Inflation, Interest Rates & Financial Represion

Ask your investment, budget, and other money related questions here
Tyler9000
Posts: 1758
Joined: Fri Jun 01, 2012 11:45 pm

Re: Inflation, Interest Rates & Financial Represion

Post by Tyler9000 »

giskard wrote:
Wed Jan 13, 2021 1:17 am
... I believe that most of them agree we will probably get negative real rates and financial repression for some years to come.

... It goes without saying you want to own no bonds in this environment.
I respectfully disagree with the second point, and the reason is your first one. ;)

Bonds make money in two ways -- coupon payments and capital appreciation due to rate changes. So even with low or negative rates, certain bonds with longer maturities can still make huge money especially once you account for convexity. If one believes that world governments will do everything they can to keep interest rates low, that effectively negates the fear of rates rising and causing big losses. So you're left with a highly volatile asset that can be quite useful as a noise-cancelling signal in a regularly rebalanced portfolio including other volatile assets like stocks.

That said, I do generally agree with your reaction to explore other real assets outside of stocks and bonds. The idea of 20% bitcoin makes me cringe, but 20% gold (with thousands more years of history) is a fine choice. I also like REITs as a simple way to weight a portfolio towards real estate. And even though I'm not big on commodities, ETFs like GSG make that easy to invest in as well.

User avatar
giskard
Posts: 320
Joined: Sat Apr 30, 2016 12:07 pm

Re: Inflation, Interest Rates & Financial Represion

Post by giskard »

Tyler9000 wrote:
Wed Jan 20, 2021 12:02 pm
I respectfully disagree with the second point, and the reason is your first one. ;)

Bonds make money in two ways -- coupon payments and capital appreciation due to rate changes. So even with low or negative rates, certain bonds with longer maturities can still make huge money especially once you account for convexity. If one believes that world governments will do everything they can to keep interest rates low, that effectively negates the fear of rates rising and causing big losses. So you're left with a highly volatile asset that can be quite useful as a noise-cancelling signal in a regularly rebalanced portfolio including other volatile assets like stocks.
I do understand that you can make money in bonds with principal appreciation by interest rate movements. But right now if you are long bonds you are betting that rates go down lower at an already 5000 year low. Do you think the 30 year will go to zero? Below zero? It seems like at that point it's an unlikely speculation which to me is not the purpose of a bond for most people.

Thought experiment: Maybe the 10 year treasury will ping pong between 0.5% and 1.5% every year. The fed could buy more when it gets higher to suppress rates and then let it drift higher as they taper. That's basically what has played out post March 2020, and it looks like they will have to increase buying again as rates go up. But the whole time it's a negative carry because inflation is right around 1.5 to 2%. I guess you can time it and re-balance if we have a little taper crisis every year but, and maybe you hope that lower bound goes down to -1.0% on the 10 yr, and you get a huge capital appreciation. But is that likely? It just seems like over time it's a losing proposition at this point and the moves will not be that great.

Another thought experiment: we get real inflation and bonds reprice. I'm talking like even 4% inflation. Do 10 yr rates spike to 4% quickly? I actually think that's more likely than the 10 yr going very negative (e.g. -1.0%). You would get an enormous bond selloff and capital depreciation. In that view bonds are risky, much more risky than people think. We've been in a 30 year bond bull market with bonds only going up and rates only falling. That could reverse. Yes the Fed will step in a buy bonds and bail everyone out, but what would that even look like? How big would their balance sheet expand if inflation really set in and they had to suppress rates?

User avatar
RFS
Posts: 86
Joined: Sun Jan 14, 2018 8:25 pm

Re: Inflation, Interest Rates & Financial Represion

Post by RFS »

giskard wrote:
Sun Jan 24, 2021 12:47 am

Another thought experiment: we get real inflation and bonds reprice. I'm talking like even 4% inflation. Do 10 yr rates spike to 4% quickly? I actually think that's more likely than the 10 yr going very negative (e.g. -1.0%). You would get an enormous bond selloff and capital depreciation. In that view bonds are risky, much more risky than people think. We've been in a 30 year bond bull market with bonds only going up and rates only falling. That could reverse. Yes the Fed will step in a buy bonds and bail everyone out, but what would that even look like? How big would their balance sheet expand if inflation really set in and they had to suppress rates?
Hey Giskard, awesome thread. Now that we're into September 2021, I'm getting the sense that US policy at every level is being driven by a focus on narrative over reality. Right now, central bankers are telling us that inflation for 2021 will be somewhere around 2% (one of Biden's press secretaries recently said that if you exclude beef, pork, and poultry, then food inflation is actually reasonable. LOL.) So, this begs the question: will the Feds ever be transparent about inflation data to the point where 10 yr rates would actually rise?
Elena Gorokhova wrote:The rules are simple. They lie to us, we know they're lying, they know we're lying, they know we know they're lying, but they keep lying anyway, and we keep pretending to believe them.
Anyway, I think the debt mountain has become so large that even a whiff of debt deflation (rising rates, higher payments on debt) has become systemically dangerous. Hell, one of Bernanke's first major speeches as a Fed Governor was literally titled "Deflation: Making Sure "It" Doesn't Happen Here."

I think it is actually more likely that the 10 yr goes negative. This is because when The Everything Bubble bursts, the US sovereign bond market will enter debt deflation. It would then be more difficult and more expensive for the US to issue debt, so more debt to cover those higher payments won't solve the problem. There would be 3 options:

1. Aggressively raise taxes (to increase revenues, reduce the deficit, pay the debt.)
2. Cut entitlements
3. Default on debt and implode the global economy, everyone takes a horse to work at the farm.

Is any politician going to push for significantly higher taxes, cutting social spending, or letting the US default on its debts? I might be wrong, but I don't think so.

I think there is only one option: the Fed is going to have to intervene big-time in the bond markets in an attempt to reflate the bond bubble. It took 7 years of ZIRP and about $4 trillion in QE to reflate the system after the housing crash, so the policies to deal with the Bond Bubble's collapse will be turbo mode Bernankeism. I think this will lead to NIRP and $100b+ QE programs per month (I know this sounds crazy, but imagine telling someone in 1995 that this is where we'd be at.)

I understand that the sensible thing to do is to dump bonds in the case of negative rates, because you'd be paying the government to lend it money. But in clown world's sovereign bond markets, everyone lines up to pay the government. Why, you say? Because the alternative is systemic collapse.

If you look at the European crisis in the mid 2010's, the PIIGS' bonds went negative. Did everyone dump these bonds? Nope. Investors actually piled into these bonds so hard, their yields went to record lows. German government bond yields went even more negative. What caused this insanity? A $1 trillion QE announcement coupled with the NIRP.

QE programs are basically a person with unlimited money broadcasting that they're going to buy bonds, and that they do not care about the price. They went NIRP coupled with a massive QE program, and so investors took this to mean that the ECB would be backstopping bond markets no matter what. The alternative was a debt-deflation induced systemic collapse where everything went bust. Wouldn't the US run this exact same play?

WFJ
Posts: 416
Joined: Sat Apr 24, 2021 11:32 am

Re: Inflation, Interest Rates & Financial Represion

Post by WFJ »

General comments:

I've observed a significant attention paid to inflation in this forum, when it's not a consideration for 99% of those in the investment world. In a lifetime of investing, I've never heard an experienced investors with say something like "I'm buying X because of inflation" with their own money, but have heard thousands of Wall Street talking heads use inflation as a hook to sell an investment. I assume ERE followers are more interested in inflation as labor (especially job hoping) is one of the easiest ways to counteract the effects of inflation and if not working, inflation is a larger consideration. Stocks of companies with flexible input costs or flexible labor which can be replaced with technology tend to do well in higher inflationary times along with RE (assuming rent moratorium in the US is not made permanent). Inflation is usually lumpy, disjointed and only observable after the fact, generalizing a strategy on this variable is impossible.

Asset allocation exhibit incredible variance depending on the individuals age/risk tolerance/duration of cash flows needs. It is also dependent on one's investing abilities/luck/experience. Generalizing this is not wise.

International equities only provide benefits if the returns are not highly correlated to home country equity returns. Correlations over the past 30 years are converging and unless this reverses (any reasons for a reversal???) owning non-home country equities increases the risk and costs (fees are usually 3x-20x higher than home country indexes) of a portfolio without increasing returns. Extremely large US companies, top 100, are global, statistically these investments are preferred for diversification compared to the general market as opposed to direct international investing. A few have produced research in these areas.

People still trade tulips/Beenie Babies/pet rocks, Sammy Sosa rookie cards, and cryptos will be traded in 100 years, but at similar values to tulips. This is not part of an investable asset, but a collectible. Crypto fits into the speculative 1% of a portfolio only, something like buying puts/calls or for vacation money, nothing more. Full disclosure, I made enough to fund 20+ vacations in Crypto in 2017 and will not return to the speculative asset.

My personal allocation is/has been roughly 70% large cap US (50% index/20% individual stocks), 10% Small/Mid cap US indexes, 10% RE or Mining stocks, real assets, 5%-9% cash/CDs depending on anticipated 1-5 year expenses and >1% speculative calls/puts/penny stocks/cypto. Fees are usually around 10 bps and every once and a while reduce individual stock holdings to reduce risk. If Democrats pass the "Tax the poor" act changing ETF tax treatment, I will have to increase individual stock holdings and attempt to self-index which is what the uber-wealthy do now.

white belt
Posts: 1452
Joined: Sat May 21, 2011 12:15 am

Re: Inflation, Interest Rates & Financial Represion

Post by white belt »

@RFS

Consider that just because a bond bull market might be ending doesn’t mean a bond bear market is starting. Bonds could very well trade sideways for a decade (e.g. look what happened after WW2 in the USA even with significant inflation).

Although real interest rates in the US are negative, nominal rates are not. This means that bonds still have some appreciation juice left if the Fed decides to lower rates again (unlike in Europe where rates are negative), so they aren’t quite chopped liver in a portfolio allocation if one is trying to protect against downside risks.

Another perspective is that the current situation isn’t an everything bubble, it’s just a devaluation of the US dollar (and most/all global fiat currencies as well). Given that, how long do you think such a devaluation could last? Certainly not forever, but people have been calling for a stock market correction for the past decade and here we are. Markets…irrational….solvent.*

We already have a few other crypto threads so I’ll leave that discussion to those threads.

*= Related is that TINA when it comes to US bonds and reserve currency. I’m sure central bank digital currencies will eventually supersede the US dollar as viable reserve currencies, but by my amateur estimates we are still at least 5 years away from that (even in China which is arguably further along than any other country).

Toska2
Posts: 420
Joined: Fri Nov 20, 2015 8:51 pm

Re: Inflation, Interest Rates & Financial Represion

Post by Toska2 »

Two things:

Unless the Fed wants to sink the USA, interest rate rates have to be under real inflation. Goes back to the quote, " Permit me to issue and control the money of a nation, and I care not who makes its laws!".

A musing I am having is a vaccine mandate is forcing the older generation out, which is a sort of financial repression. The older generation thinks their "kitty" is high enough, while the younger generation has better job opportunities. The younger will prop up the house of cards a few years longer with a higher savings but lower real wages. (Its relative to where they been to where the older generation was).

User avatar
Seppia
Posts: 2016
Joined: Tue Aug 30, 2016 9:34 am
Location: South Florida

Re: Inflation, Interest Rates & Financial Represion

Post by Seppia »

WFJ wrote:
Tue Sep 21, 2021 2:19 pm

Extremely large US companies, top 100, are global, statistically these investments are preferred for diversification compared to the general market as opposed to direct international investing.
I have never really understood this argument.
Korea is probably the biggest “exporter” in the g20, as almost all of their large companies do the majority of their business around the globe (Samsung Hyundai etc), but I would not consider Korean equities sufficiently diversified because of that (hyperbolic comparison I know, but just to explain the point).
The USA have outperformed rest of the world equities for over a decade, sometime this has to shift and reverse, not having an exposure internationally is dangerous in my opinion.
Lastly, anybody can buy a world index fund for 0.2% fees. Sure that’s 4 times the 0.05% some S&P500 indexes cost, but still an insignificant amount.

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

RFS wrote:
Tue Sep 21, 2021 12:05 pm
... will the Feds ever be transparent about inflation data to the point where 10 yr rates would actually rise?
I have been leaning towards the transitory camp for the last few months, but over time I've had to question the idea and I'll get to that in a second.  Here is the thing, bond rates may not correlate to inflation at all.  Imagine using standard analysis that the Fed tapered tomorrow.  Will stocks go up or down in price?  Likely down.  Where does that money go?  Into bonds is a reasonable guess.  It is in fact possible due to risk-on/off behavior that bond yields will *fall* without the Fed being involved.  Jeff Snider has talked through this point of view in detail if you care to research it, but all I want to do is generate reasonable doubt to the base narrative.  There are other Eurodollar stories too, like the "dollar milkshake" that put reasonable doubt to the theory.

With that, the question around inflation is, what is the cause of inflation?  If you believe inflation is about money printing, Japan is on QE # 24 I believe.  Incidentally, Japan's 2021 inflation numbers are around 0 and were lightly negative in 2020 (based on a quick google search).  It isn't clear CB printing always creates inflation.  This is all around the idea that inflation is a general increase of prices.  I don't disagree with the idea that asset prices are going up and eventually everything may get eaten up as an "asset".  I don't believe that is what is happening with inflation this time around.  Instead, I suspect it has more to do with the "external" factors.  This has been argued to be the "supply chain" issue.  I think that is where the fed is.  They are like, "Our print button never did this before, so why now?" Blame it on those darn supply chains.  Lumber is their example proof of this.

Where I think things have been different is it isn't just supply chains that are a problem.  Many of the mines we have are at capacity.  Electrification and rotting infrastructure.  Companies called in their revolving credit at insane levels in March of 2020 in case of a credit system freeze (which is money printing).  The US government repaired short term balance sheets of nearly the entire US population at the expense of their long term balance sheet, which then was bought by the Fed (actual money printing unlike that QE stuff).  Companies have levered up their balance sheets for buybacks to the point of instability, but also making the stock more rare.  "Pump and dumper" style schemes are running around everywhere from Wada in video games to Zillow in real estate.  Companies live off debt for longer, disrupting more of the conservative companies and can become monster-sized like Amazon, Google, all while buying up all the competition with debt and using network effects.  Labor behavior has changed.  More folks are learning about the games being played in wall street and are playing their own.  Folks are angry in society, feel they have no voice, have a sense things have been going wrong for a long time and companies are trying to buy them off via increased wages.  Some of these points may lead to deflation later, but have temporarily led to inflation.  I don't care if you agree or not with any given factor, nor do I care if you think a given factor is inflationary or not.  The question is: How can the Fed address these sorts of factors out loud when they believe in magical thinking (e.g. "animal spirits") causing stimulated economics?  They certainly don't believe QE has large effects when their own studies suggest "modest" effects at best.

Let me try one other example.  Imagine the farmers put 50% of the crops on fire.  Imagine at the same time the fed not only tapers but magically deleted half of all currency (M1, M2, don't care).  The last 50% of crops will: A. Inflate in value in USD terms. B. Deflate in value in USD terms.  My guess is at 50% food supply, many people will starve and thus food will inflate, regardless of the fact that there is only half as much currency.  Unless you said there would be no price change, it would appear monetary printing is not the only form of inflation and the Fed does not control all forms of inflation that appear to exist.  If the Fed said they can't fix it, they believe others will become depressed and won't spend, so the Fed can never admit to not being able to solve the problem.

One last point, in 2016 the 10-year T-note was at 1.6% (low) while inflation was at 1.8% per CPI, based upon a quick google search.  The yield-to-inflation has been flirting at negative for years.  Why do you believe if the Fed printed a 10% inflation rate that the 10 year would rise?  Why not assume the system is rigged at multiple levels?  It's not like the stories I might tell are not a rigged system, just different rigging with different players.  I'd point to stories suggesting credit creation is at a bank level and the fact that the regulation forces less banks creates less dollars for the small players, forcing players to get big, like the banks.  This kills general employment and forces prices down because the little guy can't afford more than that, ala deflation.  The same regulations require the banks to buy up a lot of bonds because these are really big banks.  They must buy even more bonds when things look shaky, like if the stock market falls for collateral reasons... pushing the yield ever down, regardless of inflation.  So it's QE pushing rates down or its banks...  The deflation you see would keep businesses from growing, so any non-QE printed money will still force the prices up because of TINA.  I'll stop that story there because my point is not to convince you this story is right or wrong, but to question if the narrative you have has the right premises and how you might test them.
RFS wrote:
Tue Sep 21, 2021 12:05 pm
... Fed Governor was literally titled "Deflation: Making Sure "It" Doesn't Happen Here."

I think it is actually more likely that the 10 yr goes negative. This is because when The Everything Bubble bursts...  Wouldn't the US run this exact same play?
I think the first question you generate is, which is worse, a "bitcoin" style deflation world or an inflation world?  In a bitcoin world, everyone HODLs it because all other assets are deflating relative to bitcoin.  The same is true for any other currency in deflation land, but this is where bitcoin is right now.  So no one spends money, no one buys anything, there are no jobs because why invest when you can just HODL?  There are lots of folks who argue we are in that world.  In fact, you might say stocks are that asset, with bitcoin joining in recently.  The deflation comes in the form of bitcoin halvings and buybacks.  To tie it back to a different thread, the number of lentils you can buy is going up every year you own stock, not because the business is doing better but because of inflating prices and flows. In such a world, the HODLers grow rich while those who must buy lentils grow poor from no work. People decide they should grow gardens and that growth has ended.

In an inflationary world, consumable and investment items cost more tomorrow than they do today.  This is that "general price increase" view of inflation again.  Lentils should cost just as much as stocks relative to each other, regardless of the inflation rate, all other variables being equal.  To put it another way, 10 dollars of lentils is equal to 10 dollars of S&P shares today and if the currency doubles, it would be 20 dollars of lentils is equal to 20 dollars of S&P shares.  In an "extreme" version of a world like this businesses have a hard time pricing things, because the price keeps going up.  This becomes hyperinflation eventually.  In a less extreme world, it is linear inflation where a business just factors in some "fudge" number into their price which then becomes the inflation rate, given the aggregate factor.  This destroys debt faster and costs retirees.

It turns out the question is a trick, both are bad, but are bad for different classes of people. This could turn into a Marxian sort of class struggle analysis, if you like that sort of thing, or it could go into a "which is easier to solve" analysis or we could just look at what has happened and see what we should do about it. I'm going for the last.

I'm currently of the mind that we've been in something more like a deflation world due to QE for years, but I continue to update my priors as I learn more. If you think this will continue, HODL assets.  The question is, when will the federal government run into liability levels that they cannot handle and what will the results be?  It seems that no one, not even China wants to be the center of the currency world or the "reserve currency".  The only other mainstream ideas are to use a basket of currencies or a relatively fixed size amount of currency (bitcoin, gold)(*).  I think history is a poor guide at this point.  Japan has 200+% of debt to GDP, "Self financed". How long the US can go for is just unknowable.  Foreigners buy/sell debt based upon their need to repay loans in US dollars.  This is the "dollar smile" idea, to say nothing of the "dollar milkshake".  If the US starts having real trouble with their debt (not debt ceiling trouble mind you), it will likely be the end of the US reserve currency.  While that is coming, the question of the how is really hard to predict.  Maybe we see foreigners have to buy up dollars one last time to pay off their US denominated debts when the US crisis you imagine occurs.  In which case, it may not be the blowup you imagine, rather it will just be the last time the US can raise more debt.  In that case, a massive deflation will happen until the US directly monetizes reserves, ala central bank digital currency.  Then it will turn into massive inflation. I personally think this is a harder thing to predict compared to the HODLer plan, but I also do think you should handicap it. How much and in what ways depends on you and how you imagine the blow up occurs.

(*) There are other ideas around solving this but they are by minor economists who are ignored.  Steve Keen would be an example of this.

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

Seppia wrote:
Wed Sep 22, 2021 12:25 am
The USA have outperformed rest of the world equities for over a decade, sometime this has to shift and reverse, not having an exposure internationally is dangerous in my opinion.
I believe the US has outperformed for the last 50-100 years but @Tyler9000 with his portfolio charts will probably have the better details than I off top of my head. If I have it correctly, the advantage to being the US is reserve currency status. When that ends will probably correlate well to when you should own international markets. Beyond that marco view, the US has more tech which has been eating the world and if you compare the Qs to the SPY you'll see why value has been a terrible trade and international basically is value (ex-China). Will that continue? I'm not sure. Place your bets accordingly.

WFJ
Posts: 416
Joined: Sat Apr 24, 2021 11:32 am

Re: Inflation, Interest Rates & Financial Represion

Post by WFJ »

The only justification for investing overseas that rewards investors for taking the extra risk is a lower return correlation, which most countries no longer exhibit. North Korea, Cuba, El Salvador are probably the only countries with (if they had stock markets) which would exhibit a correlation low enough to justify investment. In my experience, most MPT managed investments turn into complex dumping grounds where brokers dump busted investments into complex products most individuals don't monitor. A friend asked me to look into one of his managed accounts and found it has over 10,000 positions, with hundreds of exotic international positions with costs basis in the millions which had a market value under $10.

International funds are now largely used as a higher fee, higher turnover, opaque investment sold to investors, not useful for a balanced portfolio. Even at 20 bps, this is 10x higher than a low cost index fund and many of the assets are highly correlated to the US. I've had 0% international since the 2009 US based on the experience from the US mortgage financial crisis that also crushed international funds (makes absolutely no sense if one is international investing for diversification).

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

WFJ wrote:
Fri Sep 24, 2021 1:17 pm
I've had 0% international since the 2009 US based on the experience from the US mortgage financial crisis that also crushed international funds (makes absolutely no sense if one is international investing for diversification).
I agree with nearly everything you've said, but the question is will, is it always true that international goes down with the US?  Based upon correlations they are 13% uncorrelated(*).  If you are the "extreme" diversification type, 20bs might be worth it.  Certainly if you don't want to own bonds because of repression but you do believe in uncorrelated assets, some level of international might be worth it.  The most likely catalyst I can think of for a major uncorrelated event revolves around a US debt crisis/loss of reserve currency.  No doubt it would hurt everyone, but the US would probably be hurt the worst.  Is it worth it?  I don't know, I have not studied the British stock market of the 1950s to really have an opinion based upon history.  Nor do I know if history will even rhyme.  

(*) https://www.guggenheiminvestments.com/m ... lation-map

One more element that is not diversification based, but if you believe in value-investing style "PE-1" or even "PE-15"s, there is a lot more fishing elsewhere.   Not every market is experiencing Financial Nihilism or narrative based investing where valuation does not matter.  Where there is no agreed upon objective reality.  I'd argue the US market is more like Japan of the 1980s/early 90s than it is today.  If you agree, you might choose to avoid the multiple-expanded companies of the US and prefer somewhere like Japan.  To give an apples to apples comparison, the value factor in Japan is about a PE of 13 (EWJV) vs value factor in US is about a PE of 25 (IUSV).  Those are both indexes by Ishares, so the methodologies for calculating value should be similar.  

In summary, if you conclude valuation is nonsense on a pogo stick and that all US events always hurt nearly as badly internationally, then we're in complete agreement.  If either of those concerns is valid, you might choose international or some specific international stocks.

User avatar
Seppia
Posts: 2016
Joined: Tue Aug 30, 2016 9:34 am
Location: South Florida

Re: Inflation, Interest Rates & Financial Represion

Post by Seppia »

https://www.longtermtrends.net/msci-usa-vs-the-world/

Someone in 1989 could have thought that the USA was deemed to continue underperforming ROW as it did for the prior decade.

It’s fairly improbable and mathematically impossible in the longer run that the overperformance continues indefinitely.
The USA is around 55% of the total market cap IIRC, how much bigger can it get?

Of course the US has overperformed ROW in the last 100 years, it went from “relatively irrelevant country” to “world powerhouse”.
So did Denmark but I wouldn’t invest 100% in Denmark either.

Time will tell though, it’s clear that since the GFC the states have creamed ROW, and trends tend to have momentum…

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

Seppia wrote:
Fri Sep 24, 2021 3:51 pm
The USA is around 55% of the total market cap IIRC, how much bigger can it get?
I could throw in some Keynes quote about solvency, time and sanity here, but I think the question is, what matters in the world?  Take the climate change vs absolute poverty question.  One answer to using less is the ERE self-educate, share the wealthy by not over consuming.  Wall-E/Ready Player One gives another style answer where we all wear Facebook helmets and live in a virtual land (that would require a lot less buildings and allow the poor to become "wealthy" at low cost).  In a very rough sense that is the tech vs value debate summarized.  

Value is about being a low cost operator.  Tech is about taking over the world ("Growth") with a new ideology.  Currently tech is about addicting people to the devices via cat pictures and demanding things appear at your door, but tech is taking over people's lives, driving what they do and where they (don't) go.  Either tech will make the world a better place or wealthy westerners really have to live with less, assuming you accept climate change will generate world wide problems.  If tech wins, then there is no need for lots of workers, everything can be done virtually, you won't signal your wealth by a big home but by a big virtual home, and so on.  In such a case, the US market cap should go to the moon while our relative harm to the environment goes down.  Given that FANNG is ~25% of the entire US Market (10+% of world commerce based upon your stats!), this could be argued to be at least partially true today.  

If you think tech will fail to live up to its promise of a singularity style event, then owning commodities, owning infrastructure that builds stuff in the physical world, etc. makes sense and it is definitely cheaper internationally vs US.  If you want to spread your bets, own QQQ and international (possibly ex china/japan as they have a lot of tech too).  Mix to taste.

WFJ
Posts: 416
Joined: Sat Apr 24, 2021 11:32 am

Re: Inflation, Interest Rates & Financial Represion

Post by WFJ »

The "why's" of correlation and diversification have never really been developed, it is just an ex-post statistical measure. The entire motivation for international investing is MPT, which was developed in the mid-1950's when cross-border investing and trade was minimal and lower correlations were common. Today, one can trade most developed country equities and currencies for a few USD and trade between nations has ballooned, causing correlations to converge near 1.00.

If China decouples and brings along some trading partners, then investing in these countries which are decoupled would make sense for diversification, but this is not true today (or likely to change in the near future without major disruptions). I owned several country specific and world ETFs until 2009, when return correlations were nearly 1.00 during the US based mortgage debt crisis. The world is more interconnected today than 12 years ago.

Value hunting, again, worked in the 1950's-1970's, slowed working in the 1980's and dead since 2000. The reasons for this are multiple, but if you can see an annual statement from the 1950's you will see how much value could be hidden in annual statements compared to today. Unless you are a 0.00001% expert, you will find more value traps and dead money than provide any excess return by international value investing.

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

WFJ wrote:
Tue Sep 28, 2021 2:58 pm
The entire motivation for international investing is MPT, which was developed in the mid-1950's when cross-border investing and trade was minimal and lower correlations were common.
...
If China decouples...
Value hunting...
This is not an effort to refute you completely, as I agree it takes effort to dig up any sort of data, but ERE is about gaining skill, including possibly investing skill. That being said, I already cited a "value" vs "value" ETF comparison, which I believe is a "apples vs apples" comparison. They require no stock picking, no hunting, and unless you imagine there are more value traps in Japan than the US it should be a completely fair comparison. My contention was if one owned Japanese value and US growth or even US momentum you'd get the extremes of both ends. It seems likely there would be some difference in correlation vs just owning a straight SP500 index. However, you might say PE ratios are an invalid measure and that there are more value traps in Japan. Of course you're only evidence is price. So let me try to counter that with an example of the quality of Japan vs US. I'm not going to do car stocks because Tesla is the third rail of stocks. Instead, let me give a comparison of a "growthy" company (which by US valuation standards would fit value) and a reasonable US comparison:

Nintendo:

EV/EBIT: ~7
3 year Revenue Growth: ~19%
P/Cash Flow: ~10

vs

EA:

EV/EBIT: ~41
3 year Revenue Growth: ~3%
P/Cash Flow: ~28

NOTE - All data provided comes from Morning Star. Here are two links where most of the data came from:
https://www.morningstar.com/stocks/xnas/ea/valuation
https://www.morningstar.com/stocks/pinx/ntdoy/valuation

I might accept that Nintendo is topped out and will even decline 20% over the next 3 years, and maybe EA is just about to grow by 20%, but even with some cyclical adjustments, it is hard to justify a EV/EBIT of 40 will 'catch up' with a EV/EBIT of 7. The problem everyone cites with Japan is that the companies are conservatively run, but Nintendo is buying back shares--Japan is starting to join the financialization party. I can give bull and bear cases for both stocks, but that isn't the goal, the goal is to demonstrate a former non-value trap comp (it had a 150% run in 2 years and other runs previously) to a roughly comparable US stock. My point isn't to sell Nintendo/EA or Japan or video game stocks to anyone, but to show that by expanding horizons to other places, you might find that other lands have possible choices that increase diversification. Other than Microsoft which is a bit too big to compare to, there are no other US console manufacturers and while Sony (another Japan stock) exists, there certainly is no pure plays like Nintendo. I'm sure there are lots of other examples in the world where you can only buy the niche by buying internationally.

One last point, beyond valuation. I know lots of folks who think flows matter more than valuation in pricing of a stock. So let's consider flows. In the 1980s money was flowing to Japan. More recently it's been China. This decade it clearly has been the US. This is all post 1970s where integrated trade in a fiat system started to take place. There is a risk the flows will flow elsewhere in the next decade, to say nothing of war and/or change in reserve status. Furthermore, there actually was a lot of US crossborder trade going way back, so I'm not sure why you believe economies are more linked now than before, beyond stock market pricing behavior. It's not like the great depression was a US only phenomenon.

Even with 87% correlation, the risk parity guys would take that all day. Diversification for that style of consideration is important. They claim (I've never checked their math but I'll get you citation links if interested), by extremely diversifying you can get as much as 3% more gains in the rebalance.

I'm not saying anyone should be in love with risk parity or MPT, but it shouldn't be dismissed without more evidence, particularly if you are going the PP/Golden Butterfly/Dragon Portfolio style route. If you have strong evidence that there isn't some small level of diversification value beyond, "...when return correlations were nearly 1.00 during the US based mortgage debt crisis", I'm open to it. Please cite the statistics. Don't get me wrong, clearly drawdowns matter and assuming your 1 data point is 100% accurate, there still maybe differences in that different areas recover differently and different rates of recover at different levels. Also not all recessions are the same, a non-banking crisis may behave differently. For example, a recession from US/China intentionally making efforts towards decoupling, might behave very differently than the last banking crisis. If there is value, even minimal value, and you're playing a PP style game, it seems like it could be useful in spite of the fees at least for some styles of portfolio construction, given some types of investing goals. If your not playing such a game, fair enough. Charlie Munger and Nick Sleep both claim to only own 3 or so stocks and they're doing okay last I checked.

Disclosure: I am not recommending any stocks in my analysis above. Do your own homework.

WFJ
Posts: 416
Joined: Sat Apr 24, 2021 11:32 am

Re: Inflation, Interest Rates & Financial Represion

Post by WFJ »

I think that would qualify as a pair trading exercise, which is only to be undertaken by an expert with many pairs (50+). Probably the best argument for EA being overvalued compared to Nintendo is the ease of acquisition from Microsoft or other mega cap. High value stocks tend to stay high value stocks for a very long time and low value stocks remain low value stocks for a long time.

My personal hypothesis is best described as a narrowing, where only a few companies can attract the upper 0.0001% of workers, these people tend to cluster as they only like to be around other 0.00001% and the narrowing continues. 70 years ago, talent differences were not as stark, as the productivity of a worker at Pepsi or Coke may not be significantly different and valuations were more in line where differences could be exploited by diligent investors. Those days are over.

Time will tell, but in my wide ranging professional life, the demand for those with malleable brains, who can figure out how to build, run and maintain evolving technology systems is growing (probably a squared term) exponentially faster than the supply (linear at best) of these people. I have some experience with building, most is in running/using and very little in maintaining systems, but the differences are stark between organizations with those who can and can't apply the most advanced technologies. If the supply of these people is dispersed, unlimited and growing at the same rate as the demand for their services, EA and Nintendo valuations would converge over time. If the supply of this talent is scarce and narrowing, the valuations will diverge even further over time (my hypothesis).

JCD
Posts: 139
Joined: Sat Jul 20, 2019 9:12 am

Re: Inflation, Interest Rates & Financial Represion

Post by JCD »

WFJ wrote:
Sun Oct 03, 2021 8:26 pm
I think that would qualify as a pair trading exercise, which is only to be undertaken by an expert with many pairs (50+).
I was not meaning it as a pairs exercise, merely a point that a Japan Value index at a PE 15 vs a US value index of 25 suggests you are overpaying in the US. If it is purely junky, value trap companies in Japan, it should be hard to point to good companies like Toyota, Mitsubishi, Hitachi, Panasonic, Sony or Nintendo. Yet most of those are in the ETF I cited before. I'm not saying the ETF is perfect, just that it isn't made of crud. Nintendo was just an example to make it clear the difference in valuation, not quality of the business or brands. I'm not saying the valuation is right or wrong for either stock, just on a pure numbers basis the entire Japanese stock market looks relatively cheap vs the US.
WFJ wrote:
Sun Oct 03, 2021 8:26 pm
70 years ago, talent differences were not as stark, as the productivity of a worker at Pepsi or Coke may not be significantly different and valuations were more in line where differences could be exploited by diligent investors. Those days are over.
I understand in tech land how that might matter. I do get your point. I do understand the "It's different this time" which I might hold some suspicion on, but sometimes it really is different. English is a popular language vs Japanese, Japan's population is falling, they are isolationists, etc. I could point to China looking cheap and we could do the same song and dance again. I could point to Europe and note its value ETF's PE are around 16, cheaper than the US's value again at a PE of ~25. The point is, everywhere but the US, value is cheaper. If the US has more productive workers, it would be mostly in tech industries. If that is the case, bet big on tech in the US. I'm not debating your basic thought process in places that count. EA might beat Nintendo in such a case, but would you care about valuation outside of tech? Is a phone company in Europe different from the US? How about a grocery store chain? Food growers? Bankers? Life insurers? Food packagers? In those cases wouldn't cheaper be better, particularly in an index?

Beyond some high flyers that seem to me to be inappropriate to a value ETF like Walmart, Disney and Home Depot, the value index has stocks like Pepsi, GE, IBM, Goldman, Comcast, Kohls, General Mill, Kroger, Ford and MetLife. Tech is 11% vs Japan's 7% (Using IShare ETFs). In both cases tech is a small part of the index. My point is to only compare value to value because I agree there is a difference between US/China tech giants and everything else. China has other problems, so basically the US is the only place to be for Growth/Tech. If tech falls, then the US indexes probably fall with it (I mean the top 10 are like ~25% of the market). If tech goes up, the market will too, because that is how nearly all the ETFs are constructed ("Float-Adjusted" Market Cap weighted). It just seems to me If you are betting on tech owning everything, your hedge should be the cheapest value plays possible, not the most expensive value plays. What am I missing?

User avatar
giskard
Posts: 320
Joined: Sat Apr 30, 2016 12:07 pm

Re: Inflation, Interest Rates & Financial Represion

Post by giskard »

I just felt like reviving this thread with a snapshot of the current time period:

- we just had 6 straight weeks of red on all the major stock indexes & TLT. :o
- the 10yr is a 3.14%
- it's sunday night and futures are red. Nasdaq closed down 4% friday
- the Russian / Ukraine conflict continues to drag on
- WTI is at $109 and heading back up again
- Oh, btw CPI came in at 8.5% last month :o - we don't know if this the peak either
- fed funds rate is a 0.75%
- GDP for q1 2022 came in at NEGATIVE 1.5% :o
- DXY just hit 104 :o

Other things: CPI has risen much higher than most people believed it would go and inflation has not been "transitory" but in large part it's probably due to to supply chain issues, fuel price increases, and deglobalization in general. The war in Europe is accelerating this, as is China's covid-zero policy (ports are locking down intermittently and factories are being shuttered). My point in mentioning this is that the fed can't print supply chains so not sure how raising rates can even help here.

So in summary we have a greater than NEGATIVE 5% real rate on 10 year treasuries but the 10yr yield is falling by about 0.05 - 0.1 % a day :o - so yeah 60/40 portfolios are getting murdered right now.

It really looks like the fed is letting the bond market rip lower to signal they are serious about fighting the massive inflationary pressures we are seeing now.

User avatar
Seppia
Posts: 2016
Joined: Tue Aug 30, 2016 9:34 am
Location: South Florida

Re: Inflation, Interest Rates & Financial Represion

Post by Seppia »

Some people are discovering that bonds can also go down.
On the one hand, they had been going up for like 40 years so hard to blame them
On the other, if you believe lending money to someone and getting back less money after 10 years of wait can be a good idea, you kinda deserve to get murdered financially

MBBboy
Posts: 212
Joined: Sat Jan 01, 2022 12:11 pm

Re: Inflation, Interest Rates & Financial Represion

Post by MBBboy »

Don't forget fiscal and monetary policy as reasons for inflation

Post Reply