Will The Last Bear Please Turn Out The Lights

When BlackRock CEO Larry Fink grumbled about “way too much optimism” in the markets, he wasn’t kidding. An entire mindset has built up, benchmarking today’s metrics against those of the bubbles that imploded in 2000 and 2007. But little squiggles in the metrics are used to prove beyond doubt that there is no danger of this being a bubble, and even if it’s a bubble, that there is no danger of it imploding anytime soon, that it would, in fact, continue to inflate wonderfully into an even more magnificent bubble, and that that this time it won’t end in tears.

A phenomenon that in these crazy days of ours shows up in every corner of the financial markets.

The proportion of money-losing IPOs, at 74% of all IPOs, is bumping up against the all-time record set in February 2000, days before the hot air began hissing out of the dotcom bubble (chart), while historically, a good majority of IPOs were profitable. In the current mad scramble to get these companies out the door and rake in the big bucks from small investors, Wall Street has turned into a bunch of fishmongers who know their wares will soon start stinking, and they wrap them in hype and fancy new metrics and sell them in all haste at incomprehensible valuations while they still can. This is the definition of a “healthy” IPO market – healthy for those that do the selling. Of the 42 IPOs during the first two months of the year, 23 were biotechs, the Nasdaq Biotech Index having tripled from its pre-financial crisis high (with bubble chart).

And so, for the first time ever, over half of the loans extended to junk-rated companies during the fourth quarter and so far this year were “covenant-light” loans, where yield-desperate lenders, driven into sheer insanity by the Fed’s brutal interest-rate repression, no longer demand the standard protections lenders normally demand. And they don’t even demand the yield that would compensate them for the risk.

Among these lenders are our TBTF banks. A year ago already, the Fed, fretting that its policies, which espoused this reckless behavior, would take down the financial system once again, warned these banks about their loosey-goosey underwriting standards. But with jawboning alone – while still handing out free money – the Fed can’t overcome banking greed. And so, the leveraged loan tsunami has only gained momentum.

Numerous metrics across the spectrum of financial activities are at generational or multigenerational extremes, and plenty of them at all-time records, surpassing even the record set during the heady days before the crashes of 2007, 2000, and 1987. The glorious size of the Fed’s balance sheet, real and nominal short-term interest rates, the velocity of money, credit spreads, corporate profits vs. Gross Domestic Income (bubble chart, St. Louis Fed)…. The list goes on.

The VIX volatility index has been bouncing around near the bottom of its historic range. Stock market leverage, as measured by margin debt, has been setting records month after month, while the volume on the New York Stock Exchange has been declining since the last crash and now languishes at lows not seen this millennium. And the percentage of stock market bears in the Investor Intelligence Sentiment survey is hovering at around 15%, the lowest since early 1987, a few months before the epic crash when “portfolio insurance,” invented, engineered, and provided by the geniuses on Wall Street, had once and for all eliminated the risks in the stock market.

In February, Goldman’s Chief US Equity Strategist David Kostin wrote in his report “When does the party end?” that the enterprise-to-sales ratio was “now the highest in 35 years (and probably far longer), surpassing even the dotcom bubble.”

Corporate investment in plant and equipment in the US to stimulate the economy in the US, not in China, has been lagging behind. But these same companies are using their stratospherically valued stocks as an inflated currency to buy other companies with equally inflated valuations: so far this year, M&A deal value primarily paid for in stock jumped 67%.

And companies are taking on enormous amounts of new debt, not to create productive assets, but to buy back their own shares at nosebleed valuations. Share buybacks are at long-term record highs. This blind buying has pushed share prices further into the stratosphere and accomplished a masterpiece of Wall Street engineering: goosing EPS growth while actual earnings growth is anemic and revenue growth is near stagnation. Goldman’s report summarized it this way: “February was the busiest month in our buyback desk’s history.”

A seasoned portfolio manager, who has been through the last two crashes, sees the data on the wall, and worries about having to explain to his clients afterwards that a third crash in 15 years had once again wreaked havoc on their wealth, told me of a presentation he’d given. He’d outlined record-breaking metrics of this kind, diving into less common ones too, that together formed a thicket of warning signs. His audience included a wide range of his clients – high net-worth individuals and small institutions – and fellow portfolio managers. He described it this way:

There were no bears among them in terms of positions. Two people were very worried. And there were lots of casual worriers – the common kind, people always have something to worry about, the plague, terrorism, war, recession, politics, geopolitics, etc. Even the most bearish, a gold bug, was not a bear. He was certain inflation would come. It would preserve the nominal value of stocks, and gold would zoom to the moon and beyond.

But even after I presented this information to them – much of which was new to them – nobody was inclined to change positions or stops, to hedge, etc. There were simply no bears among them. It felt very much like late 2007.

So everything these crazy days of ours gets benchmarked against the last two bubbles that ended in tears. But this time, while the comparisons are everywhere, it’s different. Because this time, the boundless optimism is grounded in reality, reality being whatever magnificent miracle is going to happen in the future that will somehow justify today’s nosebleed metrics.

Even small investors are having fun in the stock market again, after years of sitting out the most phenomenal rally. They’re leveraging up their portfolios, and margin debt is spiking beautifully. Alas, spiking margin debt has a nasty habit of ending in a crash. In one painful chart. Read…. Small Investors Exuberant, Margin Debt And Risk Of Crash Soar

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