IN-DEPTH: TRANSCRIPTION - LONGWave - 06-12-24 - JUNE - The Great Debt for Equity Swap
SLIDE DECK
TRANSCRIPTION
SLIDE 2
Thank you for joining me. I'm Gord Long.
A REMINDER BEFORE WE BEGIN: DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are COMMENTARY for educational and discussions purposes ONLY.
Always consult a professional financial advisor before making any investment decisions.
SLIDE 3 - COVER
In this session I want to bridge from some previous video’s we did but had insufficient time to delve further into one of the major equity market issues in today’s markets.
Specifically we want to attempt to shed some light on why market breadth is historically narrow to an unprecedented degree.
I am referring of course to the domination the Magnificent Seven stocks now command.
As I pointed out in the recent weekly newsletter the five largest companies as share of S&P 500 total market capitalization is now 27%. The ten largest companies as share of S&P 500 total 37%.
SLIDE 4 – AGENDA
As such I want to cover the subjects listed here as a spring board from our April UnderTheLens video entitled “The Future is Coming into Focus” to support some of the conclusions we drew in that video.
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I want to start by some positioning regarding the divergence we see between rising prices and falling stock volumes.
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Our long time subscribers are quite familiar with this chart which you can see by the Copyright at the bottom, we drew in 2012 as we came out of the Financial Crisis by removing Market-to-Market accounting regulations for Derivatives and hurriedly implementing the untested Monetary Policy of Quantitative Easing.
We felt at the time that the road path the Federal Reserve was putting us on could only lead to Mal-Investment, Dysfunctional markets and Delusional valuations. We didn’t know how long it would take but the outcome was fairly assured.
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We believe the markets have now arrived at that end point.
We presently have ineffective Price discovery as a result of the mispricing of risk. The US Dollar as a consequence is seriously overvalued effectively crippling the rest of the world and driving the creation of the growing BRICS-10 as a threat to the US Dollar as the global Reserve currency and the 10Y US Treasury note as the International Risk Free Benchmark.
As a result we are in the midst of an unprecedented Debt for Equity Swap. It is the epitome of the Indirect Exchange which we have outlined in two videos which can be found on the MATASII Web Site and Gordon T Long YouTube Channel.
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To understand better what is occurring we need to look at a long term chart of both price and volume of the S&P 500.
As the S&P 500 is carried almost parabolic by the explosive rise of the top 10 stocks we see that volume at the bottom has steadily fallen. This all started with the 2008 Financial Crisis. Prior to that as price rose, supporting volumes rose.
Most will quickly and somewhat accurately point out that this correlates with the advent and growth of ETF and the use of options. That is true if we fully appreciate that ETF’s don’t actually buy the underlying stock but rather use options to mirror price change.
Therefore the chart represents not equity activity but options activity.
Who is mirroring who – but I digress.
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No one truly knows how big the option market is because quite literally 100’s of TRILLIONS of dollars of Currency & Interest Swaps are traded OTC with limited to no regulation. With well over quadrillion dollars in notional value what we need to appreciate is that derivatives are traded on literally ever element of the markets including as examples, economic indicators such as Inflation through Inflation Swaps and Collateral through Collateral Swaps and Collateral Transformations as part of Credit metrics.
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This week as we waited for the CPI to be announced the markets were moving as Inflation Swaps and other derivatives traded in advance which had a direct bearing on stocks in the way of supporting valuations and equity risk premiums. This is what I was referring to as who is mirroring who?
This chart from Richard Duncan, a global financial expert with experience at the World Bank, IMF and Thailand Crisis says here – he believes “any market in the world could be manipulated with only a few hundred Billion dollars worth of OTC derivative contracts.”
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Today we see the parabolic lift in options by ever shortening expiration – and this chart is before the new Daily Options (oDTE).
The markets have clearly become a casino.
Like any casino the only real winner is the owners of the casino. For anyone having owned a business or been part of a larger corporation, you know even the casino owners answer to who is financing the business and who has the collateral claim as the senior secured debt holder. They are the ultimate owners and where the real board room power rests!
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Which takes us to the growth in Buybacks or what is a Debt for Equity Swap or Exchange. There are many reasons that Corporations buyback their shares from creating attractive PE ratios to debt financing tax advantages.
We need to remember that many corporations are now borrowing to buyback shares and even pay dividends.
Again we see the parabolic lift.
But who are the financiers of all this and how do they win??
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There is an age old investigative adage: “Always follow the money”!
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In this case it’s follow the Parabolic Lift.
Not all markets, indices and stocks are rising in a parabolic fashion.
What we noted ourselves a long time ago was that it started with a parabolic lift in Debt and Derivatives and though it ended with the MAg-7 and Nvidia we found Private Equity players stocks also entered the fray as sovereign debt went parabolic.
Private Equity is now the dominant player within what has become known since the mid 1990’s as Shadow Banking. These are lenders who don’t operate as Regulated Banks but are creators of credit.
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As Creditism has replaced Capitalism the creation of credit which is the opposite side of the debt coin has become of central importance in today’s debt encumbered world.
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We HAD ~$62T in government debt, on a global economy as measured by GDP in 2020, of ~$84.96Tdebt
It was $82T in 2022 with GDP of ~$104T.
This is ~$20T of new Debt to grow the Global economy by the same ~$20T!
It takes debt to grow and without economic growth, profit growth normally does not occur.
It is interesting that the profits of the top 10 stocks are growing significantly with inflation in nominal terms – with inflation a direct result of increased deficit spending or too many dollars chasing the same amount of goods.
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Banks are not doing exceptionally well as US Bank Reserves haven’t been driving exchange Market Capitalization since the Fed started raising rates.
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While we know with a fair degree of certainty, with breadth so narrow those involved in any way with the Top 10 are likely to be doing well.
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The rest are barely beating inflation in nominal terms.
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Who has the Yachts besides the founders of those top 10 Big Tech firms?
Well it doesn’t take Sherlock Holmes to see that it is with the labor and stock based compensation costs of the largest listed North American Private Capital players .
They have totaled over $100B over the last five years.
We will come back to these Shadow Banks in a moment.
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Let’s revisit something we uncovered a number of years ago as these parabolic curves were beginning to form.
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In the April 2018 the release of the LONGWave video was on Understanding the Disappearing Stock Float.
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In September of the same year we followed it up with more detail in another LONGWave video entitled “The Disappearing Equity & Float Pools”.
Both videos are available at the Gordon T Long YouTube Channel.
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First some definitions.
The Float is the number of shares actually available for trading.
Float is calculated by subtracting closely held shares -- owned by insiders, employees, the company's Employee Stock Ownership Plan or other major long-term shareholders -- from the total shares outstanding.
This can be difficult to determine – it depends on definitions – and getting real time information.
SLIDE 25
What we showed in the video’s was the S&P 500’s Dirty Little Secret
How extremely quiet changes in the Methodology Fundamentally Transformed the Index
Three examples of how the S&P 500 Index Methodology had been quietly, but substantially, changed over the past 16 Years since the Dotcom Bubble Burst:
- In 2002: The Removal of all Foreign Companies from the Index
- In 2005: The Shift to Float Adjusted Market Capitalization
- In 2014: Inclusion of Mortgage REITs
SLIDE 26
Since 2005, S&P 500 has been float weighted. That is it is a “Float Adjusted Market Capitalization”
When the individual market cap is calculated for a company part of the index, only the outstanding shares that can be freely traded without any restrictions are taken account.
Not all outstanding shares of a company are available for common investors to trade, for example shares held by individuals with access to insider information are under special regulation.
The float adjusted value of S&P 500 index in ~2016 was around one trillion dollars smaller than the unadjusted total cap.
SLIDE 27
Shareholders concerned with control of a company and have regulatory restriction generally include the list shown here – a long an interesting list. A list that is dynamic and not highly visible in real time but only long after the fact.
- Officers and Directors and related individuals whose holdings are publicly disclosed
- Private Equity, Venture Capital & Special Equity Firms
- Shares held for control by another Publicly Traded Company
- Strategic Partners
- Holders of Restricted Shares
- ESOPs
- Employee and Family Trusts
- Foundations associated with the Company
- Holders of Unlisted Share Classes of Stock
- Government Entities at all levels except Government Retirement/Pension Funds
- Any individual person listed as a 5% or greater stakeholder in a company as reported in regulatory filings (a 5% threshold is used as detailed information on holders and their relationship to the company is generally not available).
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The following holders’ shares are generally considered part of float:
- Depositary Banks
- Pension Funds
- Mutual Funds & ETF providers
- 401K Plans of the Company
- Government Retirement/Pension funds
- Investment Funds of Insurance Companies
- Asset Managers and Investment Funds
- Independent Foundations 9. Savings and Investment Plans
SLIDE 29
In these videos we show a litany of charts of how restricted control and release can be used to impact stock prices and trading.
Papers from the Harvard Business School in May 2005 – entitled: “Float Manipulation
& Stock Prices” warned of this.
When a firm reduces the number of shares available to trade, then so-called float manipulation occurs:
- The price of the stock is often driven up,
- Stock prices are raised significantly when there are differing opinions about the value of shares,
- When risk averse investors have differences of opinion and are short-sale constrained, reductions in the float freeze out pessimistic investors, pushing up prices,
- When the float is released, prices fall.
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We felt strongly back then that this fit into a roadmap of controlled distortion that was underway.
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I think the proof today is pretty obvious without a full forensic accounting of the whole process of matching both stock equity and stock debt funding.
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I said we would get back to Private Equity as a major player in the area of what is now called Shadow Banking.
Globally it has become massive in scope.
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Just 9 US PE firms alone have nearly $1.2T in unleveraged assets.
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The leverage Ratio however shows you just how powerful their lending and finance clout is
Banks operate with debt to capital rations of 9:1.
Shadow Banks operate with 2:1
If the Shadow Banks buy US Treasuries and put them on deposit with money centered banks they could secure Leverage Loans at extremely high leverage for trading positions.
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The Leverage Lending could come from anywhere around the world with a multitude of partners operating under different jurisdictions, tax situations, currency and interest swap positions.
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Shadow Banking is now as big if not bigger than traditional banks as lenders -operating without banking regulators on a global basis.
It truly is the “wild west” of global lending, finance and market manipulation through the derivatives complex.
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What can we conclude?
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We must not forget that the Magnificent Seven are benefiting from rising earnings projections. These earnings in-turn are benefiting significantly from Net Interest Expense. To unpack the full reason for negative net interest Expense would take another video.
SLIDE 39
I have tried to encapsulate I number of the points we have touched upon in this video in a single instructive slide as shown here.
The parabolic curve benefits more than the corporations who’s stocks are involved and the investors benefiting from it but also the Shadow Banks and Private Equity.
The Shadow Banks potentially benefit in four ways:
First, by lending to these corporations they become creditors and in many cases secured lenders within the capital structure. We have little visibility to what covenants come with the lending but fully understand the structuring of these covenants are the central expertise and Raison D’être of Private Equity.
Secondly, the money being lent by the Shadow Banks has itself been secured in various fashions to be paid back also in various manners. This includes international rates, currencies and derivatives swaps.
Thirdly, the Private Equity firms can trade the stock while at the same time playing the float game of restricted stock timing eligibility.
Fourth, is the critically important element of the concept of the “Indirect Exchange” we have talking about in our newsletters and two prior videos on the subject?
Lenders are the losers in an inflation environment while the winners are the borrowers who pay back the money at later date in less value through Purchase Price Erosion. The Shadow Banks are really operating as borrowers by being protected pass-through lenders.
SLIDE 40
All this works because of lack of effective Price Discovery, Mis-Pricing of Risk, an over-valued US currency and the global financial game of Debt for Equity.
It is an opportunity to prey on the illusion of economic growth, mis-understanding of money and wealth.
SLIDE 41
Hopefully this video adds to the the fourth and fifth points we made in our April UnderTheLens video entitled “The Future is Coming Into Focus”.
The coming Debt Crisis will be triggered from an implosion of the Derivative Securities Complex ….
… and the Great Reset will be about Collateral Confiscation through the “Great Taking”!
Again, we encourage you to read the well researched book –“The Great Taking”.
SLIDE 42
As I always remind you in these videos, remember politicians and Central Banks will print the money to solve any and all problems, until such time as no one will take the money or it is of no value.
That day is still in the future so take advantage of the opportunities as they currently exist.
Investing is always easier when you know with relative certainty how the powers to be will react. Your chances of success go up dramatically.
The powers to be are now effectively trapped by policies of fiat currencies, unsound money, political polarization and global policy paralysis.
SLIDE 43
I would like take a moment as a reminder
DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are for educational and discussions purposes ONLY.
As negative as these comments often are, there has seldom been a better time for investing. However, it requires careful analysis and not following what have traditionally been the true and tried approaches.
Do your reading and make sure you have a knowledgeable and well informed financial advisor.
So until we talk again, may 2024 turn out to be an outstanding investment year for you and your family?
I sincerely thank you for listening!
