Tuesday, January 15, 2008

Stocks, Bonds, LBO's and PPT's

Why was the stock market -until recently- so apathetic to the various negative signals coming out of the economy and credit markets? Many point fingers to the so-called Plunge Protection Team (PPT), which has supposedly moved from rare interventions during crisis events to full-blown daily manipulation.

It is a matter of definition as to what or who exactly is the PPT but, as I have said before, the market is now easier than ever to "steer", strictly from a means and methods standpoint. These are the reasons:
  1. Individual investors and speculators have mostly departed the scene, leaving the game to the professionals (pls. refer to post from May 18, 2007). This is important because it is impossible to consistently predict and control the actions of millions of individuals holding thousands of different shares. The best example is what happened during the 2000-01 day-trader craze.
  2. The market has become derivativized to an unprecedented extent. On any given day the top most active issues are the various trackers (QQQ, Russell, super-shorts, etc.). This is a market where the derivative tail wags the cash-market dog, at least for the index-heavy issues.
  3. The emergence of highly capitalized hedge, private and sovereign funds has concentrated the market into the hands of fewer players, in combination with the few global prime brokers, who also actively trade for their own account.
It follows that the market's facade (i.e. the popular indices) has become theoretically easier to manipulate on a daily basis. Nevertheless, effective manipulation requires more than the ability and the means to do so; there must also exist an underlying current, a fundamental backstop upon which daily operations can be based. In other words, there must be ultimate buyers or sellers of cash stocks, depending on what kind of manipulation is being undertaken (bullish or bearish).

Since we are currently talking - theoretically, always - about bullish manipulation by the "PPT", we must look for ultimate buyers.

In this regard, one of the most revealing charts I have seen in months is the net amount of equity withdrawn from US markets through buy-backs, buy-outs and LBO's (black bars, chart below - click to enlarge). The amount reached a record $210 billion in the 3Q2007, from near zero in early 2004.

Chart: FRB

The US has never before experienced such a sustained equity withdrawal in the history of its public markets. In just four years between 2004-07 total net equity withdrawn came to over $1.6 trillion, an enormous sum when compared to US market capitalization (end-2003: $14.3 trillion, end-2007: $19.9 trillion). The effect was to provide a constantly growing underlying "bid" for cash shares, one that leveraged the performance of indices: while total capitalization rose only 39% in the above period, the S&P 500 index gained 67%, i.e. 70% faster. (Does this make it a Potemkin village market?)

Where did the money for the buy-backs and LBO's come from?
Some came from corporate earnings, which reached a record ratio of GDP; but most of it came from debt. Record low credit spreads and volatilities encouraged CFOs and private equity funds to buy shares with borrowed money. Investment bankers, always fee-hungry, piped in with their advice: "There is too little debt and too much equity on corporate balance sheets". (The same bankers are today eating their words as they go hat-in-hand to raise emergency capital for themselves, but that's a story for another day.)

The chart below shows net issuance of bonds (i.e. new debt) by US corporations. The total amount during 2004-07 came to $3.2 trillion, another record. Given the furious M&A and LBO activity in 2005-07, obviously a big chunk of that money went to finance share purchases.

Chart: FRB

To sum it up: the market was riding a sea of buy-backs, M&A's and LBO's that were financed by cheap and easy credit. The "PPT" helped things along, taking advantage of the means, methods and conditions mentioned above, to support their own books. By my definition, therefore, the "real" PPT is a loose association of major market players that trade their own book taking advantage of dominant position and back-stopped with customer orders from LBO's, etc. It's the oldest game in Appletown: taking advantage of customer flows, with some new bells and whistles added.

As to the future: the credit crunch slashes LBO and M&A activity, while lower corporate profits reduce share buy-backs. The sovereign wealth funds will be more prominent, but they don't have the same equity and risk appetite as the other players. In addition, they are subject to significant internal political and power-play pressures. If their investments show mark-to-market losses, their managers will quickly go into CYA (cover your ass) mode. Add all these together and the conclusion is that customer flow is ebbing quickly.

The consequences for ongoing "PPT" operations are, in my view, quite obvious.


  1. Many thanks for this extremely valuable article! I consider this to be the BEST ever!


  2. "The US has never before experienced such a sustained equity withdrawal in the history of its public markets."

    On all levels of the US economy, from corporations to the purses of the citizens, equity has been replaced by debt. This certainly appears to be a theme.

  3. Thks Okie. I owe you a cookie :)

  4. Great Post...thanks for all of your great work.

  5. Long time lurker - first time poster.

    Just wanted to thank you for a great post and one of your best yet. I agree that the first chart on equity buybacks is stunning. I have been amazed over the last few years at all of the stock buybacks during a time of high stock prices. This seems to be counter intuitive to what was taught in Investing 101 - buy low, sell high. Taking into consideration your thesis, we see the buybacks were clearly not because the underlying businesses were being "undervalued" in the market but were being purchased for more "nefarious" reasons.

  6. There is a very good article titled "The Effective Nationalization of the U.S. Mortgage Market in Q3 07" at http://www.rgemonitor.

    The article says that that the net flow of credit surged in Q3 of 2007 as the FHLB advanced USD746 bn to mortgage lenders in Q3 2007. Now, Bank of America has bought Countryfried and it is all but certain that there will be a 75 basis point cut in the next couple of weeks. The tax writeoffs BAC receives are equivalent to a 6% return on investment (if one calls CFC an investment). The Treasury Secretary says there was no Hanky Panky.

    Is there any doubt that our central planning committee is worried about the high yield corporate indexes climbing and would like to nail them down and avoid the 10-11% spreads we saw twice over the past 16 years. As long as spreads can be prevented from getting up there (they're only around 5.5% now), the game may well go on longer, maybe another year. But there are no guarantees in the world. If spreads do reach new highs, there will most certainly be a government jobs program.

    Not like the one you proposed in a previous post, though.

    Rocketing high yield spreads can do very interesting things. A 20% drop in the stock market will not cause many bankruptcies. A 5% rise on high yield spreads will have a much bigger impact though.

  7. I keep trying to watch these guys too. This was a great post. Thanks

  8. No ifs, and or buts.....

    Great post.... Market manipulation used to be an individual "thing"... Now it's institutionalized, set up with a crony system. The results are always the same as they relate to unsustainability and miscalculations of timing and price. The nature of the trading "GODS" is not to forgive such trespasses. I wonder what the nature of the people will be.

    Best regards,


  9. Hellasious,

    Great piece as you presented a different view of PPT.

    The most mysterious thing in stock market in the last 2 years especially after Paulson took over (stock market ramped up ACCIDENTALLY occur at the same time), was that there was Sudden Panic Stock Buying that spike the SP500 index up like 10 points in 1 minute.

    Funny thing is, these happened all soo frequent at index support level at bad economy news. Also, there seem to be wayyyy too many Panic Buying than Panic Selling these days, as evident from much more Spike Up than Spike down in various indexes, all with terrible economy news.

    The most compelling reason this time around, is how stock market is stretched way past its correction time. In the past, stock market peaked at 6 ~ 9 before official recession started. Now, it looked like it peaked just 1 month before recession. Even with summer credit meltdown, it can even make a new high in Oct 2007.

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  11. I have a feeling that those same shenanigans are occurring in the Treasury Bond market for some time now. It's too important of a market to "allow to fall" perhaps ? Maybe it's a way of compensating the Chinese and Arab oil exporters who hold so much US debt for the fall in the dollar.

  12. Correct me if I am wrong, but you are claiming that this "PPT" is manipulating the stock market, correct?

    However, you made a post on December 20 in which wrote, "The conclusion is that there is no heavy-duty, large scale government/PPT manipulation going on." (Stock Market Conundrum - 12/20/2007)

    Could you clear this up please?

  13. The "PPT", as I define it in this and other posts, has little to do with the government.


  14. Notice how FAST they talk on CNBC on bad news/down days. It's astonishing, as if they are running at double speed. Is this so that we don't notice the news?

  15. Agree with others' sentiments. Bravo Hellasious, this is a great post today!

  16. Great Article Hellasious. It's all about relationships. Relationship Banking has taken on a wholew new meaning.

  17. I agree with the rest of the posters. This is an important explanation on what is happening. Stocks were replaced with debt (bonds).

    What does this mean for the bond market? Would bonds default or would high inflation quietly nibble them away?


  18. Love this type of post Hel! It's what you do best.

    I thought something like this may be behind some share buy backs, but when it's explained like this, it makes one sit back and go wow! Wow for how easy it is for you to explain the concept (and provide the supporting documentation backing it) and wow when one realises the scale of what is really going on out there. I must learn not to be surprised...

  19. Related:

    'Despite the impression that Americans received from the financial press, the 1990s were not a time of wild stock buying by individuals or new issues by corporations. In fact, the opposite was true.

    Corporations were buying back their own stock in huge quantities, while individuals, on balance, were selling stocks, with about two-thirds of the proceeds being directed towards money market funds, corporate bonds, and deposit accounts (See household flow analysis).'

    Case Study: Applied Capital Flow Analysis

    United States Equities: 2000; p2


  20. I'm trying to respond to a counter argument. What would you say to "Interesting thought on repurchases inflating stock prices. Stock repurchases are definitely up but I'd attribute it to growth in corporate cash flow; dividends are way up too. Debt issuance is up but I'm not sure that its grown as a % of capitalization, or if coverage ratios are down. Also, unique to the housing picture, the trouble was less a result of low interest rates, more a structural change in the industry that led to lending excess: ARMs, teasers, subprime, no doc, low doc, and piggybacks, the removal of which took the 20% of homebuyers that were marginal out of the demand picture in an instant..."

  21. The PPT was IMHO one of the main policy tools of the Clinton and GWB administrations. The inflection point of the power of the PPT will come only if and when a major financial accident happens (i.e. AIG, Bears Stearns), or when public awareness will dismantle the card house. Michael Berger