Chart Of The Day: The DV01 Time Bomb Beneath The World's Equity Tranche

Tyler Durden's picture

While everyone is very familiar, and at times hypnotized, with the plain vanilla equity chart of stock prices which at least in the US are near all time highs, and where the small-cup Russell 2000 - long the object of Bernanke's affection - is already at never before seen levels, one chart virtually nobody has seen, perhaps the most important chart for the global capital markets right now, is the following from Goldman, which shows that while outright market cap for the G7 countries (ex basket case Japan) is near all time highs courtesy of the $15 trillion in liquidity pumped by central banks, the ratio of equity market cap to the outstanding value of debt securities underlying this equity is near all time lows!

Or, as shown another way by Deutsche Bank, the ratio of the equity tranche to all the other debt in the system is problematic to say the least:

Why are these two charts so important? Because while the bulk of equity speculators and algos out there are at best familiar with the concept of Price to Earnings, the reality is that P/E is a trivial indicator designed to fool the gullible into some anchored perspective of relative pricing, be it cheap or expensive. The reality is that for a full grasp of valuation, one must always look at the consolidated valuation metric given by Enterprise Value, which is the sum of market cap and net debt, to some metric of cash flow, either EBITDA or Free Cash Flow (EBITDA - CapEx), especially since unlike Non-GAAP adjusted "earnings", which are whatever the accounting firms makes them be to beat estimates, free cash flow is always what it is: cash the company makes, or as has been the norm lately, loses.

In other words, most forget that equity is just one half of the valuation equation. Or, as shown above, far less.

And what is even more important, is that preserving the equity tranche, which despite Bernanke's endless manipulation of every risk asset, needs ever more and more cash flows to keep the value of the debt below the equity tranche whole. Because we are confident that even the most naive investors understand perfectly well that when debt is impaired, the equity value above it is zero.

And here lies the rub: to preserve the value of the debt, and thus preserve the illusion of the overvalued market, the global financial markets need to constantly generate more and more cash flows just to keep up with this burgeoning debt

So what happens in a rising rate environment? Well, the debt, which like total sovereign debt will hardly ever be repaid and at best be rolled over (in an ever-higher interest rate environment), will demand more and more of the cash to go toward satisfying interest obligations beneath the equity tranche, leaving increasingly less for equity. The hope by the central planners is that as rates rise, and as inflation quickens, there will be more cash going out to consumers, who in turn will generate greater cash inflows. But the problem with this is that should the animal spirits indeed return, and the Fed's balance sheet can be unwound, then equities will collapse due to the simple obliteration of the abovementioned $15 trillion in government created money, before the real virtuous cycle can resume.

But before any of that happens, the DV01 time bomb contained in the world's balance sheet will first go off, as suddenly what little market participants finally remain do look at the chart above and realize that no incremental value creation will go to the equity tranche, with debt satisfaction taking up all of it. This simplified analysis also completely ignores that cash flows will implode once companies, who have delayed replenishing the asset bases with capex spend, can no longer afford to spend on organic growth and invest in themselves, resulting in even less cash going to debt, and certainly equity.

Finally, the reason everyone has ignored this chart is because in a ZIRP environment, the amount of marginal debt payments is negligible. However, once the much sought after "rotation" does indeed begin, and rates start creeping higher, suddenly the question of debt interest payments will once again become oh so very critical.

Until then: enjoy central planning.

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thismarketisrigged's picture

i am about to puke. how the fuck is this market all the way back from its lows in such a short time? heck we may finish green today, excuse while i fucking puke how disgusting this is

DoChenRollingBearing's picture

Ratioz, bitchez.  Buying bonds now, finally, seems like a disaster, although that notion has been wrong for years.

Babushka's picture

Sorry for being completely off topic but does anybody know what happened to this guy Chris Dorner? It seems there is no news!

francis_sawyer's picture

burned beyond recognition... TRUST US... [because we also killed Bin Laden & gently eased him into the Indian Ocean wrapped in fine linen, under 'Sharia Law' principles, after being scented in frankinsence & myrrh]...


Please return to your home in an orderly fashion... We're the government & we're here to help...

redpill's picture

LAPD decided to bury him at sea in case he was a muzzie, not that muzzies actually do that anyway.

Manthong's picture

Nothing to see here.. move along.

CJHames's picture

Funny how everything burned beyond recognition except for his (apparently) fireproof CA drivers license.  How convenient.

fuu's picture

I am still trying to figure out why you carry an ID after you have declared war on the cops. Not like you are going to need it if you get pulled over for speeding, either they are shooting you or you are shooting them.

Maybe he just needed beer and smokes.

francis_sawyer's picture

Wal_Mart will card you at age 40+... Just so you know that IF you happen to be a 'fugitive' ex-LA cop on the run & you want to walk into a maxi-mart full of bubble cams on the ceiling, you know which hand(s) you need 2 use to hide your possible facial ID from...


As for DORNER... He OBVIOUSLY tossed it out of his pocket [in the same way the 9/11 terrorists did, by tossing their passports out of the agape windows of jet airlines travelling at 500+ mph just 'milliseconds' before they impacted the TRADE TOWERS & erupted into fireballs]...

You obviously have ZERO understanding of the laws of PHYSICS...

WTFRLY's picture

"Please return to your home in an orderly fashion... We're the government & we're here to help..."

That will be the robo-message playing over loudspeakers as martial law provisions are exercised after the "just-in-time" grid collapses, or hiccups.

Rogue Trooper's picture

I'm partial to the theory that once the media in choppers where told to clear the area "for their own safety" a special black team went in and eliminated him (or put in some 'body'), lade down the fuel to start the 'fire', then the media are allowed in and the show begins with the local swat team.  Funny that, considering how much ammo they claimed he was packing, there where no rounds going off on the resulting heat from the blaze (check vid).  Also, the story makes no fuckin sense, since when was tear gas flammable and why blow out the windows? They where pumping mega rounds (check the vid) into the building and windows so how was he able to wire up the house to go up like a roman candle.  This needed fuel, wiring, and much care.... he must have been real good - a black Jason Bourne! The iceing on the cake was that 'indestructible' drivers license.

The OpPlans looked good on paper and in the MS Project/Powerpoint presentation before authorization in the (Oval?) office but the exercution was somewhat lacking.  It would have failed as a movie script.... not plausible.

See y'all in hell Bitchez.. cause the shit storm is coming.



Al Gorerhythm's picture

The most precient and under-reported investment info out there slapped in your lap and.............. Oh, look, the Kardashians are buying a new puppy. 


francis_sawyer's picture

What I heard was tha the puppy was pregnant... You're ovvvviously a social networking LOSER...

Canucklehead's picture

I thought Congress was holding up Chris Dorner's appointment to be the Secretary of Defense until after the recess.  I believe he will be in Washington at that time.

pitz's picture

Exactly.  And missing from that chart are the PM's -- currently worth, what, about $8T worldwide?  At the other extreme of the cycle, I expect that most of the funds that are currently allocated to bonds, will eventually end up being PM valuations.  Since the quantity of PM's is relatively finite, that implies $156T of valuation being expressed as PM's rather than debt. 

A simple ratio of $156 / $8 = ~20, which gives us $32,000 gold.  So keep buying bitchez.  Its motherfucking religion.

pitz's picture

The market is nowhere near back from its lows.  Share owners have still lost massive amounts of value in the past 5 years and even over the past decade.

Doomer's picture

Kinda depends on how one defines "the market".  I don't think survivorship bias is much of a factor in the Dow or S&P 500; however, you do make a good point, if I understand you correctly.

francis_sawyer's picture

I thought it was "PROFIT TO EARNINGS"... I guess now I'm going to have to re-bury myself in the charts now to make sense of it all... I wish I hadn't slept so much during that last semester at Wharton... Before I proceed, I have an important question... Does that DEBT TIME BOMB apply to 'all' 57 states?...

Joe Davola's picture

No, states cannot run deficits - unless you include unfunded pensions.  Oh, wait - they're counting on 8% returns on their investments forever to fix that little problem.

Melin's picture

Zero thinks there are 58, not 57 states.  Remember, he had "one more to go."

francis_sawyer's picture

I dunno... The HNX deal has me all mixed up...

nobusiness's picture

What?  Walmart said domething bad?  Can't be the market is only down a buck or two.  I am sure that if the largest retailer in the world was having trouble with sales the market would react.  After all the efficient market theory says it must.

davidsmith's picture

This assumes that the United States Government does not absolutely control the stock market.  The United States Government absolutely controls the stock market.

TruthInSunshine's picture

What's the big deal? The Fed has an awesome set of tools and can fix this through FASB or some other such thing.

Seriously, the Fed can monetize all debt instruments, parse them out for free to select financial institutions, have them mark-to-fantasy, and roll with it.

Proposal Gives Banks More Freedom to Value Assets

Published: February 14, 2013

The board that sets American accounting rules moved on Wednesday to substantially reduce the use of market values in financial statements. The move, if adopted, would give banks more freedom to value financial assets as they deem appropriate.


Long live the Ponzi.

If they'd extend this "freedom" to individuals, think of the credit boom that would result. You'd have 18 year olds obtaining loans for their "higher education," a new C7 Corvette AND a new McMansion based on their self-reported valuation of that Darryl Strawberry rookie baseball card they've pledged as collateral for said loan.

centerline's picture

mark-to-"whatever looks good on paper" here we come!

I say do it.  All the damn way.  Give em' everything.  Crank up the leverage.  Get rid of all regulations.  Dissolve the SEC, etc.  Full speed ahead... warp factor 10!  

Panafrican Funktron Robot's picture

So, basically, the final nail in the coffin on mark-to-market?  Long FAS, amiright?

Bunga Bunga's picture


youngman's picture

Finished Green.....WTF....just amazing....someday this will all be know how they do it...or did it...its not money changing hands..its electronic bits..

helping_friendly_book's picture

It is truly depressing because it gives the drones on Bloomberg and CNBC fodder to keep them relevant.

nobusiness's picture

Wow!  It took the fed buying 130,000,000 SPY shares today to keep the market close to break even.  At least that was the increase volume from either Monday tueday wednesday or thursday's volume

helping_friendly_book's picture


That is how they do it.

Notice the S&P 500 dives until the London market closes. Then Kevin Henry gets to work pumping it up until close.

makes me want to puke.

Panafrican Funktron Robot's picture

Flat or up markets = VXX negative = XIV positive.  Long XIV, hedge with cheap SPY puts, win at life in the casino.  

Yen Cross's picture

 These markets belong in the funny pages of the "Sunday N.Y. Times"...

Clowns on Acid's picture

The daily Krugman cartoon....

Obama4Ever's picture

So what happens in a rising rate environment? Well, the debt, which like total sovereign debt will hardly ever be repaid and at best be rolled over (in an ever-higher interest rate environment), will demand more and more of the cash to go toward satisfying interest obligations beneath the equity tranche, leaving increasingly less for equity.

What is this rising rate environment you speak of? I don't believe in such ridiculous fantasies. The unfolding scenario you paint is implausable.

falak pema's picture

the icing on the cake and the cake itself.

To understand the situation in french banks as an example :

The current french BS of 4 major banks are at 8 T Euros, aka 4 times french GDP. So there is awesome debt destruction potential there as those BS are virtually all debt; equity being less than 3%. And they are totally involved in incestuous intra bank deals.

Out of the current credit flow generated by french banks, 10% goes to service consumer loans, 12% to service corporate entrepreneurial loans and the rest : >78% are used to service the banks OWN financial risks including debt servicing. That is how much of the french banking sector's resources are absorbed in its own financial shenanigans which are all marked to model and opaque; as its all derivative related and OTC type stuff. 

Lets see them deleverage out of that with a flat economic scenario in 2013/2014. 

andrewp111's picture

Nothing will be deleveraged. Draghi will just buy and loan whatever he needs to, so none of these banks fail, just like he did in Spain. Most EU banks are TBTF, and are treated accordingly.

americanspirit's picture

The reason that government debt will never be repaid is that governments don't create wealth, they only tax it. "Full faith & credit" only works if someone is creating real wealth. Government is simply a vast criminal conspiracy that dwarfs all other kinds of criminal conspiracies. (Except perhaps organized religion.) Government creates nothing - it only takes, uses and destroys.

Doomer's picture

I'll give them credit for building roads, but that is about it.

Unfortunately, the other main responsibilty of the government, the national defense, has turned into global police force full of pork, guided by dubious objetives other than defense.


11b40's picture

As I said in 2009, this can't go on forever.

As I said in 2010, this can't go on forever.

As I said in 2011, this can't go on forever.

As I said in 2012, this can't go on forever.

As I now say in 2013, this can't go on forever, can it?

helping_friendly_book's picture

I have been short the S&P 500 since Oct. 2011.

hooligan2009's picture

like the blonde falling from the 65th floor far, so far, so good...

orez65's picture

There is just a lot of wealth in the United States.

It takes a while to destroy it all.

Clowns on Acid's picture

The answer is no, because Obama and his fellow Alinskyites have overreached. The new tax structure increases, regulations, class warfare rhetoric, and outright corruption on a scale since the TeaPot Dome scandal. The MSM, being filled with feckin' moronic Alinskyites are covering the real scope of the corruption and sleazyness. Don't even come close to GWB's supposed Iraq War corruption (halliburton etc..).

The reason why this has continued so far is the outright immorality (some have called it treason) of Ben Bernanke with his QE 1,2,3 to infiniyt (including bailing out European banks on US taxpayers back).

However even Benernake at this stage can't keep the collapse of cash flow afloat with USD losing Int'l status.

The Fed and banks will be manning the lifeboats soon (probably at night). Notice all the banks cutting staff furiously this Quarter yet? They know its coming this year.  

delivered's picture

The charts are informative but not complete. They need to be expanded to include all forms of debt such as currencies (which are a form of debt), derivatives, etc. Then we can get a true picture of the real leverage in the system.

But the main point is loud and clear. When debt service payments, principal and interest, begin to increase (as lenders really begin to ask for their money back), cash flows will absolutely be destroyed. To date, all we have had is debt being transferred from individuals and banks to the Fed and government to keep the system a float. Nobody has really repaid anything as it has either been written off (think mortgages and soon to be student loans) or pass around to sit on someone else's balance sheet. Can you imagine if the US Government actually had to start repaying debt (instead of not adding incremental layers). FUBAR is about the only word I can think of that would describe this.