[김정남의 월가브리핑]The’debt warning light’ turned on again due to the Bilhuang crisis

Another thing to check is the results for the first quarter of this year. According to financial information company Refinitiv, the first quarter net profit of companies in the S&P index is expected to increase by 24.2% compared to the same period last year. Looking at the fact-set aggregate, earnings per share (EPS) for the first quarter are expected to increase by 6%. EPS is net income divided by the number of shares. This means that companies will have solid performance. The S&P index has risen by more than 74% since its low in late March last year. The reporter recently asked people inside and outside Wall Street,’Even if the index skyrocketed like this, it would be justified if the performance was good.’ Many have said, “I can go up enough.” A former manager with more than 10 years of experience in bond management said, “It is true that the stock price has risen too much.” On Wall Street, bulls are dominant. Reporters also agree with the opinion.

Page 1 of the Saturday edition of the New York Times (NYT) on the 3rd (local time). (Photo = Correspondent Kim Jeong-nam)

A stock market that looks full of hope

The stock market looks just as good, but there are always variables. The reporter wants to revisit an incident that recently shocked Wall Street. It is the’Akegos Scandal’. The fund, led by Korean fund manager Bill Hwang, is now very famous.

Briefly summarizing the situation. On Friday, the 26th of last month, in the New York Stock Market, there was a situation that might seem strange. The S&P index closed at 3974.54 on the same day. He jumped 1.66% and was close to the 4000 line. The NASDAQ index also rose 1.24%. By the way, there were some stocks that were falling apart. △ Viacom CBS ($66.35→$48.23, 27.31%↓) △ Discovery ($57.75→$41.90, 27.46%↓) △GSX Techdu ($66.75→$39.01, 41.56%↓). Baidu recovered after getting 15% high during the intraday. After that, over the weekend, rumors circulated that certain funds had received margin calls (requiring additional margin payments, forced liquidation). Eventually, he appeared as Bill Huang’s Archegos. They were on the verge of bankruptcy because they couldn’t pay the margin.

In the process, I was shocked to find that leading investment banks (IBs) such as Goldman Sachs, Morgan Stanley, UBS, Credit Switzerland (CS), and Nomura were inherited. The plunge in stock prices of certain stocks was due to a large block deal as Goldman Sachs and Morgan Stanley started a large-scale block deal when the risk of losing the money lent to Akegos increased.

Bill Hwang, CEO of Akegos Capital Management. (Source = Fuller Foundation)

The implications of the Akegos scandal

The characteristics or implications of the Arcegos crisis can be seen in three ways. This is not only the secret of Archegos’ success that it borrowed money from major IBs, but it was also a factor that led to the bankruptcy crisis.

The first is the tremendous amount of leverage. In other words, you owed and invested. The investment in Akegos was 10 billion dollars (about 11.3 trillion won). It is said that the total value of the invested stock was 50 billion dollars. It caused 4 times the leverage.

Let’s take an example. Let’s say you bought a stock with 100,000 won. If the invested item is raised to 110,000 won, the return will be 10%. By the way, if you said you bought 500,000 won worth of stock by making a debt, the total stock value would be 550,000 won. Since I made 50,000 won compared to the investment of 100,000 won, the rate of return is 50%. Bill Huang is said to have raised leverage by around 10 times. At this time, the people who lent the money are Goldman Sachs, Morgan Stanley, etc. The reason they gave Bill Huang the money is simple. This is because Bill Huang has paid enormous commissions to IBs as much as he has made profits. It is said that Bill Hwang’s nickname was about’agressive, moneymaking genius’.

The reason Arcegos inflicted the magic of leverage is through derivatives contracts such as Total Revenue Swap (TRS) and Settlement for Difference (CFD). TRS is a derivative financial instrument in which the IB and others are the sellers of total returns, and instead of the investors, that is, the buyers of total returns such as Akegos, they purchase stocks, which are underlying assets, and the gains and losses arising from those stocks are attributable to investors. The contracted IB receives a certain fee from the investor in the process. Through this, Arcegos was able to make investments by raising leverage of up to 10 times.

CFD is also a type of TRS trading. It is an over-the-counter derivative contract in which an investor does not own stock and only pays the difference between the entry price and the liquidation price (profit from trading) in cash. For example, suppose the stock price of Company A is 100,000 won, but an investor predicts that it is likely to rise to 200,000 won. This investor enters into a CFD contract in which the IB puts 10% of the margin, or KRW 10,000, and the IB buys the stock for KRW 100,000 instead. If, as expected, the stock price of Company A reaches 200,000 won, IB sells the stock, and this investor recovers 100,000 won. It means making 100,000 won by investing 10,000 won.

The problem is that when the stock price goes up, there is a leverage effect in which profits jump several times, so when you lose money, you look at several times the same. Let’s take a CFD contract as it is. Let’s assume that a company’s stock of 100,000 won falls to 50,000 won. This IB will continue to demand additional margin as the stock price starts to drop from KRW 100,000. Although there will be differences for each CFD contract, if the decline increases, the IB will go into counter-trading (trading that is forcibly disposed of if the customer fails to repay the borrowed money within the contract maturity). This is how the Akegos scandal occurred.

Leverage + Intensive Investment = Akegos

The second is Bill Hwang’s unique intensive investment. While diversification may seem reasonable at first glance, that doesn’t mean concentrated investment is necessarily wrong. Making big money by investing in a few stocks you’re sure of is also an investment skill. Bill Hwang, who was once blacklisted in the risk management department of Wall Street IBs, was able to recover thanks to this concentrated investment.

However, high returns are subject to high risk. The investment method that adds leverage and concentrated investment is considered risky even within Wall Street. The Arcegos incident proved this.

Third, Akegos is a family office in a regulatory blind spot. Akegos was actually a veiled fund before. According to the Dodd Frank Act, hedge funds of a certain size or larger must be registered with the Securities and Exchange Commission (SEC). Transaction records are also required to be submitted to the authorities. However, the Family Office is not required to disclose transaction records. This is why the US financial authorities have been tense these days. Whether the 2nd and 3rd Arcegos will not appear in a row. In the financial sector, a crisis is what happens when you touch the’system’. During the Arcegos crisis, many investors were surprised to find that the money of super-large IBs was handed down to a family office. Wall Street estimates that as of 2019, the family office has assets of $6 trillion. At the same time, finance minister Janet Yellen and other high-ranking officials are keenly aware of the possibility that this situation will spread and transfer to financial system risk.

The stock price of Viacom CBS, a block deal for the Arcegos crisis, in the last month. (Source = Google)

Arcegos shock, will it continue?

The next is probably the most important question. The question is whether the aftershocks of the Arcegos crisis will continue. First of all, looking at the stock price, it seems possible to interpret that it has ended only in terms of the Akegos incident. Share prices such as Viacom CBS and Discovery, which are known for block deals, have now stabilized. CS, Nomura’s share price, which is known to have suffered the biggest losses, has stopped plunging. Margin call means panic, but it seems that the height of the Arcegos crisis has passed.

However, the’debt warning light’ has not been turned off at all. After the pandemic, the New York stock market was truly booming. But this year, too many and often signs that institutions and individuals have made unreasonable investments due to debts. The fact that hedge funds such as Melvin Capital lost a lot during the GameStop crisis a while ago is no different from the Akegos scandal in a big context. I’m not saying it’s bad to be in debt. Borrowing money and investing at such a very low interest rate is reasonable considering it. The reporter thinks that the word’debt’ is neither bad nor good, but just value neutral. The problem is that too much accumulated debt can make you vulnerable to an unexpected stock price crash, and if these cases pile up, the market can be shaken. In the future, it is assumed that more cases such as Melvin and Akegos will come out and investment should be made.

The New York Stock Market has enjoyed a historic party over the past year and is preparing to enjoy more. In the midst of this, the reporter doesn’t want to say that stocks should be sold as there will be another crisis like the Akegos crisis. The timing of buying and selling is something that God doesn’t know. Again, it’s not a bad thing to be in debt. However, the fact that the stock market index level is at its highest in history and the fact that there are many people who have invested in debt seems clear that it is a matter to consider when investing.

Credit Suisse (CS), which is known to have suffered the biggest losses from the Arcegos crisis, is the share price of the recent month. (Source = Google)