iftttwall

As we warned two months ago, the bubble in credit markets (which if you ask anyone at the Fed, except Jeremy Stein, does not exist) is nowhere more evident than in the explosive growth of so-called cov-lite loans. While total volumes of cov-lite loans are already at record, as the FT reports, we now have 55% of new leveraged loans come in “cov-lite” form, far eclipsing the 29% reached at the height of the leveraged buyout boom just before the financial crisis. LBO multiples have reached record highs and demand for secutizations of these levered loans (CLOs) has surged on the back of the Fed’s repressive push of investors into more-levered firms and more-levered instruments.

 

 

 

Via The FT,

The amount of riskier loans offering fewer protections to lenders contained in packages of debt sold to investors have hit record levels, amid resurgent lending markets and a continued thirst for higher returns.

 

…

 

as “covenant-lite” loans, or loans that come with fewer protections for lenders, have this year become the norm in the US, CLO managers have been forced to relax the limits on the percentage of the loans that can go into their deals.

 

Already, 55 per cent of new leveraged loans come in “cov-lite” form, eclipsing the 29 per cent reached at the height of the leveraged buyout boom just before the financial crisis.

 

…

 

“CLO managers have clearly taken notice of this trend, and structures have come with more relaxed caps on cov-lites this year.”

 

While the majority of CLOs sold last year had a 40 per cent limit on the amount of cov-lite loans that could be bought by the vehicles, a 50 per cent cap has become the industry standard in 2013, according to data from S&P Capital IQ.

 

At least three deals have come to market this year with a 70 per cent limit.

So wondering where the leverage is building this time? Well, record high margin debt in stocks and record high exposure to the riskiest (and least protected) credit structures once again… but it’s different this time (as Moodys told us).

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/YutPWrqcQ40/story01.htm Tyler Durden

As we warned two months ago, the bubble in credit markets (which if you ask anyone at the Fed, except Jeremy Stein, does not exist) is nowhere more evident than in the explosive growth of so-called cov-lite loans. While total volumes of cov-lite loans are already at record, as the FT reports, we now have 55% of new leveraged loans come in “cov-lite” form, far eclipsing the 29% reached at the height of the leveraged buyout boom just before the financial crisis. LBO multiples have reached record highs and demand for secutizations of these levered loans (CLOs) has surged on the back of the Fed’s repressive push of investors into more-levered firms and more-levered instruments.

 

 

 

Via The FT,

The amount of riskier loans offering fewer protections to lenders contained in packages of debt sold to investors have hit record levels, amid resurgent lending markets and a continued thirst for higher returns.

 

…

 

as “covenant-lite” loans, or loans that come with fewer protections for lenders, have this year become the norm in the US, CLO managers have been forced to relax the limits on the percentage of the loans that can go into their deals.

 

Already, 55 per cent of new leveraged loans come in “cov-lite” form, eclipsing the 29 per cent reached at the height of the leveraged buyout boom just before the financial crisis.

 

…

 

“CLO managers have clearly taken notice of this trend, and structures have come with more relaxed caps on cov-lites this year.”

 

While the majority of CLOs sold last year had a 40 per cent limit on the amount of cov-lite loans that could be bought by the vehicles, a 50 per cent cap has become the industry standard in 2013, according to data from S&P Capital IQ.

 

At least three deals have come to market this year with a 70 per cent limit.

So wondering where the leverage is building this time? Well, record high margin debt in stocks and record high exposure to the riskiest (and least protected) credit structures once again… but it’s different this time (as Moodys told us).

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/YutPWrqcQ40/story01.htm Tyler Durden

It has been a while since we heard from the rational folks over at GMO. Which is why we are happy that as every possible form of bubble in the capital markets rages, Jeremy Grantham lieutenant Ben Inkster was kind enough to put the raging Fed-induced euphoria in its proper context. To wit “the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confi rm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market…. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued.”

Key highlights:

• Our recent client conference saw the unveiling of our new forecast methodology for the U.S. stock market, a methodology that we are extending to all of the other equity asset classes that we forecast. It is the result of a three-year research collaboration by our asset allocation and global equity teams, and involved work by a large number of people, although Martin Tarlie of our global equity team did a disproportionate amount of the heavy lifting. In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.
• With that assumption, “true” ROE has been 6.5%, against a real return of 5.7% for the S&P 500 since 1970, which is certainly in the ballpark, if not quite spot on. You could simply stop there and declare that the S&P 500, which is currently trading at about 2.5 times book value, must therefore be overvalued by 25%. The problem is, even if book value has been half of economic capital on average over the last 40 years, how do we know it is still half of economic capital today?
• One way to get around the problem of accounting changes on book value is to look instead at return on sales. Sales have the nice feature that accounting changes have relatively little impact on them. Sales figures from 1970 were calculated on basically the same basis as sales figures today, and probably the same as they will be in 2050. Return on sales has looked fairly stable historically, and as you can see in Exhibit 3, we are significantly further above normal profit margin on sales than we are above normal ROEs.
• Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued. But the assumption of stable return on sales is problematic for a different reason than ROE. Book value is at least an accounting estimate of equity capital, and as imperfect as it is, return on equity capital is what is supposed to mean revert in a capitalistic system. There is not such a strong argument for reversion when it comes to return on sales. Historically it has been mean reverting, but a high return on sales for a given company does not necessarily mean that competition will follow. Intel has a high return on sales on its microprocessors, but being in a position to sell those microprocessors requires huge amounts of investment and intellectual capital. An economy driven by Intels could easily support higher profit margins than one of supermarkets. So there is a chance that this return on sales framework overstates the degree of overvaluation in the U.S.
• But enough about the details. The basic point for us remains the same – the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market. To answer the question we get most often about our forecast – “How could you be wrong?” – there are a couple of ways we could be wrong. One of them is pleasant and implausible, the other is more plausible, but far less pleasant.
• The less pleasant way we could be wrong is if 5.7% real is no longer a reasonable guess at an equilibrium return for U.S. equities. If equity returns for the next hundred years were only going to be 3.5% real or so, today’s prices are about right. We would be wrong about how overvalued the U.S. stock market is, but every pension fund, foundation, and endowment – not to mention every individual saving for retirement – would be in dire straits, as every investors’ portfolio return assumptions build in far more return. Over the standard course of a 40-year working life, a savings rate that is currently assumed to lead to an accumulation of 10 times final salary would wind up 40% short of that goal if today’s valuations are the new equilibrium. Every endowment and foundation will find itself wasting away instead of maintaining itself for future generations. And the plight of public pension funds is probably not even worth calculating, as we would simply fi nd ourselves in a world where retirement as we now know it is fundamentally unaffordable, however we pretend we may have funded it so far. William Bernstein wrote a piece in the September issue of the Financial Analysts Journal, entitled “The Paradox of Wealth,” which explains far too plausibly why generally increasing levels of wealth might drive down the return on capital across the global economy. It’s well worth a read, although perhaps not on a full stomach, as it is one of the most quietly depressing pieces I have ever come across (and this is coming from someone who has spent the last 21 years reading Jeremy Grantham’s letters!).

Full letter below (pdf):

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/MB47qQNZj70/story01.htm Tyler Durden

It has been a while since we heard from the rational folks over at GMO. Which is why we are happy that as every possible form of bubble in the capital markets rages, Jeremy Grantham lieutenant Ben Inkster was kind enough to put the raging Fed-induced euphoria in its proper context. To wit “the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confi rm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market…. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued.”

Key highlights:

• Our recent client conference saw the unveiling of our new forecast methodology for the U.S. stock market, a methodology that we are extending to all of the other equity asset classes that we forecast. It is the result of a three-year research collaboration by our asset allocation and global equity teams, and involved work by a large number of people, although Martin Tarlie of our global equity team did a disproportionate amount of the heavy lifting. In a number of ways it is a “clean sheet of paper” look at forecasting equities, and we have broadened our valuation approach from looking at valuations through the lens of sales to incorporating several other methods. It results in about a 0.7%/year increase in our forecast for the S&P 500 relative to the old model. On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. For those interested in the broader U.S. stock market, our forecast for the Wilshire 5000 is a bit worse, at -2.0%, due to the fact that small cap valuations are even more elevated than those for large caps.
• With that assumption, “true” ROE has been 6.5%, against a real return of 5.7% for the S&P 500 since 1970, which is certainly in the ballpark, if not quite spot on. You could simply stop there and declare that the S&P 500, which is currently trading at about 2.5 times book value, must therefore be overvalued by 25%. The problem is, even if book value has been half of economic capital on average over the last 40 years, how do we know it is still half of economic capital today?
• One way to get around the problem of accounting changes on book value is to look instead at return on sales. Sales have the nice feature that accounting changes have relatively little impact on them. Sales figures from 1970 were calculated on basically the same basis as sales figures today, and probably the same as they will be in 2050. Return on sales has looked fairly stable historically, and as you can see in Exhibit 3, we are significantly further above normal profit margin on sales than we are above normal ROEs.
• Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued. But the assumption of stable return on sales is problematic for a different reason than ROE. Book value is at least an accounting estimate of equity capital, and as imperfect as it is, return on equity capital is what is supposed to mean revert in a capitalistic system. There is not such a strong argument for reversion when it comes to return on sales. Historically it has been mean reverting, but a high return on sales for a given company does not necessarily mean that competition will follow. Intel has a high return on sales on its microprocessors, but being in a position to sell those microprocessors requires huge amounts of investment and intellectual capital. An economy driven by Intels could easily support higher profit margins than one of supermarkets. So there is a chance that this return on sales framework overstates the degree of overvaluation in the U.S.
• But enough about the details. The basic point for us remains the same – the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market. To answer the question we get most often about our forecast – “How could you be wrong?” – there are a couple of ways we could be wrong. One of them is pleasant and implausible, the other is more plausible, but far less pleasant.
• The less pleasant way we could be wrong is if 5.7% real is no longer a reasonable guess at an equilibrium return for U.S. equities. If equity returns for the next hundred years were only going to be 3.5% real or so, today’s prices are about right. We would be wrong about how overvalued the U.S. stock market is, but every pension fund, foundation, and endowment – not to mention every individual saving for retirement – would be in dire straits, as every investors’ portfolio return assumptions build in far more return. Over the standard course of a 40-year working life, a savings rate that is currently assumed to lead to an accumulation of 10 times final salary would wind up 40% short of that goal if today’s valuations are the new equilibrium. Every endowment and foundation will find itself wasting away instead of maintaining itself for future generations. And the plight of public pension funds is probably not even worth calculating, as we would simply fi nd ourselves in a world where retirement as we now know it is fundamentally unaffordable, however we pretend we may have funded it so far. William Bernstein wrote a piece in the September issue of the Financial Analysts Journal, entitled “The Paradox of Wealth,” which explains far too plausibly why generally increasing levels of wealth might drive down the return on capital across the global economy. It’s well worth a read, although perhaps not on a full stomach, as it is one of the most quietly depressing pieces I have ever come across (and this is coming from someone who has spent the last 21 years reading Jeremy Grantham’s letters!).

Full letter below (pdf):

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/MB47qQNZj70/story01.htm Tyler Durden

Courtesy of the revelations over the past year, one thing has been settled: the statement “Wall Street Manipulated Everything” is no longer in the conspiracy theorist’s arsenal: it is now part of the factually accepted vernacular. And to summarize just how, who and where this manipulation takes places is the following series of charts from Bloomberg demonstrating Wall Street at its best – breaking the rules and making a killing.

Foreign Exchanges

Regulators are looking into whether currency traders have conspired through instant messages to manipulate foreign exchange rates. The currency rates are used to calculate the value of stock and bond indexes.

 

Energy Trading

Banks have been accused of manipulating energy markets in California and other states.

 

Libor

Since early 2008 banks have been caught up in investigations and litigation over alleged manipulations of Libor.

 

Mortgages

Banks have been accused of improper foreclosure practices, selling bonds backed by shoddy mortgages, and misleading investors about the quality of the loans.

 

* * *

And in the latest news on manipulation, according to the FT, “The UK’s financial regulator is probing the use of private accounts by foreign exchange traders amid allegations they traded their own money ahead of clients orders, in a serious twist in the global probe into possible currency market manipulation. The Financial Conduct Authority has asked several banks to investigate whether traders used undeclared personal accounts, two people close to the situation said.”

Investors and foreign exchange traders have been speculating for a while that less scrupulous colleagues might have used private accounts at spread betting firms to gain advantages from their inside knowledge.

 

Hiding personal accounts is viewed as a clear breach of the rules. “If someone was [using a PA] to sell or buy ahead of the fix, I have no sympathy for him,” said one trader.

 

Personal accounts – or “PAs”, as traders call them – generally have to be declared to the bank and usually to a trader’s boss. Each individual trade then also has to be declared – often through an automatic email that is sent out when a trade is made.

 

Regulators are focusing their investigations on possible manipulation of a crucial benchmark, the 4pm WM/Reuters fix, in an affair that is echoing the Libor benchmark rate-rigging scandal.

Guess what they are going to find…

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/fAfJPfMVphY/story01.htm Tyler Durden

Submitted by Ron Paul via The Free Foundation blog,

Last Thursday the Senate Banking Committee held hearings on Janet Yellen’s nomination as Federal Reserve Board Chairman. As expected, Ms. Yellen indicated that she would continue the Fed’s “quantitative easing” (QE) polices, despite QE’s failure to improve the economy. Coincidentally, two days before the Yellen hearings, Andrew Huszar, an ex-Fed official, publicly apologized to the American people for his role in QE. Mr. Huszar called QE “the greatest backdoor Wall Street bailout of all time.”

As recently as five years ago, it would have been unheard of for a Wall Street insider and former Fed official to speak so bluntly about how the Fed acts as a reverse Robin Hood. But a quick glance at the latest unemployment numbers shows that QE is not benefiting the average American. It is increasingly obvious that the Fed’s post-2008 policies of bailouts, money printing, and bond buying benefited the big banks and the politically-connected investment firms. QE is such a blatant example of crony capitalism that it makes Solyndra look like a shining example of a pure free market!

It would be a mistake to think that QE is the first time the Fed’s policies have benefited the well-to-do at the expense of the average American. The Fed’s polices have always benefited crony capitalists and big spending politicians at the expense of the average American.

By manipulating the money supply and the interest rate, Federal Reserve polices create inflation and thereby erode the value of the currency. Since the Federal Reserve opened its doors one hundred years ago, the dollar has lost over 95 percent of its purchasing power —that’s right, today you need $23.70 to buy what one dollar bought in 1913!

As pointed out by the economists of the Austrian School, the creation of new money does not impact everyone equally. The well-connected benefit from inflation, as they receive the newly-created money first, before general price increases have spread through the economy. It is obvious, then, that middle- and working-class Americans are hardest hit by the rising level of prices.

Congress also benefits from the devaluation of the currency, as it allows them to increase welfare- and warfare-spending without directly taxing the people. Instead, the increase is only felt via the hidden “inflation tax.” I have often said that the inflation tax is one of the worst taxes because it is hidden and because it is regressive. Of course, there is a limit to how long the Fed can facilitate big government spending without causing an economic crisis.

Far from promoting a sound economy for all, the Federal Reserve is the main cause of the boom-and-bust economy, as well as the leading facilitator of big government and crony capitalism. Fortunately, in recent years more Americans have become aware of how the Fed is impacting their lives. These Americans have joined efforts to educate their fellow citizens on the dangers of the Federal Reserve and have joined efforts to bring transparency to the Federal Reserve by passing the Audit the Fed bill.

Auditing the Fed is an excellent first step toward restoring a monetary policy that works for the benefit of the American people, not the special interests. Another important step is to repeal legal tender laws that restrict the ability of the people to use the currency of their choice. This would allow Americans to protect themselves from the effects of the Fed’s polices. Auditing and ending the Fed, and allowing Americans to use the currency of their choice, must be a priority for anyone serious about restoring peace, prosperity, and liberty.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/nqNrCmymksE/story01.htm Tyler Durden