Stock Market Leverage Higher than at Any Time in History | Michael Green

The crack spread (difference between gasoline and crude prices) is rising rapidly due to refining capacity constraints, indicating supply pressure in refined products rather than crude.

“what's called the crack spread, the spread between gasoline prices and oil prices, is rising rapidly.”

South Korea has historically shut its market only 8 times in history (including the Asian financial crisis), but has now shut its market 6 times in a single year, and has banned 2x leveraged and leveraged ETFs expressing regret that they ever approved them, indicating regulators do not understand the products they are introducing.

“Korea has actually only shut its market eight times in history including the Asian financial crisis. It is now shut its sixth time this year. Um they have banned 2x levered and levered ETFs. They have expressed regret that they ever approved them. That suggests as I think is the case that the regulators don't understand the products that they're actually introducing and how those are being marketed to retail.”

GDP growth has declined in both real and unit terms consistently; full-time jobs have not grown for nearly 4 years, indicating the economy is weakening even as market-focused administrations claim nothing has ever been better.

“GDP growth has declined in um both real and unit terms um or GDP growth has declined in both real and unit terms consistently. Full-time jobs have not grown now for nearly 4 years. Um this is creating conditions under which the economy is weakening but a an administration that is very focused on the stock market is convinced that nothing has ever been better.”

We are a social species that flourishes when we are excellent to each other, and should approach the current context by being excellent to one another despite emphasis on 'party on.'

“we are a social species, we do exist in harmony with our neighbor, um and we all flourish in which we are excellent to each other, and I would encourage people to be excellent to each other even as the emphasis seems to be on party on, dudes.”

President Trump ran on a campaign that he was the only president who hadn't started a war in recent years, but has now started multiple wars including extraordinarily short-lived ones like Venezuela, and protracted ones like the Iran conflict, creating loss of perceived US capability and emboldening countries like China.

“Yeah, I mean it's remarkable. This is a president who ran under the campaign that he was the only president who hadn't started a war in the past, you know, X number of years and now we've seen him start multiple wars, some of which were extraordinarily short-lived like Venezuela, others are proving into proving to be more protracted and more negative candidly for the, you know, observation that the US has functioned as the global policeman.”

AI/internet search will ultimately become advertiser-supported and available to all individuals unless the US chooses to embrace national security narratives that protect proprietary frontier models under a too-big-to-fail framework.

“That will ultimately discover much like internet search it simply becomes advertiser supported and it's available to all individuals unless of course we choose to embrace the national security narrative that this needs to be protected in some manner and the unique champions that are pursuing their proprietary frontier models are, you know, too big to fail before they even get public. Um that's certainly a possibility with this administration.”

China's sanctions-driven semiconductor capacity expansion will likely dominate the market and bring down prices, following the historical pattern that whenever China has put its sights on a market (solar, steel, aluminum), it has come to dominate that market in a low-cost framework, suggesting the semiconductor commodity cycle may be much worse than currently anticipated.

“I would highlight that the sanctions against China have created conditions under which China is aggressively ramping up its semiconductor production and producing in many of the areas attempting certainly to produce in areas it has historically been unable to do. Um anytime China has put its sights on a market whether it's solar or steel or aluminum, etc. it has come to dominate that in the low cost framework that suggests to me actually the commodity cycle may be much worse in terms of memory, etc. and chips than people are currently thinking about. That's my hypothesis. I can't be correct. I can't articulate that I'm correct on that”

The narrative around AI being the solution has emerged because elevated stock prices are creating a story that becomes self-reinforcing through reflexivity; management and policy behaviors adapt to support the narrative rather than to fundamental economic reality.

“and it's creating a story that people are buying into that, you know, everything is fantastic and AI is the solution. And the work that I'm doing right now actually suggests roughly 2/3 of this move is just tied to this mechanical component. So sure, Micron should have appreciated on the increase in earnings but the multiple should have contracted significantly and significantly more than it has um on a fundamental basis. So I would highlight that the sanctions against China have created conditions under which China is aggressively ramping up its semiconductor production and producing in many of the areas attempting certainly to produce in areas it has historically been unable to do. Um anytime China has put its sights on a market whether it's solar or steel or aluminum, etc. it has come to dominate that in the low cost framework that suggests to me actually the commodity cycle may be much worse in terms of memory, etc. and chips than people are currently thinking about. That's my hypothesis. I can't be correct. I can't articulate that I'm correct on that, but I am correct on the math at this point that it is the mechanical components that are driving these prices to extraordinary levels and creating the volatility that we're experiencing. And unfortunately that suggests that much of this money is going to evaporate into that into that lost volatility and continuous releveraging framework. Um I think it's an unfortunate tragedy that is is playing out before our eyes even as people think that they're getting much wealthier.”

The US had an opportunity to address China's mercantilist overproduction through collaborative economic frameworks similar to those used against Japan in the 1980s (forcing Japan to internalize its excess demand), but has squandered diplomatic capability through political assertions of dominance rather than economic competitiveness.

“There was an extraordinary opportunity that that could have been pursued under economic frameworks not dissimilar to what was pursued against Japan in the 1980s as the European complex had to absorb um the imports that were increasingly rejected from the United States. Eventually the world came together to to uh negotiate with Japan and force them to internalize their lack of demand which resulted in a two-decade-long stretch um of, you know, lost economy. Um China faces something very, very similar if the rest of the world decides to um uh unify against this type of abuse. But we as I as I highlighted, I think unfortunately we appear to have squandered some of that capability”

The implications of emerging nihilism are adverse for future outcomes; the speaker encourages people to "be excellent to each other" as a social principle, invoking Bill & Ted's Excellent Adventure.

“Um I think that type of behavior we are seeing increasingly across our society and the implications for it, unfortunately, are adverse for our future outcomes. You know, I I I finished a another discussion earlier today with a reference to Bill and Ted's Excellent Adventure and I I would just remind people that at the end of the day we are a social species, we do exist in harmony with our neighbor, um and we all flourish in which we are excellent to each other, and I would encourage people to be excellent to each other even as the emphasis seems to be on party on, dudes.”

Companies like SpaceX borrowed capital immediately upon becoming public, but that borrowing is underwritten against multi-trillion dollar equity valuations rather than actual negative cash flows that would never justify lending in normal circumstances; if share prices collapse, that leverage will evaporate alongside it.

“Many of these companies, I would highlight SpaceX's very first action after getting public was to go out and borrow capital. That cap that borrowing is, um, underwritten not against the cash flow of SpaceX, which is fantastically negative and nobody in their right mind would lend that money to SpaceX in the absence of a multi-trillion dollar valuation.”

S&P 500 profits are likely to become far more cyclical and sensitive to the technology sector because the representation of hardware within the index has been dramatically increased, contrary to the narrative of a diversified index.

“It ultimately means that the profits of the S&P 500 are likely to become far more cyclical and far more sensitive to the technology sector. Um, primarily because we've dramatically increased the representation of hardware within the index. I understand that that is contrary to the narrative that most people are experiencing, but it is what the math suggests.”

In environments of overvalued equities, there is no capacity for activist investors or short-sellers to discipline management because the mechanical bid from passive flows has wiped out short-seller community capacity and overvalued securities cannot be effectively attacked through shorting.

“There's nothing that can really be done against an overvalued security other than attempting to short it and in the environment that I was describing where the mechanical process and inflation of these bids that's occurring through the passive complex has wiped out the short-seller community there's really no capacity for any form of reform”

Real interest rates are extraordinarily high and compensating those with significant cash holdings for doing nothing but putting money in bank accounts earning interest; this income supports financial speculation from upper income deciles and would be replaced if rates were cut, which would prove contractionary.

“an extraordinarily high real interest rate that is actually compensating those who have significant quantities of cash for really doing nothing with that cash um other than putting it into bank accounts that are now earning relatively significant income for them. That in turn is being used to fund the financial speculation. Perversely, if we were to cut interest rates, I think the reality is is that it would ultimately prove contractionary as that income is replaced and spending from the upper uh decile in terms of capacity um because of the interest income falling with a cut in interest rates would likely begin to retreat adding additional weakness to the economy.”

Capex spending by hyperscalers in AI/semiconductors is more productive than if they hoarded billions through buybacks, but it may still represent a prosocial bubble where overinvestment becomes available as distressed assets when cost structures collapse and are repurposed.

“it's important to distinguish between what's called a a prosocial bubble in which investment is creating opportunities for those assets to return to the market under distress conditions under which their cost structure is radically lowered. And I I ultimately think that we will see that in the AI space.”

China is becoming the primary beneficiary of refined product (gasoline, naphtha, kerosene) refining capacity through "gasoline diplomacy" as refining capacity in Russia, Ukraine, and the Middle East is targeted or degraded in conflicts.

“it puts the world more dependent on Chinese refining capacity, which itself, of course, if hostile action were to increase, um would potentially become at risk in in future conflict. Um if that does not emerge, I think unfortunately the United States runs the risk of finding that China through its gasoline diplomacy is ultimately um better positioned than they were going into this conflict.”

The Strait of Hormuz has become increasingly irrelevant as alternative oil sourcing solutions emerge through capitalism's incentives; the real problem is refined product capacity which has specific geographic constraints and cannot be easily replaced.

“the quantity of oil that will need to transit the Strait of Hormuz as alternative solutions are sought and obtained, which is what capitalism does. Um will ultimately uh mean that the Strait of Hormuz is diminished greatly in terms of importance as this oil more broadly. The bigger issue, candidly, is in the refined product space”

With mechanical market inflation and eliminated shorting capacity, everyone is betting that this time is different, but the speaker can mathematically demonstrate why it's not different; like a teacher saying 2+2=4, the mathematical proof doesn't stop people from disagreeing.

“there's less and less capacity you know, or or fiduciary flexibility to pursue the type of protection that many people would would otherwise seek in these frameworks. But, you know, the math is very straightforward. You have a mechanical inflation of the market shorting is a disaster. And so, everyone is now in one form or another betting that this time is different. And I I don't think that's the case. I think I can mathematically demonstrate why it's not different. Um but you know, the teacher telling you 2 + 2 = 4 doesn't stop the kid in the back of the class shouting, 'No, it's five.'”

Bitcoin miners have recognized that their primary asset is not mining hash rate but the power purchasing agreements and off-take agreements they entered into, which they can now repurpose as sales to data centers; capacity and hash rate in Bitcoin are falling, lowering aggregate network security.

“the Bitcoin miners themselves have recognized that their primary asset is not the mining of Bitcoin, but the the power purchasing agreements that they entered into when energy prices were low. And the off-take agreements they have associated with that, which they can now repurpose into sales to data centers. Um, and you know, as that occurs, the um, capacity and hash rate in the Bitcoin universe is actually falling, uh, lowering the aggregate security of the asset itself.”

The leveraged ETF complex has grown to approximately $200 billion in assets under management, and when multiplied by 2-2.5x leverage across products, represents roughly half a trillion dollars in capital that is likely to evaporate due to volatility drag, constituting a real economic loss

“at one point the levered ETF complex had grown to about 200 million 200 billion dollars in AUM. Um, multiply that by approximately two to two and a half, um, given the relative leverage leverage across the products, and you're suggesting suddenly somewhere in the neighborhood of half a trillion dollars in capital that has flowed into this space that ultimately is likely to evaporate over time due to this volatility drag feature.”

Data center construction debt in the semiconductor space is being added to investment-grade credit pools that can least afford credit risk, and is underwritten against posted equity values rather than actual cash flows which have deteriorated or are negative

“An incredible amount of leverage is being added into the investment grade community. That debt that can least afford any form of credit risk. Uh and it's largely being underwritten against the equity values that we're seeing posted on the screen rather than the cash flows themselves, which is I noted have deteriorated in many cases are quite negative.”

Option hedging dynamics similar to those that powered meme stock movements in GameStop and AMC are now playing out at a much larger scale in mega-cap stocks, where options hedging forces buying that artificially inflates stock prices

“it is similar to the behavior of meme stocks in which option positions created conditions under which forced buying from those hedging their underlying market exposures um in an attempt to preserve a neutral directional component powered moves significantly higher in stocks like GameStop or AMC. Uh that same phenomenon is now unfortunately playing out at a much larger scale in some of the largest companies in the index um and is powering a lot of the behavior that we're seeing.”

Bitcoin holding companies like MicroStrategy are now willing to sell Bitcoin if needed to cover debt obligations; this reflects the reality that leveraged equity positions in Bitcoin-holding vehicles create debt that must be repaid through whatever means available.

“On top of all the other shenanigans that we were talking about in terms of levered Bitcoin holding vehicles like a MicroStrategy, which of course is, you know, now turned into a hey, we will sell Bitcoin after all if we need the cash. This is unfortunately the reality of credit. If you have to repay debt, you have to get those dollars.”

If there is a downturn in stock markets, it will flow through to consumer sentiment and the broader economy; the bigger issue is the impact on corporate decision-making as management teams attempt to justify the elevated valuations they see rewarded in the market.

“Yeah, I think there's an element of that. We certainly saw sentiment take a downturn associated with that. I think the bigger issue is the impact it has on the decision-making process of companies themselves who are trying to justify the valuations with the expenditures that they see rewarded in the market.”

Tesla's inclusion in the S&P 500 caused fantastic appreciation that has largely gone sideways to down since, but the company has maintained a very high valuation despite deteriorated fundamentals; this will replay in the current AI/semiconductor bubble where mechanical flows inflate prices that will not be sustained when flows reverse.

“I liken it to Tesla being included in the S&P 500 which caused a fantastic appreciation of Tesla which has largely gone sideways to down in the period since, um, but unfortunately it has maintained itself at a very, very high valuation even as the fundamentals have deteriorated. Um, I think this is going to play out in a very similar fashion.”

In current markets with mechanical inflation and declining shorting capacity, trying to deviate from the benchmark benchmark results in losses while the market inflates around you; most investors respond by playing close to home and minimizing deviation, accepting that losses are explained by overall market losses.

“Well, I think most people's reaction myself included to this, you basically try to you know, play as close to home as possible and minimize your deviation from the benchmark because the answer is always well, I lost money because the market lost money. Um you know, in long only configurations and with with short dedicated long short funds rapidly moving towards net long positioning in aggregate, there's less and less capacity you know, or or fiduciary flexibility to pursue the type of protection that many people would would otherwise seek”

Current credit underwriting against equity values in data centers and semiconductors closely mirrors 2006 housing market credit underwriting that was based on home prices rather than borrower capacity to pay, suggesting history is repeating at scale

“we've created a a replay in many ways of what happened in the housing market in 2006 in which credit underwriting was effectively written against the home prices, not necessarily the capacity of the underlying borrower to pay back the loan. Um this this looks very similar, unfortunately.”

The loss of US perceived capability from military interventions embodies the police metaphor: when citizens see the police respond ineffectively to home invasion, it raises probability of future home invasions and increases antisocial behavior more broadly.

“the cost of the loss of face and the loss of perceived capability is certainly emboldening countries like China to more aggressively pursue their own strategies and um you know, unfortunately raises the conflict that it raises the risk or probability that a wider conflict ultimately develops. If if you see the police respond to a home invasion ineffectively, it raises the probability that there will be future home invasions in the area. It also raises the probability of a broader increase in antisocial behavior.”

Private credit lending has increasingly shut out of the market and is seeing accelerating defaults and delinquencies; new lending is shifting toward leveraged financial ETFs as an alternative source of borrower demand.

“private credit, which is increasingly shut out of the market. Um, and as they are shut out, we are seeing defaults and delinquencies continue to accelerate in that space. Um, but the new form of lending is, 'Hey, let's lend to financial leveraged financial ETFs.'”

There is a cyclical industrial recovery emerging after 3.5 years of recession in the industrial sector, partly tied to reduced capacity and consolidation allowing price increases; however, broader industrial base (auto sales, housing) continues to deteriorate significantly.

“after nearly 4 years or 3 and 1/2 years of recession in the uh industrial sector of our economy, we've now started to have a cyclical recovery associated with that. Part of it is tied to the simple reality that very few things go down forever and we are beginning to see an impact on pricing as um capacity has been reduced in many areas of the economy. But the broader industrial base continues to deteriorate. If we look at auto sales, housing sales, etc. Um those all suggest that the weakness is quite profound and quite real”