Category Archives: Capitalism

Asset-Stripping by Private Equity Firms Is Booming, by Wolf Richter

There are many ways to legally steal money, and asset-stripping ranks close to the top of the list. From Wolf Richter at wolfstreet.com:

Here are the numbers. Peak chase-for-yield by institutional investors?

Most of the brick-and-mortar retailers that have filed for bankruptcy protection to be restructured or liquidated over the past two years have been owned by private equity firms – including the most recent major casualty, Toys ‘R’ Us. Part of how PE firms make money is by stripping capital out of their portfolio companies via special dividends funded by “leveraged loans” – more on those in a moment – leaving these companies in a very precarious condition.

So just how much have PE firms paid themselves in special dividends extracted from their portfolio companies? $4.76 billion in the third quarter, bringing the year-to-date total to $15.3 billion. So the year-total for 2017 is going to be a doozie.

In all of 2016, this sort of activity – “recapitalization,” as it’s called euphemistically – amounted to $15.7 billion, up from $10.5 billion in 2015, according to LCD, of S&P Global Market Intelligence. LCD’s chart shows the quarterly totals:

“This high-profile recap activity is a sign of the times in today’s still-overheated leveraged loan market,” LCD says:

Deals such as these typically proliferate when there is excess investor demand, allowing borrowers to undertake “opportunistic” issuance, such as corporate entities refinancing debt at a cheaper rate or, here, PE firms adding debt onto portfolio companies, then paying themselves an often hefty dividend with the proceeds.

As private-equity-owned retailers that are now defaulting on their debts have shown: this type of activity where cash is stripped out of the portfolio company and replaced with borrowed money is very risky.

Leveraged loans are provided by a group of lenders to junk-rated over-indebted companies. They’re structured, arranged, and administered by one or several banks. But leveraged loans are too risky for banks to keep on their balance sheet. Instead, banks sell the structured products to loan mutual funds or ETFs so that they can be moved into retirement portfolios, or they repackage them into Collateralized Loan Obligations (CLO) to sell them to institutional investors, such as mutual-fund companies.

To continue reading: Asset-Stripping by Private Equity Firms Is Booming

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Personal Recollections From The Crash Of 1987: “There Was No ‘Smart Money’ That Day!” by John S. Lyons

We’re coming up on October 19, the 30th anniversary of a hellacious stock market crash. Will the market crash soon? Probably not, its usually trends down for a period before it crashes. That was the case in 1987, when the stock market topped out in August. From John S. Lyons at LyonsSharePro.com via zerohedge.com:

Personal Recollections of the Crash of 1987 on its 30th Anniversary

“There was no ‘smart money’ that day.”

What do the assassination of President John F Kennedy, the beginning of Desert Storm and 9/11 have in common? Provided you are old enough to recall JFK’s assassination, the answer probably is that you remember exactly where you were on the day of those events. If not that old, there is most likely another event that is so memorable that you recall where you were and what you were doing at that moment.

Being in the securities business for many, many years, the Crash of ’87 on October 19th of that year is right up there with JFK’s assassination and 9/11 as one of the mind-numbing catastrophes I’ve witnessed.

In retrospect only, it was fortunate that I had entered the brokerage business in 1969 and immediately weathered a 36% market decline into 1970. On the heels of that decline, I then endured one of the worst bear markets in modern history in 1973-74 when the Dow Jones Industrial Average lost almost 50% of its value. As a result, I was weaned on risk in my new profession. And I learned early on that if a career that centered around the stock market were to be endurable, I had to find a way to practice risk management.

As a result, I developed a risk model during the 1970’s as a means of guarding against such disastrous losses in the future. Fortunately, the model has been of very valuable assistance, protecting clients from every major decline since its inception in 1978. Its Sell Signals have occurred prior to insignificant declines as well, but its risk avoidance guidance supersedes those times. On September 25th of 1987, for example, our model issued a Sell Signal and I sold over half of my clients’ holdings. I was reminded just recently by an associate of mine at that time about how he passed by my office that day and was amazed at the pile of sell orders on my desk.

To continue reading: Personal Recollections From The Crash Of 1987: “There Was No ‘Smart Money’ That Day!”

The Curious Case of Missing the Market Boom, by Raúl Ilargi Meijer

You only benefit from a booming financial market if you sell at a higher price than you buy. Most people don’t do that. From  Raúl Ilargi Meijer at theautomaticearth.com:

“The Cost of Missing the Market Boom is Skyrocketing”, says a Bloomberg headline today. That must be the scariest headline I’ve seen in quite a while. For starters, it’s misleading, because people who ‘missed’ the boom haven’t lost anything other than virtual wealth, which is also the only thing those who haven’t ‘missed’ it, have acquired.

Well, sure, unless they sell their stocks. But a large majority of them won’t, because then they would ‘miss’ out on the market boom… Some aspects of psychology don’t require years of study. Is that what behavioral economics is all about?

And it’s not just the headline, the entire article is scary as all hell. It reads way more like a piece of pure and undiluted stockbroker propaganda that it does resemble actual objective journalism, which Bloomberg would like to tell you it delivers. And it makes its point using some pretty dubious claims to boot:

The Cost of Missing the Market Boom Is Skyrocketing

Skepticism in global equity markets is getting expensive. From Japan to Brazil and the U.S. as well as places like Greece and Ukraine, an epic year in equities is defying naysayers and rewarding anyone who staked a claim on corporate ownership. Records are falling, with about a quarter of national equity benchmarks at or within 2% of an all-time high.

If equity markets in places like Greece and Ukraine, ravaged by -in that order- financial and/or actual warfare, are booming, you don’t need to fire too many neurons to understand something’s amiss. Some of their companies may be doing okay, but not their entire economies. Their boom must be a warning sign, not some bullish signal. That makes no sense. Stocks in Aleppo may be thriving too, but…

“You’ve heard people being bearish for eight years. They were wrong,” said Jeffrey Saut, chief investment strategist at St. Petersburg, Florida-based Raymond James, which oversees $500 billion. “The proof is in the returns.” To put this year’s gains in perspective, the value of global equities is now 3 1/2 times that at the financial crisis bottom in March 2009.

If markets crash by, pick a number, 20-30-50% next week, will Mr. Saut still claim “The proof is in the returns”? I doubt it. Though this time he might be right. As for the ‘value’ of global equities being 250% (give or take) higher than in March 2009, does that mean those who were -or still are- bearish were wrong? Or is there some remote chance that the equities are part of a giant planetwide bubble?

To continue reading: The Curious Case of Missing the Market Boom

Hard Core Doom Porn, by Robert Gore

It will be a crash like we’ve never seen before.

SLL has been accused of trafficking in “doom porn.” Guilty as charged. If you don’t like doom porn, don’t read this article, it’s hard core. If you prefer feel good and heartwarming, there are plenty of Wall Street research reports and mainstream media stories about the economy available. Enjoy!

In 1971, President Nixon closed the “gold window,” which allowed foreign governments to exchange their dollars for gold. This severed the last link between any government and central bank-created debt and the real economy. Debt could be conjured at whim, and governments and central banks have done so for the last 46 years.

Not surprisingly, credit creation without restraint has papered the globe with the greatest pile of debt mankind has ever amassed, measured in nominal terms or relative to the underlying economy. A measure of how extraordinary this situation is: most people regard it as normal, if they think of it all. Debt is a first mover, a financial constant. Any exigency small or large can be met from an unlimited credit pool that will always be with us. How to rebuild Houston, Florida, and Puerto Rico? No problem, borrow.

Although fiat credit creation by governments and central banks is unconnected to the real economy, its effects are not. Their debt becomes an asset within the financial system. Through fractional reserve banking, securitization, and derivatives it become the basis for a multiplication of the original debt. That multiplication is many times the multiplier (the reciprocal of the reserve requirement) taught in introductory macroeconomics classes whereby the debt is contained within the banking system.

Nominal global debt is reckoned at between $225 and $250 trillion, or about three times global GDP. Financial, debt-supported derivatives (financial instruments whose prices are derived from the prices of other financial instruments) are estimated at anywhere from $500 trillion to $1 quadrillion notational, or six to twelve times global GDP.

Overpriced houses did not cause the last financial crisis and almost bring down the world’s financial system, securitized packages of mortgages and their associated derivatives did. The Panglossian view of derivatives is that most of them can be netted out against offsetting derivatives, thus actual exposures are far less that notational amounts. The real world view is they can only be netted out as long as all counterparties remain solvent. As we learned in 2009, that is not always a correct assumption.

Globally, unfunded old age pension and medical liabilities, not counted as debt but still promises made that often have the force of law, sum to another $400 trillion. In the US, they are about $210 trillion, or about 11 times US GDP. Demographics amplify the liability: across the developed world, declining birth rates and extensions in life expectancies mean a shrinking pool of workers supports an expanding pool of beneficiaries. In the last month, SLL has posted four excellent articles by John Mauldin for those who want all the gruesome details. (Just enter John Mauldin in SLL’s search box and they’ll pop right up.)

This doom porn, the skeptics will say, is almost as old as Deep Throat (released in 1972). Markets crash from time to time, but they always bounce back. Central banks and governments come to the rescue with fiscal stimulus (increased government debt) and unlimited fiat debt. Why should we worry now?

There are a number of reasons. When the world was less indebted, a fiat currency unit’s worth of debt produced more than a fiat currency unit’s worth of expanded output of goods and services. Sometime within the last year or two, the marginal economic effectiveness of all that government and central bank debt reached zero, and is negative after debt service.

With the world saturated in debt, another fiat currency unit of debt produces no increase in output. Kick in the costs of servicing and repaying that debt, and increasing debt is actually retarding economic growth. It accounts for the long-term slowing growth trend, flat incomes, and “secular stagnation” that puzzle so many economists.

It also accounts for the lack of inflation that puzzles so many central bankers, at least in the price indexes they look at. They are looking at the wrong indexes. The relevant indicia are stock, high-grade bond, real estate, and cryptocurrency prices, still at or close to record highs, and corporate and securitized-debt credit spreads to treasury benchmarks at record lows (indicating massive complacency about corporate credit risk). Here inflation—the speculative kind that blows bubbles—is alive and thriving.

With the Federal Reserve now taking steps to shrink its balance sheet and other central banks making noises about doing the same, global fiat debt creation may go into reverse for the first time in many years. Brandon Smith at Alt-Market.com argues that this is part of plan leading to a crash and global, centralized monetary control.

He may or may not be on to something, however, valuation extremes and sentiment indicators point to the same conclusion concerning a crash. SLL maintains financial markets are exercises in crowd psychology, impervious to government and central bank efforts to control them, designed to separate the maximum number of speculators from a maximum amount of their money.

Robert Prechter, of Elliott Wave International, has written the chapter and the verse on markets and psychology. (SLL reviewed his groundbreaking tome, The Socionomic Theory of Finance.) Consider the following from Elliot Wave International’s October “Financial Forecast.”

Every month another sentiment indicator seems to pop to a frothy new extreme. Last month it was the percentage of cash that members of the American Association of Individual Investors harbored in their investment portfolios. At 14.5%, it was the smallest allocation to this safe alternative since January 2000, the same month that the Dow Industrials began a 38% decline that lasted through October 2002. Last month, we also showed a new bullish extreme for the five-day average of Market Vane’s Bullish Consensus survey of advisors. On September 15, the average pushed to 71%, a new ten-year extreme.

The most recent Commitment of Traders Report shows that Large Speculators in futures on the CBOE Volatility Index (VIX) have amassed a record net- short position of 172,395 contracts.

This record bet on subdued volatility sets the stage perfectly for the period of “high volatility” that EWFF called for in August.

…Large Speculators in the E-mini DJIA futures have pushed their net-long position to 95,976 contracts, more than four times the number of contracts they held in January 2008, shortly after the Dow started its largest percentage decline since 1929. So, investors are betting to a record degree that the stock market will continue to rise and volatility will continue to remain subdued. Paradoxically, these measures indicate that exact opposite.

Various media accounts confirm that a rare complacency now dominates the stock market.

One doesn’t have to buy in to socionomics to realize that virtually everyone is now on the same side of the boat, a condition generally followed by the boat capsizing. Using conventional valuation measures, the only time stocks have been more highly valued is just before the tech wreck in 2000.

If one does buy into socionomics, the last few upward squiggles in the stock market will put the finishing touches on intermediate, primary, cycle, supercycle, and grand supercycle Elliot Waves dating back to 2016, 2009, 1974, 1932, and the 1780s, respectively. In other words, this is going to be a crash for the ages.

Given the unprecedented level of global debt, that appears to be the most likely scenario. Every financial asset in the world is either a debt claim or an even less secure equity claim—a claim on what’s left after debt is paid. Much of the world’s real, tangible assets are mortgaged.

When the debt bubble implodes, a global margin call will prompt forced selling, driving down all asset prices precipitously. Most of what is currently regarded as wealth will vanish. Opening up the world’s fiat debt spigots full force won’t stop this one. The notions that governments and central banks have speculators’ backs, that problems caused by excessive debt can be solved with more debt, will be revealed as monumental follies. And markets will not come back, at least in our lifetimes.

Long-time readers will point out that SLL has been issuing warnings for years. Again, guilty as charged. However, we’ll join Mr. Prechter and company in their prediction that US equity markets top out before the end of this year. (They called last year’s top in the government bond market, adding to an impressive list of correct calls.) If we’re wrong, it won’t be the first or last time. If we’re right, given the magnitude of what’s coming, being a few years early won’t matter at all. Our concluding clichés: fear is stronger than greed and markets go down much quicker than they go up.

Alt-Historical Fiction!

AMAZON

KINDLE

NOOK

He Said That? 9/23/17

From Garet Garrett (1878–1954), American journalist and author, noted for his opposition to the New Dealand U.S. involvement in World War II. “The Balance Sheet of Capitalism,” (May 19, 1934):

The whole of the emotional case against capitalism turns on the unequal distribution of wealth. But is it peculiar to the nature of capitalism to concentrate wealth in a few hands? Here the first aspect truth
is a little hard. It begins with the human disparities; and for these, God is responsible, not capitalism. Much more, perhaps, than we wish to believe, economic inequalities answer to human inequalities.

Again and again, wealth has been socially divided and then, in a little while, it has been again as it was before, that a few were rich and many were not. Lycurgus, who did it for the Spartans, heaping
all their wealth in one pile and then, dividing it equally, thought of measures to make this pleasing equality permanent. He banished gold and silver money and put in place of it iron money so heavy
and so nearly worthless that to hoard or save it would be absurd. All the same, it was not long until again there were debtors and creditors and a concentration of wealth in the hands of a few.

Such a very old fact has a kind of simplicity. Somewhat more than nine-tenths of us consume all that we receive, and would consume it all, no
matter how much it would be. The wish to accumulate wealth is universal; the will to do it belongs only to a few, and the proportion of those
few in any kind of society has probably been constant for thousands of years.

Bubble Fortunes, by Raúl Ilargi Meijer

A lot of bubble fortunes will be no more when the bubble pops. From Raúl Ilargi Meijer at theautomaticearth.com:

A few days ago, former Reagan Budget Director and -apparently- permabear (aka perennial bear) David Stockman did an interview (see below) with Stuart Varney at Fox -a permabull?!-, who started off with ‘the stock rally goes on’ despite a London terror attack and the North Korea missile situation. His first statement to Stockman was something in the vein of “if I had listened to you at any time after the past 2-3 years, I’d have lost a fortune..” Stockman shot back with (paraphrased): “if you’d have listened to me in 2000, 2004, you’d have dodged a bullet”, and at some point later “get out of bonds, get out of stocks, it’s a dangerous casino.” Familiar territory for most of you.

I happen to think Stockman is right, and if anything, he doesn’t go far enough, strong enough. What that makes me I don’t know, what’s deeper and longer than perennial or perma? But it’s Varney’s assumption that he would have lost a fortune that triggered me this time around. Because it’s an assumption built on an assumption, and pretty soon it’s assumptions all the way down.

First, that fortune is not real, unless and until he sells the stocks and bonds he made it with. If he has, that would indicate that he doesn’t believe in the market anymore, which is not very likely for a permabull to do. So Varney probably still has his paper ‘fortune’. I’m using him as an example, of course, of all the permabulls and others who hold such paper.

Presumably, they often also think they have made a fortune, and presumably they also think that means they are smart. But that begs a question: how can it be smart to put one’s money into paper that is ‘worth’ what it is today ONLY because the world’s central banks have been handed the power to save the ailing banks that own them with many trillions of freshly printed QE? And no, there can be no doubt of that.

And there are plenty other data that tell the story. The world’s central banks have blown giant bubbles all over the place. That’s where the bulls’ “fortunes” come from. They are bubble fortunes. It has nothing to do with being smart. And of course, as I’ve said many times before, there are no investors left to begin with, because you can’t be an investor if there are no functioning markets, and for a market to function you need price discovery.

To continue reading: Bubble Fortunes

21st Century Shoe-Shine Boys, by Pater Tenebrarum

This article is pretty much chapter and verse on why the stock market should head down soon. It’s a good primer for those blissfully unaware of downside risk. From Pater Tenebrarum at acting-man.com:

Anecdotal Flags are Waved

“If a shoeshine boy can predict where this market is going to go, then it’s no place for a man with a lot of money to lose.”

– Joseph Kennedy

It is actually a true story as far as we know – Joseph Kennedy, by all accounts an extremely shrewd businessman and investor (despite the fact that he had graduated in economics*), really did get his shoes shined on Wall Street one fine morning, and the shoe-shine boy, one Pat Bologna, asked him if he wanted a few stock tips. Kennedy was amused and intrigued and encouraged him to go ahead. Bologna wrote a few ticker symbols on a piece of paper, and when Kennedy later that day compared the list to the ticker tape, he realized that all the stocks on Bologna’s list had made strong gains. This happened a few months before the crash of 1929.

 

Joseph Kennedy in 1914, at age 25 – at the time reportedly “the youngest ever bank president in the US”

Photo credit: John F. Kennedy Presidential Library and Museum, Boston.

Kennedy sold all his stock market investments over the next several months and put the money in what he considered the safest banks. He had already made a fortune in the bull market, and reportedly augmented it later by going short in the bear market. We are pretty sure his meeting with the market-savvy shoe-shine boy wasn’t the only reason for which he decided to sell. He did mention the anecdote later in life though and the experience served to solidify a conclusion he had already arrived at: It was very late in the game and the market was likely to  crack badly fairly soon.

We felt reminded of this story when a good friend (who invests for a living) visited us this summer. He inter aliatold us about an acquaintance of his, whom he described as an autopilot investor who only very rarely looks at the market and has a record of getting the wrong ideas at the wrong time. His latest idea was noteworthy: he thought it would be a good idea to “sell volatility” (by writing puts, if memory serves). This was in July, just before the VIX reached a new all time low.

To continue reading: 21st Century Shoe-Shine Boys