The Stock Market’s Echo Bubble
The following commentary is an excerpt from the latest issue of my Short Seller’s Journal. The newsletter is published weekly. It reviews the weekly stock market action, economic numbers and some short ideas. Tesla is reviewed weekly. You can learn more about this newsletter here: Short Seller’s Journal
The run higher in the Nasdaq has become insane. It’s an “echo bubble” from the bubble that popped in November 2021. The Fed fueled this when it juiced its balance sheet by $400B in order to bail out uninsured depositors at the regional banks. But don’t be mistaken, Citigroup was feeding hungrily at the Fed trough as well. That $400B is now being drained. That along with the liquidity sucked out of the financial system should lead to another Nasdaq crash sometime this summer and possibly usher in the next round of QE.
All of the classic “blow off top” indicators are flashing again. The Vix is back to where it was in November 2021, when the bear market began with the Nasdaq heading south:
The chart above compares the Vix “fear” indicator with the Nasdaq composite index over the last two years. Based on the Vix, which measures equity call premiums vs put premiums, investors are as fearless as they were in November 2021.
The put/call ratio is at its lowest level since March 2022:
The previous two times over the last two years that the put/call ratio was as low as it is now, it preceded a big sell-off in the stock market.
The negative divergence between the Nasdaq and its advance/decline line is astonishing:
The advance/decline line is calculated by taking the difference between the number of advancing stocks net of the number of declining stocks. When the ratio is declining, it indicates that there’s more stocks selling off than moving higher. This chart is another to illustrate that the run in the Nasdaq has been driven by just a handful of the largest cap stocks in the Nasdaq composite.
Finally, last week a weekly record of $8.5 billion flowed into tech mutual funds.
The stock market – particularly the Nasdaq – is showing all of the classic signs that a speculative blow-off top is forming. In addition to the above indicators, the RSI and MACD momentum indicators for the Nasdaq are in nose-bleed overbought territory. The Nasdaq also has outperformed the Dow and the SPX by a considerable amount since mid-May. The momentum indicators for the SOXX index, which is subject to the highest degree of retail speculative frenzy, are extremely overbought and the parabolic rise in the SOXX has been accompanied by rapidly declining volume. It’s impossible to know when the rug will be pulled out from under the market, but in my opinion the sell-off will be sharp and swift.
Extraordinary Bullish Conditions For Gold (A Couple Of Stock Picks Too)
Banking crises, debt ceiling crisis, a U.S. recession (yes, real economic activity is contracting particularly in housing, manufacturing and consumer spending) and geopolitical crises – the fundamental conditions supporting considerably higher gold and silver prices strengthen by the day. Bill Powers invited me on to his Mining Stock Education podcast to discuss the prospects for the precious metals. I also offer a couple of my favorite current mining stock ideas.
If you are looking for mining stock ideas that should outperform the sector, especially junior microcap ideas, I publish the Mining Stock Journal, which now offers Stripe as a payment alternative to Paypal
Housing Market Misinformation And Disinformation: Beazer $BZH Example
The hype, misinformation and disinformation from housing market propagandists and home salesman (aka “realtors”) has become unbearable. Here’s a prime example:
Now, I don’t know if this fella actually examines SEC-filed financials or if he just sees financial headlines announcing that a particular homebuilder “beat” estimates and, from that, assumes that “profits have been fantastic.” Make no mistake, there’s a big difference between “beating” management-sandbagged guidance and actual profitability. The “earning” beat game in fact has become mindless idiocy.
While it’s true that homebuilder stocks are hitting 52-week highs, the profitability and industry fundamentals have diverged quite negatively from homebuilder valuations. This is not unlike the tech stocks peaking in early 2000 despite rapidly deteriorating fundamentals.
Beazer Homes ($BZH) is a prime example and just the latest homebuilder to report its fiscal year quarter accompanied by an earnings “beat.” But a look under the hood including a perusal of the footnotes that accompany the financial statements – a place no stock promoter would dare venture – shows sharply declining profitability and rapidly shrinking book of orders.
BZH reported is FY Q2 on April 27th after the market closed. The headline EPS of $1.14 handily “beat” the Street consensus of 83 cents. It didn’t matter that new orders fell 8.5% YoY in Q2 vs 2022 and were down 36.2% from FY Q2 2021. New orders through the first half of BZH’s FY 2023 are down 31.6%; the cancellation rate in Q2 was 18.6% and 25% through the first six months; and the order backlog is down 40.5%, with the dollar value of the backlog down 37.7%. BZH’s operating income plummeted 29% and its net income plunged 22% YoY for the quarter. But because the headlines number “beat,” BZH’s market cap jumped by $125 million:
BZH’s valuation is back to where it was in November 2021, around the time it was apparent that the housing bubble was popping. At the end of 2021, BZH’s market cap was 50% of the value of its order backlog value at the time. Currently BZH is valued at 66% of the value of its order backlog. Keep in mind that the Company’s contract cancelation rate over the last six months is running at 25%, which implies that, going forward, a material number of homes in the order backlog will be finished without a buyer. This is sheer insanity, particularly with the economy sliding into what will be a nasty recession.
Beazer is not unique. DR Horton recently reported an earnings “beat” accompanied by financials and operating statistics similar to Beazer’s. Yes there’s been a small dead-cat bounce in home sales in 2023 attributable in part to seasonality and in part to the drop in mortgage rates that accompanied the decline in the 10-year Treasury yield. But for the potential average home buyer (sub-740 FICO, less than 20% down payment) a 30-year conforming mortgage is still at least 7% when all of the various add-on charges are included (the boilerplate rates advertised are for mortgage applicants with a FICO of at least 740 using a 20% down payment – not the majority of applicants).
Moreover, the economy continues to contract and the layoff cycle is just warming up. Mortgage delinquency and default rates are moving higher, a trend which will accelerate going forward. At some point the stock market will begin to incorporate reality in to homebuilder valuations, which should silence the housing market promoters who are trying to squeeze the last few nickels out of the housing market before it collapses again.
Time To Short Shopify $SHOP Again
The following commentary is from the May 7th issue of the Short Seller’s Journal. Follow this link to learn more about this newsletter: Short Seller’s Journal info.
SHOP reported its Q1 numbers Thursday morning. Revenue was in-line with expectations. SHOP’s revenue growth was driven by the growth in the Merchant Solutions segment, which provides payment processing, shipping, fulfillment and working capital loans to merchants that sign-up for this platform. But the stock shot up 24% on Thursday, incredibly, because the Company unexpectedly reported net income vs the consensus estimate for another loss. As discussed below, the “net income” is phantom GAAP non-cash “net income.”
The market didn’t care about the $193 million operating loss, which was nearly double the operating loss from Q1 2022. The source of the positive GAAP net income was “other income” of $269 million. In digging through the footnotes, the source of this “other income” is “unrealized gains on equity and other investments” net of other investment noise. $215 million of that unrealized gain was non-cash per the reversal of that amount in the statement of cash flows. This reeks of SHOP’s management playing the GAAP earnings management game in order to “surprise” the stock market with an earnings report that showed net income.
From SHOP’s Q1 10-Q – truncated income and cash flow statements:
While revenues in the Merchant Solutions segment grew 31%, the cost of providing merchant services grew 45%. This is why the gross profit grew just 12.3%. Most of that positive “growth” can be explained by price inflation. However, SHOP’s gross margin declined YoY in Q1 from 53% to 47.5%. This likely reflects the implementation by management of aggressive promotional pricing deals to attract new merchants. Many will drop off when the free subscription period expires. Additionally, SHOP competes with AMZN and other online retail sales platforms like ETSY, OSTK and W. The big drop in SHOP’s gross margin also reflects cut-throat competition in the consumer products e-commerce space as e-commerce platform providers fight for a shrinking revenue pie.
SHOP also announced that it is selling its logistics division to Flexport. Flexport is a private logistics company on which there is not any material financial information. “Logistics” is a fancy name for a company that delivers products from the seller to the buyer. Trucking, rail, FedEx and UPS are examples of logistics companies. The high cost of free delivery deals – i.e. fulfillment – is one of the primary reasons AMZN is unable to achieve material profitability.
SHOP sold its logistics division in exchange for a 13% equity interest in Flexport. The move enables SHOP to migrate a division that loses money away from its GAAP financial statements. It also allows SHOP to cover up the fact that it paid $2.1 billion in cash and stock for the logistics business just a year ago. A year later it sold the business for far less than $2.1 billion and SHOP received hard-to-value stock in a private company that needs to raise capital intermittently to fund its operations.
Other than disclosing the payment of 13% of Flexport’s private equity, the actual dollar value assigned to the deal was not disclosed. This means that the value received by SHOP is not a material amount in relation to SHOP’s balance sheet. “Material” in GAAP is defined as 5-10%. SHOP’s balance sheet is $10.7 billion. Thus, the amount that would be assigned to the transaction was likely under $1 billion and possibly less than $500 million. Whatever the amount, it was paid in Flexport’s private, illiquid shares and may never be monetized. I will be curious to see if SHOP takes a charge against income in Q2 for the difference between the $2.1 billion paid for the logistics business and the amount of money it lost selling it to Flexport.
Along with the sale of the logistics business, SHOP announced that it is cutting 20% of its workforce. This move to cut operating costs reflects management’s outlook for difficult business conditions the rest of this year.
The market’s reaction to SHOP’s non-cash phony net income in Q1 is a reflection of the degree to which the stock market has reverted back to the silliness that was occurring in the run-up to the Nasdaq’s peak in November 2021, when the bear market in the Nasdaq began. The RSI is the most overbought since early November 2021. SHOP faces strong economic headwinds going forward, particularly the dwindling disposable income of its customer base, a retail environment that is becoming more cut-throat as e-commerce retailers fight for a shrinking pie of consumerism and general economic weakness.
Yesterday’s Jay Powell Post-FOMC Presser: Total And Utter Clown Show…
The Look And Feel of a Precious Metals Bull Market
The following analysis and commentary is an excerpt from the latest issue of the Mining Stock Journal. You can learn more about this newsletter here: Mining Stock Journal Information
It’s starting to look, smell and feel like a sustainable bull market may be unfolding. For the first quarter, gold rose 8.2% and silver was basically flat for the quarter but rose 15.6% in March. The mining stocks, generically using the GDX ETF as a proxy, rose 12.2%.
The chart above shows the price of gold and silver priced in U.S. dollars from 2001 to present. That is the chart of a secular bull market punctuated by cyclical ebbs and flows. The first bull cycle lasted from 2001 to 2011. It was followed by a bear cycle from 2011 to the end of 2015. In my view, the sector has been in a lateral “tug of war” that will be resolved by a historical move higher.
Several fundamental factors underlie the current – and my expected – performance of the precious metals sector, not the least of which is the continued massive accumulation of physical gold by non-western Central Banks (per the World Gold Council data). Eastern hemisphere Central Banks, including the CBs in countries that make up the BRICs alliance (Brazil, Russia, India, China) hoovered physical gold bars at a record pace in 2022 going back to when the records began in the 1950’s. The pace of buying continued in Q1 2023 per a recent report from the World Gold Council.
It would appear that the accumulation of gold reserves is part of a plan by the non-western Government geostrategic and economic alliances to reincorporate gold into the monetary system by using gold to back a new reserve currency that will be an alternative to the use of the dollar as the only reserve currency. Indications of this have been surfacing for a few years, but intensified and accelerated after the U.S. froze Russian dollar-based assets held in western Central Banks. In fact, earlier this month, Brazil’s President, Luiz Lula da Silva, joined Beijing in calling on “developing countries to work towards replacing the US dollar with their own currencies in international trade…” (The Financial Times).
As significant, if not more significant, after a recent trip by China’s Xi Jinpin to Saudi Arabia, where he was greeted by the Crown Prince of Saudi Arabia (Mohammed bin Salman Al Saud, or “MBS”), it appears as if China and MBS struck an agreement to start settling oil trades between the countries using the Chinese yuan. The significance can not be understated. The exclusive use of dollars to settle oil trades globally – the “petrodollar” – has been the basis of U.S. global economic dominance and the foundation of the dollar as the sole reserve currency since the early 1970’s. India has also been buying oil from the UAE and settling the trade in dirham (the UAE’s currency). Interestingly, in late March France’s Total Energy sold LNG (liquid national gas) and settled the trade using yuan.
As the world shifts away from using the dollar as a reserve currency, I believe a competing reserve currency will be used. A transition of the global monetary system away from the dollar and toward a new reserve currency is extraordinarily bullish for the price of gold and silver, particularly the price of each metal priced in dollars.
Another development that is exceptionally bullish for the precious metals sector is the emerging bank crisis in the United States and Europe. The sudden collapse of Silicon Valley Bank and Signature Bank was presented in the mainstream media as a limited bank crisis confined to regional banks. But SVB was the 16th largest U.S. and Signature was the 29th largest bank. What was particularly shocking was the suddenness and swiftness of the collapse of these two banks. The demise of these two banks drew attention away from the collapse of Credit Suisse, which was one of the largest banks in the world and a designated GSIB (global systemically important bank).
Because of the inter-connectivity of big banks globally via derivatives, GSIB accidents do not occur in isolation. I expect more big bank blow-ups will occur. But what stands out to me was the alacrity with which the Fed printed more money to bail out the uninsured depositors of SVB and Signature in an effort to prevent a run on the banks in general. While not termed “QE” or “a bailout,” that is exactly what occurred. The Fed’s balance sheet jumped in size by $400 billion over a two week period.
Similarly, the Swiss Government gave UBS a $100 billion safety net to absorb Credit Suisse. While these official monetary inventions may have temporarily stalled the onset of a bigger crisis, they invariably did not fix the underlying systemic problems. The point here is that I expect several more large banking system accidents and a correspondingly massive quantity of Central Bank money printing to prevent a western hemisphere financial system collapse. This will be extraordinarily bullish for the precious metals sector.
Along the same lines, I also expect that the Fed will be forced to pause hiking interest rates before autumn and, probabilistically, will have to start cutting the Fed funds to address the severe economic recession emerging. The Fed has yet to raise interest rates high enough to pull the negative real interest rate (Fed funds minus the rate of inflation) into positive territory. Negative rates are one of the primary drivers of the price of gold (and silver). If the Fed is forced to cut rates, I believe that the ensuing bull move in the precious metals sector will dwarf the bull move in the sector that occurred between late 2008 and mid-2011.
The sector is extremely over-extended technically per the charts and the HGNSI. The banks have built up a big short position in gold contracts and I think the markets are going into another “risk-off” down-cycle. Hedge funds and other short-sighted traders treat paper gold/silver and mining stocks like a risk-on trade. If the big banks are unable to engineer a material pullback in the prices of gold and silver, a possibility that not beyond consideration, the signal sent to the market could trigger a move in the sector that takes everyone, even the staunchest of long-time gold bugs, by surprise.
Inflation, The Debt Ceiling And Hobson’s Choice
Most people mistake rising prices for inflation. Inflation occurs when a Central Bank creates money at a rate in excess of the rate of wealth creation that theoretically “backs” the additional currency. Simply stated, the ratio of additional money supply to additional “widgets” is rising.” Rising prices are the evidence that inflation has occurred. The amount of money created (“money” as defined by Austrian economics) has dwarfed the amount of wealth creation since 2008. This is why rising prices have not become a “transitory” phenomenon.
The Government and the Federal Reserve is faced with a tough choice: immediate systemic collapse or death by a thousand cuts. If the Fed caves in to political and public persuasion and “pivots” by abandoning QT and rate hikes, it will further defer the inevitable and further fuel rising prices. If it continues on its course, in all likelihood 2008’s great financial crisis will become this year’s great financial collapse. But the Fed (and the Government) has already signaled its decision when it engineered the recent de facto bailout of the banks. And the uninsured depositors at SVB and Signature bank were not only ones bailed out. Citibank fed prolifically at the FHLB loan trough (which is part of the Fed’s balance sheet) over the last several months. And now this country must accept a Hobson’s Choice, which is to say there is no choice other than the path offered by the Fed.
GATA’s Chris Powell wrote a must-read analysis/commentary for the Manchester, Connecticut’s “Journal Inquirer.” It’s a shame that this piece is confined to a local newspaper in the northeast. It should be republished in every major newspaper across the country.
In their recent endeavors to spend ever more money than is backed by the economy’s production, members of Congress and presidents have been emboldened by the failure of the public to wonder what causes inflation, the devaluation of their money. For inflation is the main danger with money creation, and the country and the world are already suffering an inflationary disaster…If the United States can’t keep borrowing more from the rest of the world — money that will never really be repaid, since the debt keeps growing and is used to repay earlier debt — the country will have to start living within its means. Or else the government will have to create so much more money that inflation will increase many times more than the current official and already much underestimated rate of 6%.
Read the entire commentary here: Living on our own earnings is the real threat of the debt ceiling
The Bank Crisis Is Just Warming Up – So Are Gold And Silver
The banking crisis is just starting. The implosion of the fraud-riddled FTX and the counterparty collateral damage that occurred was an early warning sign. But it is a glimpse of the malinvestment, accompanied by fraud and corruption, enabled by the nearly $9 trillion printed by the Fed since 2008. SVB and Signature were indicators that the force behind the nascent bank crisis has put the ball and play and is safe at first. While the Central Banks can try to stamp out lit fuses as they appear, it will prove to be a failed game of whack-a-mole. The Fed knew Lehman was going to collapse but it had no idea that Goldman and AIG would impale themselves on credit default swaps until the explosion occurred.
At some point there will “a hit heard around the world” and precious metals investors – gold, silver and mining stocks – will be win the pennant. Jason Burack – Wall St for Main St – and I discuss derivatives along with the meaning behind the massive accumulation of physical gold by non-western Central Banks:
I publish the Short Seller’s Journal and Mining Stock Journal. You can learn more about either newsletter here – Mining Stock Journal – and here – Short Seller’s Journal. I do all of my own research and I do not accept compensation or gratuities from the mining companies I cover and recommend. I continue to be highly bearish on the housing market. I also have firm conviction that the S&P 500 has another 50% downside before the bear market ends.
The Banking Crisis Is Just Getting Started
Back in January, John Titus warned that we were in the midst of a banking crisis. And sure enough, just over a month later, the evidence of the crisis emerged with the sudden collapse of Silicon Valley Bank and Signature Bank. I invited John back on to my bi-weekly Arcadia Economics podcast to discuss his prediction in January and his view on what happens next. The Fed has already pivoted from its tightening policy. The stock market’s acknowledgement of that is reflected in the big decline in interest rates across the yield curve, particularly at the longer end as well as the recent partial reflation of the stock market, especially in the large-cap tech sector.
We all knew the Fed would be faced with an “inflate or collapse” decision – a decision that has to occur sooner than expected:
In the latest issue issue of my Mining Stock Journal, I update several “portfolio” mining stocks, as well as highlight a couple of irrationally undervalued micro-cap junior development stocks in which I am invested and recommend in my newsletter. You can learn more here: Mining Stock Journal information
Is 2008 Unfolding All Over Again?
The Fed and U.S. Treasury have made to decision to back-stop depositors at U.S. banks – a liability that could potentially hit $2 trillion. More interestingly, there must be a considerable amount of counter-party default risk embedded in the banking system because several Too Big To Fail U.S. banks have agreed to commit as much as $30 billion in capital to rescue First Republic Bank, which would next to collapse. The Swiss National Bank is ponying up $54 billion to prop up Credit Suisse, which is teetering on the brink of collapse. My bet is that $54 billion won’t be enough. The Central Banks have signaled that bank bailout 2.0 is a go. However, the scale of the problem this time, compared to 2008, is multiples larger. Furthermore, the legislation after the great financial crisis that was pimped as preventing another banking crisis served only to make it easier for the banks to hide their indiscretions.
The following commentary is an excerpt from the latest issue of my Short Seller’s Journal. For the record, I pegged Silicon Valley Bank as a short about 18 months ago. How? Because I spend most of my time analyzing public financials filings in the footnotes to those disclosures, where the good stuff is buried.
Aside from what the Fed is doing, the stock market is ignoring several event risks that could potentially trigger a stock market crash. First is the debt ceiling issue. Second is the conflict in Ukraine, which is a de facto war between Russia and the U.S. Third is the U.S. economy, which is in far worse shape than is reflected by the stock market. And finally, and perhaps foremost, is what could be the start of a series of bank and financial firm blow-ups.
Janet Yellen says the Treasury, at the current cash burn rate, will run out of cash by September or October. Everyone just assumes that Congress will go through the mating dance required to reach enough support to raise the debt ceiling. But right now the one-year credit default swap spread is 80 basis points. This means that the cost to buy insurance against the Government defaulting on its debt payments is close to 1% on the principal amount of the Treasury bond being insured. The cost of Treasury default insurance is at its highest level since 2011, when a previous debt ceiling impasse led S&P to downgrade the Government’s debt rating from triple-A to AA+.
Another risk the market is ignoring is the escalation of the de facto war between the U.S. and Russia being fought in Ukraine. The U.S. has rejected Russia and China’s call for peace talks. By all indications this conflict could take a turn for the worse, the potential of which is not remotely priced into the stock market.
And the economy is in much worse shape than indicated by some of the economic reports – particularly the major reports conjured up by the Government. A prime example is the employment report, which is statistically manipulated to show a much higher rate of employment than reality. As an example, the report for January purported the economy added 517k jobs, comprised of 894k new jobs less 377k jobs lost. However, 810k jobs were created using a statistical gimmick the BLS refers to as “population control effect:”
The “population controls” are statistical hocus pocus that uses the latest decennial population survey and adds an estimate of births and deaths and estimates of net international migration. It’s basically a statistical sausage grinder fed with dubious statistical ingredients to produce a highly unreliable statistical estimate of new jobs created. Per the graphic above, the “population control effect” manufactured 810k new jobs. We already know (as detailed in a prior issue of SSJ) that most of the jobs created since March have been part-time and most of those part-time jobs are people working multiple part-time jobs. I literally cringe when I hear “experts” like Jerome Powell say that the labor market is strong…
Nevertheless, not only is the economy much weaker than is reflected by some economic reports like the employment report but it is starting to look like the rate of inflation is heating up again, as some of the price measurement metrics are trending higher again and energy prices are starting to rekindle, led by the price of gasoline futures which are up 32% since mid-December. Additionally, Wall Street 2023 corporate earnings estimates have been trending lower and are expected to be cut further in the coming months. While P/E ratios on stocks have fallen over the last year, if earnings head south, P/E ratios will head south, which means stock prices head south.
In another indication of economic stress and soaring costs, General Motors is offering voluntary buyouts to a majority of its 58,000 salaried workers in an effort to cut $2 billion in structural costs over the next two years. It is encouraging as many as possible to take it. I would bet those who don’t will be forced to “retire” at some point in the future. This to me is a “realignment” of costs in response to the expectations of higher manufacturing costs and lower sales volume over the next couple of years.
Finally, the collapse of Silicon Valley Bank (SIVB – $0.00) may be a signal that a financial system melt-down is beginning. But SIVB is not the first indicator. Credit Suisse has been on death watch for several months. FTX blew up and appears to have taken down Silvergate Capital with it. And now SIVB has been taken into receivership by the FDIC. How does anything go bankrupt? Slowly then suddenly – this shows just how inefficient the NYSE is in terms of discounting risks – largely because of stupid retail money and hedge fund/CTA algo trading programs. It was known by those who bother to take the time to analyze fundamentals that SVB was a ticking time-bomb of asset/liability mismatch – a socially correct way to say that SVB was egregiously mismanaged:
I actually recommended SIVB as a short maybe 18 months ago or so. I made some money on puts but then the stock ran up $750 by early November 2021. The chart above is deceptive because the stock traded down to $35 in the extended hours before the NYSE opened. It was halted in pre-market and never opened. The FDIC took SIVB into receivership Friday morning. The stock is worthless.
Many people were under the impression that SIVB was a conservative commercial/consumer bank. But that’s what happens when you listen to Jim Cramer on CNBC and do not do proper due diligence. A month earlier, Cramer was recommending SIVB, saying it was “still cheap” and has “room to run.” Earlier in the week SIVB launched a $2.25 billion capital raise via stock, convertible preferred and money from a PE firm (General Atlantic). That deal failed almost as quickly as it was announced. Two days earlier (Wednesday) SIVB told investors in a mid-quarter update that it had $180 billion in liquidity – it turned out to be a fraudulent claim.
SIVB has $211 billion of assets against $173 billion in deposits $22 billion in other liabilities. $120 billion of the deposits were invested in Treasuries, agency-issued bond trusts (mortgages, collateralized mortgage obligations, commercial mortgage-backed securities, etc). On the surface those look safe. But with the big jump in interest rates, those securities are underwater vs SIVB’s cost. SIVB booked a $1.8 billion loss on part of those holdings when it sold its “available for sale” securities in a desperate attempt to raise cash.
What happened? SVB is a case-study on how not to manage a bank for which the primary source of funding is demand deposits. 54% of SIVB’s assets were in long-maturity, somewhat risky assets:
Because SIVB classified these as “hold-to-maturity” securities, it was not required to run mark-to-market losses through the income statement and it was entitled to show these assets on the balance sheet at their cost of acquisition. But in fact the market value assets at the end of 2022 were worth $15.1 billion less (16.5%) than the stated value. GAAP permits a Company is bury this mark-down in the shareholder equity section of the balance sheet.
Then, SIVB has a $73 billion loan portfolio of questionable credit quality:
This is how the Company describes the assets (from the 10-K footnotes): “We serve a variety of commercial clients in the private equity/venture capital, technology, life science/healthcare, commercial real estate and premium wine sectors. Loans made to private equity/venture capital firm clients typically enable them to fund investments prior to their receipt of funds from capital calls.” The bear market and Fed rate hikes shut off the money flow to PE and VC funds and it shut down the IPO market, which shut off the funding for these loans.
We don’t know the true nature of each individual line item because each separately is not big enough to require details from a regulatory standpoint. But the “investor dependent” and “cash flow dependent” loans are mezzanine securities that are worthless unless the private equity and venture capital funds that used those loans for portfolio companies are able to attract later-round financing for the companies or take them public. This part of the loan portfolio is $17.2 billion, or 23.8% of the total loan portfolio and it might be worth, best case, 10-20 cents on the dollar. I also suspect that the “innovation C&I (commercial & industrial)” loans are also likely not worth very much. That’s a big capital hole to fill.
SIVB had a book value of $16.2 billion at the end of 2022 per its 10-K. Per the math shown in the 10-K footnote, the investment securities, assuming SVB still had $13 billion in cash (mostly likely not), were down 16.5% – or $17.6 billion, on $107 billion of investment securities. Assume the $17 billion in investor/cash flow-dependent securities plus the “innovation C&I” loans are worth 15 cents (a generous assumption), that’s another $14.4 billion in losses. Among these assets, SVB was sitting on $32 billion in losses. That means SIVB had a real negative book value of $16 billion (minimally) at the end of 2022. It was technically insolvent before 2022 was over.
Earlier in the week there was a capital call on SVB in the form of depositors who wanted to withdraw their cash from the bank. According to media reports, some venture capital titans advised their portfolio companies to withdraw their money held as deposits from SIVB, which led to $42 billion in withdrawals. This means that there were some people who understood the degree to which SVB was potentially insolvent.
Bank runs are the market’s method of signaling information to the market that has been concealed by accounting gimmicks and unscrupulous management. However, the information was publicly available in the footnotes to the 10-K filed on February 23rd. The CEO, CFO and CMO (chief marketing officer) sold $4.5 million in shares representing a large percent of the stock holdings of each on February 27th. It would be naive to assume that they did not know what was about to unfold. This was a classic bank run which overtly exposed the truth about SIVB’s assets and liquidity.
On Wednesday last week, the CEO of SVB gave a presentation in which he made the claim that the bank had $180 billion in available liquidity. But $180 billion of “available liquidity” should have been ample to cover 100% of the deposits. If the assets were truly liquid, SVB would have been able to sell enough to cover 100% of the deposits, not just the $42 billion in withdrawals during the week. The CEO thus lied about the nature of SVB’s assets. Even if SVB had managed to bamboozle those looking at the $2.25 billion equity raise, it would have not come close to keeping SVB liquid.
SIVB is emblematic of the giant asset bubble in which lending and Wall St institutions used near zero-cost capital to leverage up and take risks beyond the ability to manage while the regulators looked the other way. But in many ways this is a replay of 2008 only, I believe there will be bigger blow-ups coming. And SIVB is not the first warning flare. Credit Suisse has been under care and maintenance by the Swiss National Bank and the Fed for several months. While SIVB likely won’t initiate contagion with the Too Big To Fail Banks, Credit Suisse will. Furthermore, the FTX blow-up, which has now taken down Silvergate Capital, shows the degree to which the financial system is infested with financial Ponzi schemes.
I believe what is starting to unfold will be 2008 x five unless the Fed and the other big Central Banks print enough money to monetize the fraud in the banking system. But if the Fed takes that kind of action, the dollar will likely collapse. It may take bigger blow-ups for the Fed to act. In which case, I am confident that Blackrock (BLK), Citigroup (C) and Goldman Sachs (GS), among several others, are at risk. It’s also worth looking at some of SVB’s regional peer banks, like Signature (SBNY), Pacwest Bancorp (PACW) and First Republic (FRC).