Permanently low interest rates?

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IlliniDave
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Re: Permanently low interest rates?

Post by IlliniDave » Sun Aug 18, 2019 7:27 am

CS wrote:
Sat Aug 17, 2019 9:46 am
The thing about the PP is that no matter what something will be doing shitty it seems. That is part of its design I think. Over time those red digits faded for me (in the accumulation phase) but perhaps there will always be something that triggers the red/regretful/why-did-I-buy-that-dud feelings.
Part of the conventional wisdom is if most of the time you have at least one thing you wish you didn't have, or had less of, and vice-versa, comes with the territory of diversification. Looking at individual components, sometimes wishing you had more and other times wishing you had less of a given asset class is said to indicate being close to an allocation suitable for your risk tolerance/temperament.

Dunno if there's a lot of science that backs up either of those.

I'm not an expert on PP, but I'd tend to agree it's not a huge liability relative to other common allocation strategies, and depending on what a person wants out of their portfolio, it probably has advantages. Looking forward I don't know that any portfolio arrangement can sustain systematic withdrawal rates that past performance suggests. With asset prices high and therefore the outlook for future returns muted, it's reasonable to be a little more conservative in approaching WRs (in practice or at least maintaining the flexibility to do so). Taking on more risk (e.g., substantially increasing stock allocation) is another way to try to counter muted expectations, but it could come at a high cost to peace of mind.

FWIW, I'm converging on something in the 50/50-60/40 range (stocks/bonds+MM) and looking to achieve a sub-2% WR. That's arguably overkill, especially compared to what history suggests is sustainable. But I have goals for my portfolio that extend beyond sustaining me (although if need be some of what's earmarked for other uses also serves as extra margin). Without those I might be comfortable with 3% or a little under given a low return outlook in the medium-term. I could have opted to keep my equity exposure up near where I had it during the heart of accumulation (85%-100%) to support a more aggressive WR, but opted instead to combine dialing back lifestyle a little with extending accumulation to keep volatility/risk lower. I can't represent that approach as being superior to any other, it's just what I'm comfortable with. IOW, I outlined my approach for context, not to make an argument against PP, etc.

It's also wise to look away from a portfolio when contemplating apocalyptic/doomsday scenarios. I don't think the infrastructure nor elaborate system of rules and enforcement that allows us to turn an abstract portfolio into food, shelter, and other tangible things is likely to survive such an occurrence.

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Re: Permanently low interest rates?

Post by jacob » Tue Aug 20, 2019 8:09 am

One thing I'm trying to game out is how the idea of permanently low interest rates remains compatible with the concept of the business cycle.
Does extending low interest rates also extend/slow the business cycle? Is the business cycle driven by the interest rate settings or is it the other way around?

Over the past couple of years, every hiccup on the market (which indexers see as volatility) has caused a slow rotation into non-cyclical sectors. Non-cyclical sectors also tend to pay a yield (cf. non-cyclicals) so this could also be the pensioner's solution to the low interest rates forced by central banks---the other solution being to spend less and save more (in direct conflict with central banks' intention to stimulate the economy). As a result relatively safe and yieldy instruments have done better.

As long as the alpha continues, it doesn't really matter which explanation is true :mrgreen: but it would be nice to know how to disentangle them once it stops.

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Re: Permanently low interest rates?

Post by finity » Tue Aug 20, 2019 1:46 pm

jacob wrote:
Tue Aug 20, 2019 8:09 am
One thing I'm trying to game out is how the idea of permanently low interest rates remains compatible with the concept of the business cycle.
Does extending low interest rates also extend/slow the business cycle? Is the business cycle driven by the interest rate settings or is it the other way around?
The ever-lowering interest rates are inherent to our monetary system. Money is basically created by issuing debt. In order to service the debt long-term, a later debtor needs to be found. For a growing monetary base, credit needs to expand.

This can be accomplished by
a) consumer credit (i.e. more debtors, higher debts),
b) corparate bonds / debt taken on by companies
c) government debt

It gets harder and harder to find a later debtor because the population is growing less / not at all anymore, companies have already satisfied their needs and governments are maxed out in terms of debt-capacity. Ever lowering interest rates can diminish this problem by

a) lowering costs to borrow, thus allowing people to borrow more
b) companies take on debt to buy back stock
c) allowing governments to take on more debt than they could afford otherwise (i.e. Italy)
d) forcing banks to lend money to more debtors (negative interest in Europe)

We already are pretty late in this long term credit cycle and it will end the business cycle. When the monetary base starts to contract (or stops growing) money will be hold onto, investments deferred, deflation may happen. That will kill the business cycle.

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Re: Permanently low interest rates?

Post by unemployable » Tue Aug 20, 2019 2:26 pm

finity wrote:
Tue Aug 20, 2019 1:46 pm
governments are maxed out in terms of debt-capacity
No they're not. The fact that bond rates are so low is plain evidence to the contrary, and their appetite to borrow more is insatiable.

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Re: Permanently low interest rates?

Post by finity » Tue Aug 20, 2019 2:48 pm

unemployable wrote:
Tue Aug 20, 2019 2:26 pm
No they're not. The fact that bond rates are so low is plain evidence to the contrary, and their appetite to borrow more is insatiable.
The reason bond rates are low is because central banks buy up everything they get their hands on (especially the ECB and the Bank of Japan).
The ECB is already running into problems, because they have to buy up bonds of all countries in a fair way, and it's getting harder and harder to get their hands on some of them.

Additionally, european banks put a lot of money into EU-government bonds, because that investment is considered risk-free (by the regulators) and no risk reserve has to be build for it.

Germany will emit 30 year bonds at 0% tomorrow.The US is now discussing to emit 100 year bonds.

Of course their appetite is insatiable, otherwise we would have seen a stronger contraction already ;-) The question is: how much can they afford. And they could afford far less without QE.
Last edited by finity on Tue Aug 20, 2019 2:58 pm, edited 3 times in total.

black_son_of_gray
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Re: Permanently low interest rates?

Post by black_son_of_gray » Tue Aug 20, 2019 2:50 pm

In chemistry, if we want to know what state a substance will be in, we can plot out a phase diagram—a graph of temperature and pressure that shows the boundaries of the different states. An example diagram for water:
Image
(Image link if you can't see it)

So, for the intuitive example of water, low temperatures usually give ice, high temperatures usually give water vapor, and in-between, moderate temperatures and pressures allow liquid water. Science 101, sure, but I bring it up for the (hopefully) useful concept of the triple point. The triple point is the intersection point along the phase boundaries where three different states can coexist and easily tip into any of the distinct, bordering states. And I can't help but think that we are close to the economic equivalent of the triple point. Here's my thinking...

A thought experiment
[TL;DR: all of your ideas are correct at the same time.]

If we were to plot a phase diagram for the economy, our two axes might be interest rates and debt load and the states of the economy might be inflation, deflation, and stagnation. In the US, interest rates broadly have been going down since the 1980's, and we find ourselves pretty close to zero, but just above it. Around the world, some places are below zero, some are at zero. This is the economic triple point.

Barring some black swan reorganization of the financial system (global debt jubilee?), the interest rates can go three ways from this economic triple point: up, down, or zero.
  • Up: Debt loads are so massive that slight increases in interest rates tip the system into inflation, because the only policy way to relieve the crushing burden of all that debt is to inflate it away. The problem with intentionally trying to inflate away the debt, outside of the fact that it violates one of the two Fed mandates (employment, stable prices), is that it can easily get out of control and shoot to the moon. Gold bugs might do very well in this state of the system. Holding bonds would be a disaster.
  • Down: In a race to the bottom to devalue currency, interest rates can keep on chugging deep into the negative. The system here is in deflation because spending $130 to get back $100 in the future ultimately reduces money supply (right??). Long term this is unsustainable, because it literally turns the banking business model upside down (borrow short/lend long doesn't work). See Japan and European bank stocks. Without a workable banking sector, modern economies cannot function—the patient can only be bled so long. But in the meantime, falling rates are good for bonds, even if rates are negative because the prices still go up, and bad for stocks because appreciating inventory incentivizes slow turnover/sales/waiting-instead-of-moving-forward.
  • Zero: The system near zero is in a state of stagnation. Real growth in the economy is very slow or non-existent for a number of reasons. 1. Unproductive, zombie companies can keep limping along financed by cheap debt. 2) Any company that can borrow for less than the rate of its dividend will just buy back its own stock instead of make capital investment (it's a no-brainer balance sheet move) 3) etc. The main theme here is that money continues to be so inefficiently allocated that the best the economy can do is tread water. Stocks may be the cleanest dirty shirt here, even "growth" stocks with negative cash flows. Cash and bonds and everything else stink. TINA. But that party can't last forever right? Zombies do eventually die, right?
Looking forward, there are 1) very reasonable/logical arguments 2) championed by very smart, successful investors, and 3) historical precedents/examples for each of these states. That is why I like the triple point metaphor: because it provides a context for understanding how all of these arguments could be correct, just as multiple states of a substance are reasonably possible at its chemical triple point. Another useful observation: because we are near the triple point, a move into any state could rapidly change course and enter another state. This is because the boundaries are still very close to each other in the area surrounding a triple point. In water terms, that is just saying that ice that is close to the freezing point can pretty quickly start to melt vs. ice that is -100C. Economy-wise, this means a rapid switch of states is maybe even likely: for example, my best guess for the near-term trajectory is that rates will plummet globally (deflation) until that course reaches the breaking point (no sure when, but soon-ish?), and will then be followed by a rapid shift toward inflation in a desperate attempt to relieve debt burdens. Straddling the zero line might be possible for an extended period, but I doubt it can be maintained permanently—if for no other reason, simply because the area on the phase diagram that describes stagnation is pretty narrow (spitballing, we might define it as between 0ish and the S&P dividend rate). So even being deep in stagnation territory is still relatively close to either inflation or deflation, and it is too taxing for central banks and the lags in their policy actions to be able balance in this narrow space indefinitely (their track records for soft landings is almost nonexistent/ can they even agree on what r* is?).

Ok, I'll leave it at that. My intention wasn't to be comprehensive—I'm just throwing this idea out there for discussion. Please tear it apart, add to it, ignore it as you see fit.

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Re: Permanently low interest rates?

Post by Seppia » Tue Aug 20, 2019 3:59 pm

finity wrote:
Tue Aug 20, 2019 2:48 pm
Germany will emit 30 year bonds at 0% tomorrow.
Fun fact: at current dividend yields (3.5%), a broad European stock index funds would have to lose 2/3rds of today's value (nominal terms) to be a worse investment than those 30y bonds over the same timeframe.
This is assuming dividends have zero nominal growth for the next 30 years, and ETF is held in a tax advantaged account (dividends reinvested and taxed at 0%)

How any sane person could buy those bonds is beyond me.
Last edited by Seppia on Wed Aug 21, 2019 12:22 am, edited 1 time in total.

bigato
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Re: Permanently low interest rates?

Post by bigato » Tue Aug 20, 2019 5:14 pm

This probably has no rational basis whatsoever, but now that everybody and their mother is telling me to buy gold, including all of mainstream media, I'm growing increasingly suspicious of this strategy.

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Re: Permanently low interest rates?

Post by unemployable » Tue Aug 20, 2019 6:08 pm

Seppia wrote:
Tue Aug 20, 2019 3:59 pm
Fun fact: at current dividend yields (3.5%), a broad European stock index funds would have to lose 2/3rds of today's value (nominal terms) to be a worse investment than those 30y bonds.
That's basically the Fed Model, although it uses inverse P/E rather than dividend yield. I like to think of it in reverse: The S&P's "fair value" is over ten thousand, meaning the level at which its component companies would earn the equivalent to Treasuries. So get ready, the stock market is about to triple! No, I don't believe this.
Seppia wrote:
Tue Aug 20, 2019 3:59 pm
How any sane person could buy those bonds is beyond me.
One plausible reason is you think they're going to get even more negative! Also one may believe they will still have a positive real return if deflation exceeds (is more negative than) the interest rate. Although in that case you're still better off mattressing your cash at 0%.

I want to see how negative they can get. I think a full minus 1% in Germany is a done deal. Can they get to -2?

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Re: Permanently low interest rates?

Post by classical_Liberal » Tue Aug 20, 2019 7:48 pm

Seppia wrote:
Tue Aug 20, 2019 3:59 pm
How any sane person could buy those bonds is beyond me.
Not all investors have a 30 year horizon. Bond convexity allows for some nice returns at very low rates in short/medium term. Also, institutional investors.

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Re: Permanently low interest rates?

Post by CS » Tue Aug 20, 2019 8:29 pm

Wow, interesting discussion!

@C_L good point about holding 30 yr bonds short term.

@Jacob

Okay, can you please explain to me like I'm five years old:

What is "a slow rotation into non-cyclical sectors."

Also, what does "cf. non-cyclical" mean?

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Re: Permanently low interest rates?

Post by Seppia » Wed Aug 21, 2019 12:21 am

@ unemployable
I used dividend yield because it’s historically much more stable and reliable VS price.
I also edited to add that I meant European stocks should lose 2/3rd of nominal value over the next 30 years (not today).
Other than nuclear wars I can’t think of a scenario where this may happen.

@c_l buying something at a price that makes no sense, in the only hope that will go up even more, is historically not a winning strategy (in the aggregate).
I know some institutions are obliged to own them, but some people are proactively buying them.

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Re: Permanently low interest rates?

Post by The Old Man » Wed Aug 21, 2019 5:47 am

Seppia wrote:
Wed Aug 21, 2019 12:21 am
I also edited to add that I meant European stocks should lose 2/3rd of nominal value over the next 30 years (not today).
Other than nuclear wars I can’t think of a scenario where this may happen.
During the Great Depression of the 1930s the U.S. stock market was down 90% and took a long time to recover. The Great Depression was world wide, but I am unaware of the impact in Europe.

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Re: Permanently low interest rates?

Post by Seppia » Wed Aug 21, 2019 6:27 am

IIRC in the usa there is no period of 20 years in recorded history with real negative returns

EDIT: apparently those 30 year bonds are now yielding.... drumroll....
MINUS 0.19%!

YAY!
https://www.bloomberg.com/news/articles ... n-set-at-0
Last edited by Seppia on Wed Aug 21, 2019 6:31 am, edited 1 time in total.

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Re: Permanently low interest rates?

Post by jacob » Wed Aug 21, 2019 6:31 am

The Old Man wrote:
Wed Aug 21, 2019 5:47 am
The Great Depression was world wide, but I am unaware of the impact in Europe.
In Europe, the Great Depression, which in some places started earlier than in the US lead to various populist combinations of fascism, nationalism, and socialism. Aggressive expansionary foreign politics then lead to WWII. The impact on the stock market of the losing nations of WWII is why their historically based SWRs are so low.

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Re: Permanently low interest rates?

Post by 7Wannabe5 » Wed Aug 21, 2019 7:12 am

Picketty writes quite a bit about the early 20th century loss of wealth in Europe. Before WWI the average 80 year old held significantly more wealth than the average 40 year old, this demographic completely flipped by mid-century.

I can think of quite a few, known unknown 3 punches that could do the same. For instance, extended Midwestern Bread Basket Drought X Major Effective Multi-Corporate CyberHacking Incident X military crack-down in Hong Kong triggering WW4.

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Re: Permanently low interest rates?

Post by jacob » Wed Aug 21, 2019 7:30 am

@bsog - I once read a paper on option pricing that IIRC started with the axiom that the market always strove to maximize disagreement. (If you think about it, this is a rephrased version of the EMH. When the market clears, there's about equally many bid and ask orders sitting across the price.) I like the triple or N-ple point theory, but I fear that the market is ALWAYS in such a state unless it's moving rapidly. Therefore, it's not directly useful.

Indirectly, I use this idea a lot. There are always several reasons for why to buy or sell something. This comes about because whereas information is rapidly transmitted, opinions develop rather slowly in the market. The benefit of reading a lot (of news, etc.) is to be able to see the rate as which other investors/players change their opinions. (A recent example would be how the VTSAX people in the FIRE movement suddenly had the fear of god put in them. JL Collins even put out a meditation youtube video to calm them down :-D . Another example is the WH's changing narrative on how stronk the economy actually is.) I think of these as different votes that haven't been polled yet---this doesn't happen until they start pulling the trigger---but the more people willing to pull the trigger, the greater likelihood of a price move.

If I wanted to write this out, I'd present it as a table with faction labels e.g. "Silly speculators", "Dogmatic indexers", "Econ undergraduates", "Jim Cramer", ... for the rows. A belief for each column, e.g. "The economy is great", "The economy sucks", "Tariffs are going to help the steel industry", and then a list of check boxes or rather probabilities for each field.

I overlay this matrix on my general idea of where the market is going (my opinion being another vote)---where the actual market is going would correspond to the "temperature". But basically, I don't cast my vote until I'm reasonably sure that many other "factions" are ready to cast their vote in the same direction. If I "go early" I just end up sitting on a position that goes nowhere.

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Re: Permanently low interest rates?

Post by Jason » Wed Aug 21, 2019 7:30 am

@ 7W5

I believe Picketty would partially explain loss of that generation's wealth to rise of early 20th century totalitarian regimes and the interruption of the accumulation of private capital due to state controlled economies and pilfery i.e. the Nazis seemed to love art as much as they hated Jews and Gypsies. That being said, he states individual age has always been and remains primary determinate of capital accumulation.

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Re: Permanently low interest rates?

Post by 7Wannabe5 » Wed Aug 21, 2019 8:03 am

@Jason:

Right. I was just noting that you don't have to be insane to purchase 30 year Treasuries, just a certain mix of deeply pessimistic. I am trying to get the hang of Bayesian analysis, so I try to practice whenever I can. Kind of like I am the annoying character in "Green Eggs and Ham."

"I do not like the Treasury Buy. I do not like it 7WB5!"

"Would you could you in a war? Would you could you if Bull turned Boar?"

"I would not could not 7WB5! I do not like the Treasury Buy!"

"Would you could you if oil up post-peak? Would you could you based on Fed scandal leak?"

Etc.

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Re: Permanently low interest rates?

Post by jacob » Wed Aug 21, 2019 9:32 am

@CS - See e.g. https://www.investopedia.com/articles/t ... 020305.asp

I meant "cf. cyclicals". In the link non-cyclicals (laundry detergent) is are called staples---something that always has a demand. An example of a cyclical stock would be a manufacturer of washing machines---something that only has a demand when people have money.

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