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Last Two Times This Happened, Stocks Crashed

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Wolf Richter   www.wolfstreet.com   www.amazon.com/author/wolfrichter

Global growth is languishing, corporate revenues too, but CEOs are trying to show they can grow their companies the quick and easy way. Cheap debt is sloshing through the system while yield-hungry investors offer their first-born to earn 5%. And this cheap debt along with vertigo-inducing stock valuations have created the largest M&A boom the US has ever seen, with May setting an all-time record.

There may be a sense of desperation among CEOs as the Fed’s cacophony evokes interest rate increases, the first since July 2006. So companies are issuing all kinds of cheap debt while they still can. Bond issuance has totaled over $100 billion per month in the US for the past four months, the longest such streak ever, according to Bank of America Merrill Lynch.

And that record issuance doesn’t account for the booming “reverse Yankee issuance,” where US corporations take advantage of the negative-yield absurdity Draghi has concocted in Europe and issue euro-denominated bonds into European markets.

“Issuers should realize that the window to lock in low long-term yields for any purpose is closing,” Hans Mikkelsen, a senior strategist at BofA, wrote in a note, according to the Financial Times. And so in May, M&A deals hit an all-time record of $243 billion.

US-M+A-record-months-May-2015-May-2007-Jan-2000

The prior two record months: May 2007 ($226 billion) and January 2000 ($213 billion). Not long after those records were set, markets crashed with spectacular results.

May included Charter’s $90-billion acquisition of Time Warner Cable and Bright House. Charter will issue around $30 billion in junk-rated debt to accomplish this, likely the second largest junk-debt deal ever, behind that of TXU in October 2007, which is now in bankruptcy [Junk-Debt Apocalypse Later].

May also includes Avago’s $37-billion acquisition of Broadcom, the largest tech deal since the dotcom bubble blew up.

This pressure to buy drives up prices and premiums. And the “synergies” needed to make these deals work even on paper will be harder and harder to come by. “Synergies” is corporate speak for cost-cutting, so mass layoffs, which will be announced with fanfare to push the shares higher. For these companies, it seems the only way to grow revenues is to acquire other companies, and the only way to grow profits is to cut costs. It’s not productive, hurts the economy, and mucks up the future of the company. But what the heck, it looks good on paper.

These deals are financed by a mix of shares, new debt, and cash raised with prior debt issuance – the “dry powder.” Much of this debt is in form of junk bonds and junk-rated leveraged loans, which banks then either sell to loan funds or craftily slice and dice and fabricate into highly-rated collateralized loan obligations (CLOs). Some of these CLOs are then put through the Wall Street sausage maker again to reemerge as tipple-A rated bonds denominated in yen for the Japanese market.

Loading up overleveraged junk-rated companies with more debt – even if it’s cheap – has consequences down the road: US default rates are creeping up, hitting 2% in May, the highest in 17 months, according to S&P Capital IQ’s LCD:

There were eight corporate defaults during the month, and all were public. Magnetation and Patriot Coal filed for bankruptcy; Colt Defense and Tunica-Biloxi Gaming Authority/Paragon Casino skipped bond coupons; Warren Resources and Midstates Petroleum inked sub-par bond exchanges; and SandRidge Energy and Halcon Resources completed bond-for-equity exchanges, also below par.

The report forecast a default rate of 2.5% by December 2015 and 2.8% by March 2016, assuming cheap debt continues to flow without limits. Once the money dries up, defaults will soar. Layoffs and defaults are the bitter aftertaste of M&A booms.

Downgrades are now hailing down on these companies. In May, Standard & Poor’s downgraded 41 issuers with total debt of $71 billion, but it only upgraded 18 issuers with total debt of about $43 billion – for a downgrade ratio by count of 2.28x, more than double the ratio of 1.0x in 2014 and 0.89 in 2013. It’s getting messier out there.

When our corporate heroes are not busy buying each other’s shares, they’re buying their own shares. In April, S&P 500 companies announced an all-time record of $133 billion in buybacks. It’s attracting the ire of the largest money managers in the world.

Blackrock Managing Director Rick Rieder wrote:

While some defend the buyback practice as a method of returning cash to shareholders, others, including my colleague Larry Fink, have argued that some companies today are focusing on maximizing short-term shareholder value at the expense of investing in the future.

In my opinion, today’s boom is just one economic distortion created by the Federal Reserve’s excessively accommodative monetary policy.

The boom is, in essence, a response to today’s extraordinarily low interest rates….

Using debt to fund buybacks and dividends eventually crowds out long-term investment in the company’s core business and threatens its credit quality, which is, according to Rieder, “what we are seeing today.”

Oh, and we almost forgot, there are other consequences. Blackrock’s Rieder:

Indeed, the global economy is witnessing a massive redistribution of wealth and income with borrowers, equity shareholders, and short-term investors benefiting; and savers, bondholders and longer-term investors being placed at risk.

Monetary policy wins again.

Investment bank Natixis just pulled the rug out from under self-satisfied, complacent, monetary-policy-fattened markets. Read…  Today’s ‘Liquidity Regime’ Is ‘Far More Dangerous for Investors’

 

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Wed, 06/03/2015 - 09:30 | 6158747 Orwell was right
Orwell was right's picture

The title of the article pretty much sums things up...."The last Two Times This Happened....".     

Yep, two stock market drops and nothing much changed.     I suspect the next drop will be pretty much the same thing......painful but not reformative.      Eventually we will have a truly traumatic economic experience, after which life could tip either towards dictatorship or improvement....(and I couldn't give odds on which we will get)......but I don't think the upcoming "correction" will be deep enough to do it.    Get another cup of coffee and keep on doing whatever it is we do to make a living....and prepare as best we can without completely putting our lives on hold....because it could take a while.

Wed, 06/03/2015 - 09:02 | 6158660 cn13
cn13's picture

This time is different?

Tue, 06/02/2015 - 22:50 | 6157929 OC Sure
OC Sure's picture

 

 

"The shares crash, hopes are dashed. People forget. Forget they're hiding behind an eminence front. An eminence front. It's a put on!"

(Who said that)

Wed, 06/03/2015 - 07:44 | 6158479 Gold Dog
Gold Dog's picture

Come and join the party dressed to kill.....

Wed, 06/03/2015 - 03:44 | 6158322 GuusjA
GuusjA's picture

Netwerk @SuperWil is hoopvol dat de veranderingen die worden doorgevoerd binnen de FIFA (script KlaverenTeam) de eerste grote stap zijn om de organisatie te hervormen tot het alternatief voor de VN.

http://nos.nl/artikel/2039225-overleg-belgische-burgemeesters-over-neder...

Dat één en ander is uitgelekt blijkt wel uit het feit dat in België de burgemeesters van enkele grensgemeenten al hun minister van Binnenlandse Zaken informeren over ...?!?!?

http://www.nrc.nl/nieuws/2015/06/03/grote-sponsoren-tevreden-over-vertre...

Duitsland, Frankrijk en de ECB zijn akkoord dat Griekenland geen geld zal overmaken aan het Internationaal Monetair Fonds (IMF). Op die manier mag het IMF als eerste grote instituut de volgende stap in de 3e SpinozaGolf zetten. Natuurlijk komt er in de media het verhaal dat 'er geen uitzicht is op een schuldenakkoord tussen IMF en Griekenland'.

http://www.trouw.nl/tr/nl/4492/Nederland/article/detail/4050204/2015/06/...

Uiteraard snakt het electoraat (waaronder politiemensen) naar meer duidelijkheid. De MACHT reageert vooral procedureel, omdat de volgende fase van de 3e SpinozaGolf nog niet mag uitlekken. Maar dat de rente in Duitsland al hoger wordt en de dollar zwakker is echter wel het teken dat ...?!?!?

Wed, 06/03/2015 - 04:21 | 6158337 GuusjA
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Eurogroepvoorzitter Dijsselbloem benadrukte in de Tweede Kamer dat de 3e SpinozaGolf niet tegen is te houden. vaststaan, alleen daarbinnen kan nog geschoven worden. De kaders van het systeem 'Leven en Laten Leven' staan immers vast en alleen binnen het 'recht op uniciteit' kan nog geschoven worden.

 

http://www.volkskrant.nl/buitenland/griekse-geldschieters-eens-over-eind...

 

ChristenUnie-leider Slob wil weten 'waarom de premier na 4,5 jaar stilzwijgen nu pas een 'discussie wil over waarden'. 

 

http://nos.nl/artikel/2039137-kamer-wil-debat-met-rutte-over-dikke-ik.html

 

Verslaggevers van onze parlementaire redactie weten dat nu het ‘gratis verdienmodel van banken' onder druk komt te staan. 

 

http://www.ftm.nl/exclusive/banken-hullen-zich-in-stilzwijgen-over-grati...

 

Dus zal binnenkort in de Tweede Kamer premier Rutte verslag gaan doen hoe de 'Dikke Ik' de echte economie in het verleden in zijn greep kon krijgen door psychosegelovige denkpatronen. Gisteren bleek dat de toespraak die de @MinPres zondag voor eigen publiek had gehouden ook in de Tweede Kamer op instemming kan rekenen. Dat Arie Slob (ChristenUnie) zich 'positief verrast' voelde, heeft te maken dat hij verwacht dat nu de wiskundige definitie van de 'participatiesamenleving van twee jaar geleden' in het publieke domein wordt behandeld. 

Wed, 06/03/2015 - 04:44 | 6158344 GuusjA
GuusjA's picture

Alexander Rinnooy Kan (D66) zal vandaag op het VNG-congres de consequenties van het 'recht op uniciteit' uitleggen. 

 

http://nos.nl/artikel/2039230-gemeenten-moeten-meer-belasting-heffen.html

 

Volgens topman Richard Fuld waren niet de banken verantwoordelijk voor de schuldencrisis die volgde na het faillisement van Lehman Brothers, maar de politiek! 

 

http://www.trouw.nl/tr/nl/4324/Nieuws/article/detail/4046071/2015/06/01/...

 

Toen had men al kunnen inzetten op het systeem 'Leven en Laten Leven', maar dit zag netwerk WitteGejT nog niet zitten. Dus nu afwachten hoe men gaat reAgeren, als het IMF Griekenland failliet gaat verklaren. 

 

http://www.trouw.nl/tr/nl/4492/Nederland/article/detail/4043535/2015/05/...

 

Online colleges over de 3e SpinozaGolf gebeurt nu nog allemaal een beetje onder de radar, maar dit zal binnenkort wel verleden tijd zijn.

Wed, 06/03/2015 - 03:56 | 6158327 JoeySandwiches
JoeySandwiches's picture

Finally someone around here making some sense.

Wed, 06/03/2015 - 01:44 | 6158238 Zuke Kook
Zuke Kook's picture

Nice! One of my favorite songs! :)

Tue, 06/02/2015 - 22:15 | 6157851 q99x2
q99x2's picture

A bankster jumped and now CEO's are going to lose money? Times are getting better.

Tue, 06/02/2015 - 21:38 | 6157786 CHC
CHC's picture

Crash you bitchez!!

Tue, 06/02/2015 - 20:06 | 6157554 harrybrown
harrybrown's picture

i see old yellow with a silver smile....

Tue, 06/02/2015 - 19:05 | 6157368 SillySalesmanQu...
SillySalesmanQuestion's picture

I am getting really old...this article could have been written thiry years ago about Drexel, Burnham & Lambert, KKR, Nabisco and R.J .Renyolds Co. I see "junk bonds" haven't changed all that much, except how they are structured and what they are denominated in...they're still junk.

The Barbarians are well past the gate, have occupied cities and castles for many years and are still making up the rules as they go along.

Tue, 06/02/2015 - 18:23 | 6157208 will ling
will ling's picture

let them fuggin' crash!

 

Tue, 06/02/2015 - 20:58 | 6157638 El Oregonian
El Oregonian's picture

No pain, no gain... To now its...  No brain, to retrain.

Tue, 06/02/2015 - 22:19 | 6157854 new game
new game's picture

another fed job and buffy with draconion terms for the "not enough donor money"from corps for the hill reps. and/or jack rides in with all the kings horsemen mounted for a grand distribution to all the "losers". maybe this time it will be different, maybe the dollar will be worth shit or half a shit. irregardless, burn y'all bastards...

Tue, 06/02/2015 - 22:55 | 6157938 Stuck on Zero
Stuck on Zero's picture

I was a founder of a publicly traded high tech company in the dot com era.  Our valuation went through the roof and we knew it was beyond ridiculous.  The only way to gain any shareholder value at all was to sell out or to acquire real value with an acquisition.  Management was forced into stupid decisions by Wall Street.  Needless to say, it all crashed and burned in the end.

Wed, 06/03/2015 - 08:45 | 6158622 dontgoforit
dontgoforit's picture

My friend was weedled out of his family's company, a $200 million container company about 8 years ago.  His family founded it and kept it going for nearly 90 years.  He shot and killed himself about 5 years ago.  The love of money is greater than the love of people.

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