By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Testosterone Pit.
Nothing could have been a more pungent metaphor for the current investment climate than the headline, “Macau gambling revenue hits record $45 bn in 2013.”
Revenues jumped 18.6%, after rising “just” 13.5% in 2012 – which had caused a lot of handwringing, since they’d soared 42% in 2011. Post-financial-crisis Macau – like its bigger sister, high finance – fizzes with optimism. Last year, it extracted $45 billion from the pockets of people who gambled there; this year, it’s going to set another record.
Or maybe there was an even more pungent metaphor: Stephen Cohen’s pad in Manhattan. He personifies the smart money; his hedge fund, SAC Capital Advisors, pleaded guilty to insider trading and agreed to pay a fine of $1.2 billion and wind itself out of existence. So he is trying to sell his 9,000-square-foot duplex on the 51st and 52nd floors of Bloomberg Tower. The metaphor isn’t that he dropped his asking price by $17 million, from $115 million down to a measly $98 million, but what he’d paid for the two units in 2005, namely $25.9 million, plus whatever it took to combine and remodel them. That he thinks he can get nearly four times the amount he’d paid for it less than nine years ago – that’s the metaphor for our crazy investment climate.
Hedge funds raked in the moolah in 2013, with assets under management rising by $228.8 billion to an all-time record of $2.01 trillion – not counting the hedge funds that our TBTF banks have become. But returns paled compared to the miracles the Fed performed with the stock market. Hedge funds specializing in distressed debt outperformed all other strategies with a 16.8% gain, ahead of long/short equities hedge funds, up 14.3%, and event-driven hedge funds, up 11.3%. Compared to 29% for the S&P 500.
But hey, what matters is that the all-important metric of assets under management gets pushed to new highs. Hedge funds get paid 2% on it, come hell or high water, so about $40 billion in 2013. And they get paid another 20% on any gains, so roughly $55 billion in 2013, for a total fee intake of $95 billion or so. Hopes are riding high for a killer 2014.
Corporate deal-making also bloomed in the US in 2013: mergers rose 11% to over $1 trillion, the highest since the financial crisis. Reshuffling the corporate deck is good for everyone: CEOs, investment banks, hedge funds with insider knowledge, and workers who are going to get laid off as the post-merger synergies are being implemented….
“This era of low interest rates has encouraged companies to consolidate and clean up some structural inefficiencies,” is how Michael Carr, head of Goldman’s Americas M&A, explained the workers-getting-laid-off phenomenon. Goldman pocketed $1.5 billion in fees for its M&A advisory work.
The accelerating pace of the mergers during the last two quarters is goosing extrapolations of what an insanely good year 2014 is going to be – helped along by a “stronger economy,” some sort of “stability at the Fed,” and an inexplicable absence “of near-term economic bumps,” according to Scott Barshay, head of the Corporate Department at Wall Street law firm Cravath, Swaine & Moore. In reality, to get a bumper crop of mergers, you must have a gravity-defying stock market and a continued flood of freshly printed money made available to large corporations at near-zero cost.
Companies are motivated. Stock valuations have moved into the stratosphere. Financial engineering, such as share buybacks, has been covering up, more or less elegantly, the ugly reality of stalling growth in revenues and earnings. But there will be a moment of truth.
“The pressure is building for companies to justify their trading multiples,” warned Chris Ventresca, co-head of Global M&A at JPMorgan, which pocketed $1.3 billion in fees for its M&A advisory work. “It will be hard to deliver that organically, so you have to look for inorganic growth.”
You can practically hear the fizzing optimism for IPOs. In 2013, there were 229 IPOs, raising $61.3 billion, the highest amount since 2007, and up 58% from 2012 [read my take on this and other extraordinary accomplishments in 2013….. Financial Engineering Wildest Since The 2007 Bubble]. Now even Chinese IPOs are coming back. Everything that isn’t nailed down will get shoved out the door, viable or not, at dizzying valuations. And somebody is going to end up holding the bag.
“The longer this window stays open, the more the quality of the deals falls, the more you get the piggyback deals,” explained Tony Ursillo, a tech analyst at Loomis Sayles & Co., which has $193.5 billion under management. “I feel like we’ve cleaned out a number of the first-tier companies, from a quality standpoint.”
The casino mentality that has set in, and the billions it extracts from the real economy, is dependent on the most addictive drugs of all: a flood of nearly free money. It sets off a chain reaction, including ecstatic stock markets, where IPOs without earnings can soar and where even the most convoluted mergers that will haunt stockholders for years to come seem to make divine sense – and our favorite Wall Street engineers are out making hay while they still can.
Central banks rule! They’ve accomplished the impossible: separating stock markets from the economies they’re based on. But in 2014, the US and China are trying to unwind these crazy policies – without taking down the entire global economy. Read… So This Isn’t Exactly A Rosy Outlook For 2014, Or Something
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With corporate profits-to-gdp at all-time high this means more room to the downside than upside.. Leading to more M&A to keep margins up, or hide problems. Leading to more layoffs. Leading to economic slowdown and more capacity destruction… When paper shuffling takes over industry, purchasing power erosion typically follows.
I won’t change my forecast until I see bankers getting put back in their proper place.
Totally nutty. I keep smiling at the thought of all that free-floating capital desperately seeking a reality. Will it save the investor class if the dollar is devalued? Or only if the dollar is devalued less than all the other earthly currencies? Back in 1954 when capitalism had quickly run out of reality-based investment ideas, the US (D.C. anyway) was anxious about a pending bankruptcy. Which was fluffed off with a big “Bankruptcy Ball” in Washington (Catherine Graham’s autobiography). After which we began spending money like there was no tomorrow, much the same as today. The money was used to advance the military and buy up assets around the world, and pay for the Vietnam War. Which I believe was originally intended to separate southern China from northern China. We all know how that ended in 1971. In the end, this time, the corporations who have purchased the most assets (corporate imperialism) will come out on top. But it is a shameless process based on pure embezzlement and racketeering.
The first major earnings disappointment could topple the whole house of cards. Asset prices are supported by debt which must be serviced and will be liquidated if it cannot be serviced. How much of the stock market bubble is supported by overnight loans? What happens when the lenders get nervous or the insiders decide to cash out? I guess we’ll just see, but it is looking a lot like the year 2000 to me. I don’t think the risk is higher interest rates, since the Fed knows full well that even a taper will pop the balloon. But are low interest rates enough to keep it going, and how high can stock prices go without earnings increases to justify the prices?