.
  2. Prices of individual components of Matter(assets) will fluctuate based on their perceived value.
  3. Central Banks, acting in concert, can manage the perceived value of classes of Matter (assets) within a relative range through open market operations. i.e.) Purchasing anything their hearts desire with money hot off the press.
  4. Nominal prices are irrelevant as long as perceived value relationships remain constant within a relative range. 
  5. If classes of Matter (assets) never decline in value or default, Economic stability is guaranteed.

Of course, the key question is:  Does the world really have a theoretical debt ceiling?....if so...what is it?  The Theory of Financial Relativity would conclude that there is none.

It's a given that individual businesses, economies and governments all have a theoretical "debt limit". They borrow money and  reach their debt ceiling when their creditors believe, through complex analysis, there is a possibility that they might not be paid back.  At that point, lenders have their lawyers draft a carefully worded letter that says.  (Dick Fuld Banker-Speak-Translator "BST" Translation:):  "NO MORE %$&#!! MONEY FOR YOU!....YOU LOSER!....GIVE ME MY MONEY BACK NOW!".   These letters are of course, generally ineffective (the money is gone/spent), but they feel good to write and legally absolve the author from any responsibility to shareholders or regulators for making the bad loans in the first place. As a nugget of trivia, I believe the Mafia coined the term "debt ceiling"....or was that "cement overshoes".....but I digress.

Let's consider the possibility (and it seems to be happening), that if all of the Central Banks on the planet are on the same page and collude to prevent any and all defaults, they will all keep printing money at a coordinated rate, maintain stable currency relationships and allow borrowers to keep paying debt service with cheaper and cheaper currency.  If Central Bankers continually increase the outstanding global debt and money supply (i.e. nobody demands their money back, similar to how the PBOC is operating today) the cycle could conceivably continue on forever.  Central Bankers, when they work as a team, can simply keep printing money, preventing anyone from having to send out those nasty "GIVE ME MY MONEY BACK!" letters.  Like in China today, everyone gets a participation trophy.  The world is sunshine lollipops and rainbows in perpetuity.

Carlo Reiter, an analyst at JCAP estimates that the Chinese Central Bank (PBOC) spends RMB 570 to 600 Billion (US$ 85 to 90 Billion) per month rolling over bad loans that would otherwise be considered non-performing (NPLs).  One series of actions which might indicate that the FED, ECB and BOJ are acting in concert with the PBOC would be a continued, coordinated easing to assist the PBOC in an orderly depreciation of the RMB.  Carlo expects this roll-over-funding to continue and the RMB could decline by up to 15% within the year.  If Carlo is correct, for this to be a truly orderly adjustment, the PBOC will absolutely need a little help from their friends.  If the Theory of Financial Relativity is genuinely being implemented, we can expect this stealth refunding and expansion of Open Market Operations to accelerate, softening the blow when perceived value shifts, if and when Central Banks around the globe deem it necessary to step in.

Naturally, Central Bank Balance sheets continue to expand. (Yardeni)  Combined assets (FED, PBOC, BOJ & ECB) have increased nearly US$ 2 Trillion, to roughly US$ 17.3 Trillion this year. This increase would most likely be even greater had the PBOC not been required to spend "a few hundred billion" of its FOREX reserves defending an over-valued RMB.  (Remember my post a year and half ago.....China's Dream?)  Of note, this increase, of course wasn't a liquidity driven TARP-like-free-for-all yard sale where the Central Banks were forced to buy every orphan, unwanted security on the street in order to keep financial markets from freezing up.  The bulk of this expansion, as far as we can tell, has been voluntary.  Global, pre-crisis balance sheet levels were roughly US$ 6 Trillion and rose to about US$9 Trillion once liquidity was safely restored.  Today, Central Bank Assets have nearly doubled from that level.  As you might suspect, it's apparently lots of fun to print money and buy stuff!    


Moreover, the "Theory of Financial Relativity" provides that, as long as the perceived value relationships remain constant, the nominal value of assets (Matter) is irrelevant.  Asset prices might be increasing at the speed of light but it feels like we are standing still.  There is no debt ceiling and there can never be an actual default.  The deck chairs are simply reshuffled.  Sadly, there is also no real economic growth.  Like Major League Baseball during the steroid era, all of the historic ratios become meaningless. Wages and commodity prices will always decline in real terms since new money must be used to roll-over bad debt, stave off defaults and pay the negligible debt service due to BZIRP.  (Below-Zero-Interest-Rate-Policy....like the Frozen theme song....just "let it go"...) Interest rates must remain negative forever. Yet, the world remains in equilibrium.

So, you might ask, what happens if one of the major players won't/can't participate in the choreography? What happens if  some political shock appears on the horizon that a coordinated Central Bank effort can't handle?  What if the currency/valuation relationships are disrupted?  What if Central Bankers just can't seem to get along, or god forbid, disagree?  Isn't there a good chance that the rogue economy/Central Bank might be sucked into a financial black hole, taking anything near its' perimeter (counter-party) with it?  Well, yes, of course, that probability exists, just as it always has, but I might suggest that there is also a point where, once the giant ball of global debt reaches a critical mass, the consequences for not playing along would be so severe that no banker or politician would dare tempt fate.  The safe political path would always be to continue pumping stimulus into zombie banks, paying paltry debt service on loans that will never be paid back in a mad scramble to an undefinable, infinite bottom.

Central Bankers behavior would resemble a financial arms race reminiscent of the cold war. Remember MAD? "Mutually Assured Destruction"?.  (Authors Note: When I typed that phrase I had a chilling flashback of the days when my classmates and I would huddle under our kindergarten desks when the Nuclear drill alarm went off.)   The deterrent of MAD relied on the belief that the consequences of launching a missile were so dire that it was thought no rational leader would ever consider doing it.  Central Bankers may be nearing a monetary MAD, but instead of ICBM's, today we use junk bonds, derivatives, "dog-shit-wrapped-in-cat-shit"CDO's and the discount rate.  Today, no rational Central Banker would dare tighten unilaterally.  When they press the button they would risk destroying the global financial equilibrium and their own country's economy....along with everyone elses.  What Central Banker worth his/her salt would want his/her picture to pop up after a Wikipedia search entitled: "Dude responsible for the Global Financial Armageddon"?

Interestingly, there may also be, in this author's opinion, a moral hazard attached to all of this acceleration.  The money we've earned and managed to save from back in the 80's & 90's, when treated like any other commodity, declines in value rapidly.   When the supply of dollars/currency increases geometrically, every one of those original '80's & '90's dollars is now worth a fraction of what it was worth when we earned/saved it, in terms of purchasing power.  The value of our savings is destroyed.  As a "saver" choices become limited.  Our life savings is the validation of our hard work and good decisions over the last few decades.  Today, as Investors, we can either 1.) "Invest" in risk assets that should either increase dramatically in nominal terms if the Central Bankers stay the course..... or could go away overnight if the choreography of the Central Bankers is somehow violently disrupted; or 2.) hold cash and watch its purchasing power silently devalue over time.  Risk averse savers on fixed incomes (our Mom's & Dad's and eventually you and I) will slowly go broke.  Sadly, those are really our only two (2) options today.

Therefore, if the Theory of Financial Relativity is correct, and Central Bankers will never permit risk asset prices (in aggregate) to decline, we should all throw caution to the wind and trust our Central Bankers.  We should pile our savings into risk assets (stocks & derivatives tied to stock performance) forever. Jeremy Siegel was right!  We're all going to be filthy rich (in nominal terms) without doing a blessed thing!  Participation trophies all around!


The Only (Painless) Way Out.....

Now, let's say that, perhaps, just for the sake of argument, that the Theory of Financial Relativity (what's happening now) might be.....well.....and I shudder to think it......dead wrong.   I'm not talking about an Ooops...I bounced a check or forgot to renew my license plates kind of "wrong".  I'm talking about something more like a "the world is flat...this ship is unsinkable.....those O-rings should work just fine... and I'm positive Saddam has Weapons of Mass Destruction" fire and brimstone kind of "wrong".  As a scientist (particularly an Economist), I feel it's my duty, and only prudent, to speculate about the ramifications of being catastrophically wrong.  It's just part of the job.

The first way out, of course, is the aforementioned valuation reset and a Global Financial Armageddon, which hopefully no Central Banker would be in favor of.

The second path, and perhaps, the only painless way out of this spiral might be a carefully choreographed, cooperative, global Central Bank tightening? Central Banks would/could/should meticulously coordinate a slow march back up to "normal" interest rates, hopefully in a cooperative, joint effort, limiting market disruption, restoring the perceived value of savings and salvaging the future for the generations to come. Or, in the nearly immortal words of the globally respected economist, Dr. Tom Petty:  "Hey ....Baby....there ain't no easy way out.....You can stand me up at the gates of hell....but I won't back down..."

Success, of course would demand that Central Bankers lay all of their cards on the table and come clean, describing, in great detail, all of the skeletons in their collective closets and own up to all of the politically motivated misrepresentations and accounting gimmicks they've cooked up over the last decade.  Agendas, ideologies and self-interest would be put aside.  Peace and harmony would flood the streets.  Central Bankers would march arm in arm, shoulder to shoulder on Washington, Frankfurt, Beijing and Tokyo, armed with the truth, demanding monetary responsibility and a new, cooperative world order.  No Banker left behind....No Justice!....No Peace!.....Power to the People!.....They would rise up in stalwart unity, forever Facebook friends, dedicated to the proposition that they will no longer facilitate financial weapons of mass destruction fueled by cheap money and irresponsible, steaming financial turd proliferation.   As has been aptly demonstrated on the interest rate spiral down, Central Bankers are a brilliant, cooperative, benevolent, politically savvy group, deeply concerned about the common good and the welfare of all mankind.. and.....hey stop laughing!....it could happen!.....

Armageddon here we come.....


Additional Reading:

April 21st Yahoo! Finance Interview
http://finance.yahoo.com/news/ecbs-draghi-havent-talked-helicopter-124843859.html

Negative Interest Rates
http://www.bloomberg.com/quicktake/negative-interest-rates

People are starting to look.....Anne Stevenson Yang at Grant's re: RMB
http://www.valuewalk.com/2016/04/alibaba-group-holding-ltd-baba-jcap/

Gordon Chang - China's Credit growing 4x GDP
http://www.forbes.com/sites/gordonchang/2016/04/17/china-credit-growing-four-times-faster-than-gdp/#190b9108256c

Interest Rates
http://www.global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/central-bank-china/pbc-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/european-central-bank/ecb-interest-rate.aspx
http://www.global-rates.com/interest-rates/central-banks/central-bank-japan/boj-interest-rate.aspx

CIA Factbook - Total Stock of Domestic Credit
https://www.cia.gov/library/publications/resources/the-world-factbook/rankorder/2211rank.html

World Bank - Domestic Credit
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=US
http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS?locations=CN

BIS - Debt Statistics
http://www.bis.org/statistics/totcredit/tables_f.pdf

Trading Economics - US, EU, China, JPN Stats
http://www.tradingeconomics.com/country-list/government-debt-to-gdp

MAD Flashback
https://www.youtube.com/watch?v=sTJ0GB1ltAQ

John Williams - SF Fed President - Take on ZIRP
http://www.bloomberg.com/news/articles/2016-08-15/williams-calls-for-rethink-of-fed-orthodoxy-in-new-economic-era

Bloomberg - Monetary Policy
http://www.bloomberg.com/news/videos/2016-08-17/trennert-monetary-policy-has-become-actually-harmful?cmpid=yhoo.headline&yptr=yahoo

Yardini - Central Bank Balance Sheets
http://www.yardeni.com/pub/PEACOCKFEDECBASSETS.pdf




Thursday, August 11, 2016

Really?.....how silly can these numbers get?

Well, I just finished listening to the Alibaba Investor Call and reviewing the press release & 6K.

What can I say.....It just keeps getting better and better.

Here are the links:

Webcast
http://edge.media-server.com/m/p/wnauw9sh/r/1
Press Release
http://www.alibabagroup.com/en/news/press_pdf/p160811.pdf
Presentation:
http://www.alibabagroup.com/en/ir/presentations/pre160811.pdf
SEC Filing:
https://www.sec.gov/Archives/edgar/data/1577552/000110465916138896/a16-16621_1ex99d1.htm


My history of the Alibaba growth phenomenon is chronicled in "It's Like Deja Vu ....all over Again..."  I won't bother rehashing how we got here, but this Investor Call was even more entertaining than the last.....here are the bullets:.

1.) Astounding Revenue Growth (59% year over year for the quarter ended).  No other (real) large business or economy on the planet is experiencing this type of growth. Businesses all over the world are generally treading water right now, looking for direction and sanctuary,  Global growth, even though supported by extraordinary levels of Central Bank stimulus can best be described as stagnant, yet Alibaba's reported growth story is somehow immune to macro-economic factors.

2.) Even though Alibaba's GMV growth has slowed to just 24% YOY, if we have some fun with ratios, we can extrapolate that Alibaba's GMV this year, with a "conservative" 24% annual growth rate will be just short of US$ 600 Billion (Using this quarter's slowing 24% GMV growth rate applied to the 3/31/16 YE numbers).  This extrapolated number now becomes 125% of Walmart's annual sales.   If Alibaba's projected GMV were GDP, Alibaba would then be the 34th largest Economy on the planet, right behind the United Arab Emirates.  They've somehow accomplished this economic miracle with 35,000 employees, a few computers and an "ecosystem" of undisclosed, odd partnerships that somehow get these goods from point A to point B.  Truly amazing.

3.) Share-Based Compensation (Stock Grants & Options) slowed a bit to $556 million for the quarter, but continue through the roof at 11% of FQR (i.e. Fake Quarterly Revenue ).  Since FQR increased 59% this naturally drives the SBC ratio lower.  Math is a wonderful thing.

4.) The creation of "Questionable Assets" also accelerated dramatically during the quarter.  Questionable Assets (as defined in prior posts) increased by US$ 8.4 Billion during the quarter and now comprise 2/3rds of the Balance Sheet.





















As an aside, did they really convert US$ 8.4 Billion in cash to financial vapor in just three months? Again, there is no discussion re: the details/components of this gigantic write up/purchase in the Investor Call, Press Release, Presentation or 6K filing.  They've increased these same "Questionable Assets" a whopping $30 Billion in just two short years (since the IPO), fueled primarily by increased bank debt, bond issues and the IPO money.  How is this even possible?  At some point, these investments (aka  boondoggles) will have to be written down/off.  This is indeed a milestone quarter for Alibaba.  It's the the first quarter where "Questionable Assets" have exceeded Shareholder Equity. If I'm indeed directionally correct about the "real" value of all of this intangible fluff, Alibaba is un-officially insolvent as I type.

5.) For the first time the Group has reported Segment data.  (pg 7 of the Press release).  All of the acquisitions generally since the IPO, described as Cloud Computing, Digital Media & Entertainment and Innovation Initiatives contributed operating losses of US$ 581 million.  BABA's share of losses for its' "Equity Investees" (Koubei, Youku Tudou, Cainiao, et al.) came in at US$ 221 Million, more than doubling the loss for the prior quarter.  (pg 15 of the 6K)  From a purely cash flow perspective, these businesses are providing about as much utility as a steaming turd on a hot August sidewalk.

6.) Costs are skyrocketing.  Quarterly Expenses excluding Share Based Compensation (SBC) increased by US$1.29 Billion on an absolute basis, or an additional 7% of Revenue YOY. (pg 11 of the 6K)

7.) Borrowing has also, of course, increased significantly in the quarter.  Liabilities are up by US$5 Billion, of which US$ 3 Billion is Non-Current Bank borrowing. (pg 22 of the 6K)

8.) They are burning through cash like drunken sailors.  Despite all of that additional borrowing, Cash & Equivalents declined US$ 3.7 Billion.  (pg 24 of the 6K).  US$ 2 Billion was used to Repurchase (support) BABA shares from Softbank at US$74.00 per share, ostensibly to help Mr. Son, an Alibaba director, out of his own self-inflicted mess.

9.) Again, there is no detail provided for the required Alipay/Ant Financial profit sharing accrual and "processing fee" offset.  Presumably, since there is no discussion of the net profit-sharing amount, it stands to reason that there must continue to be no significant profits in Alipay/Ant.  Perhaps they have adopted the Lending Club (NYSE:LC) model. (i.e.) Make under-priced loans to un-bankable businesses and hope for the best.  It might look good for a while, but as we learn repeatedly, it's hardly sustainable.

10.) Finally, in my mind the most important figure, the FNI (Fake Net Income)  decreased Q over Q from US$ 4.6 Billion in 2015 to US$ 1.1 Billion in the quarter just ended (pg. 26 of the Press Release).  It's actually relatively flat after the elimination of the absurd prior year US$ 4 Billion  "Gain on deemed disposals/disposals/ revaluation of investments and others" (Authors note: That description still cracks me up whenever I read it.  You just can't make this stuff up.)  This Net Income number (albeit fake) is shockingly small for a business which purportedly has cornered the e-Commerce market in China, (US$125 Billion GMV in the quarter) shares profits with the preferred payment method of every Chinese Consumer (900 million registered Alipay users) and holds estimates of up to US$ 200 Billion of the Hard-Working-Chinese People's money in related, off the books investment funds.  Moreover, Alibaba's demonstrated, unquenchable thirst for cash is far from typical of a business that, by Alibaba's own account has a virtual monopoly on eCommerce, and all that is on-line in the "World's Second Biggest Economy".  With reported dominance like this, one would think that Alibaba treasury personnel should be driving to the bank daily with dump trucks full of cash to deposit, rather than scouring the globe for more sucker capital lurking under any remote off-shore rock they are fortunate enough to overturn.

Sarbanes-Oxley

All that said, to jump off on a tangent, some of my readers have been opining that, for some reason, Sarbox doesn't apply to Alibaba since it's an off-shore ADR.  I'm not sure where this is coming from and I've addressed it privately via email.  Sarbox absolutely applies to Alibaba management.  I've also attached a link to the Alibaba Audit Committee Charter spelling out the committee's Sarbox Responsibilities as they apply to the signors, Daniel and Maggie. Again, even though the Sarbox sanctions, penalties and fines apply to them, my assertions that they are "safe in China"would seem reasonable.  Like the financial equivalent of the Nuremberg trials, they could only be prosecuted in absentia, as I doubt their lawyers would advise them to get on a plane and defend themselves in an American court room.  If you are reading this and have any additional insight, or work in the world of Sarbox, please fill me in, I'd enjoy hearing your thoughts. Fascinating stuff.

Last Words....

Moreover, and again I need to emphasize this, Alibaba's audit work-papers and supporting data for their bizarre, incomplete, fragmented financial statements have never been available for regulatory review.   Regulators continue to clamor for access, but oddly, are stymied every step of the way.  When domestic businesses refuse to comply, regulators have lots of hammers available and never hesitate to swing them. For whatever reason, with Alibaba, regulators are either reluctant or unable to do their job. Which, of course begs the question, how could a business like this have ever been allowed to list on a US Exchange in the first place?

On the other hand, Mr. Market seems to think all is peachy, driving the Alibaba stock price up another 5% after they reported today.

Finally, given all of the convoluted discussion above, I have to hand it to them.  Just when I think Alibaba management couldn't possibly report anything sillier than they already have, they go ahead and do something like what we've seen today.........and totally redeem themselves!


More Relevant Reading

Alibaba Audit Comittee Charter -  SARBOX Responsibilities
http://docs.alibabagroup.com/assets2/pdf/Audit_Committee_en.pdf

CIA - World Fact Book
https://www.cia.gov/library/publications/the-world-factbook/rankorder/2001rank.html

Alibaba WSJ Comments prior to the Earnings Call
http://www.wsj.com/articles/analysts-seek-clarity-on-alibabas-accounting-practices-1470774166

Alibaba - WSJ - Auditor Limitations
http://www.wsj.com/articles/u-s-regulator-expected-to-get-access-to-alibaba-baidu-financials-1470377222