mattee2264

5%+ bond yields = PAIN seems to be the consensus in the financial media at the moment. Not really sure I completely buy it. Equity risk premium has almost been wiped out. But if investors are confident in long term growth prospects for the market and especially Big Tech then they can get their margin of safety in growth (something bonds can't offer). And the US economy is still growing. Difficult to imagine another financial crisis and the Fed is fairly adept at bail outs so the rate sensitive sector should hold up reasonably OK and a housing market correction is going to be fairly mild so long as unemployment rates stay low. While borrowing is more expensive companies and consumers are getting more interest on their cash balances which is a partial offset. And a lot of consumers and companies have locked in low rates of borrowing in recent years which will increase their staying power and buy them time to prepare for any required refinancing at higher rates and also will stagger the required adjustment for consumers and companies as a whole. And of course market psychology is such that as soon as there are signs things are breaking or the economy is slowing down there will be market bets on a pivot which will send stocks higher. I think the only thing that could sink markets is going to be if there is a proper corporate earnings recession. Because if it does turn out that Big Tech is cyclical then bonds become a more attractive safe haven. But right now Big Tech is the hiding place of choice for institutional investors because they've been the big winners over the last decade, showed their resilience during the COVID recession, have a new lease of life with AI, and so far they have managed to maintain elevated earnings in spite of weak revenue growth through cost cutting initiatives. There would be a rude awakening however if we went into a proper recession and Tech earnings fell significantly and in a proper recession cyclicals would also head lower so there would be a synchronised and probably quite significant market decline

Worth noting that the US economy is at full employment and any maturing government debt will need refinancing at higher interest rates. And if the US economy goes into recession that will automatically increase the budget deficit as unemployment benefits go up and tax receipts go down.

Since the GFC economic growth has been anaemic. Even trillion dollar emergency pandemic deficits (still ongoing!) and ZIRP and successive rounds of QE and tax cuts etc have failed to push real GDP growth above 2% for more than about five minutes. Inflation gave a little boost to nominal growth post-pandemic but that will only be temporary. Obviously the market and the large cap segment especially have done wonderfully well over the last 15 years. But the operative factors are easy to identify and are unlikely to be sustainable and may even go into reverse and become severe headwinds 1) Successive rounds of QE flooding the markets with liquidity which has gone towards the most liquid large cap stocks and index funds. I think there is still some stealth QE going on e.g. the Fed expanding its balance sheet to help the regional banks but if the Fed ever gets serious about quantitative tightening and reducing its balance sheet that is going to spell trouble for stocks and especially the most liquid large caps. 2) ZIRP has allowed large caps with good credit ratings to borrow money to buy back shares and therefore achieve EPS growth well in excess of underlying earnings growth. Obviously this doesn't work so well when the cost of borrowing is a lot higher. 3) Various factors have resulted in much more concentrated markets so larger companies have been benefiting at the expense of smaller companies and therefore able to post impressive earnings growth even if the overall market is growing at not much more than GDP growth. And with greater market concentration it allows better margins that are not competed away. But market share gains are also not sustainable and market growth is far more linked to GDP growth so if GDP growth is weak then that will mean much weaker growth for large caps going forward. 4) Technology has a winner takes all dynamic which has meant that Big Tech companies have been able to "eat the world" and achieve mindboggling multi-trillion market caps. And of course much of the increase in the S&P 500 from the pre-COVID peak of around 3000 to the current level of around 4500 has been driven by Big Tech who enjoyed the benefits of a lot of technology investment spending being pulled forward as well as an acceleration of adoption of online retail/online advertising/cloud etc. Obviously the hope is that AI will extend their growth runway. But under the surface over the last few years growth has stalled and while in the short term efficiency improvements and cost cuts can sustain growth a little longer they are not sustainable. 5) Since the pandemic markets have become very speculative and it is much easier to speculate in large cap liquid stocks through the use of call options etc and they are also far easier to trade and holding periods are as short as they've ever been. And the reason for the speculation is that there is ever increasing confidence that markets will always recover and there will always be an eventual bailout. We had a V shaped recovery at the end of the last tightening cycle in 2018/19. We had a V shaped recovery from COVID. A V shaped recovery from last year's inflation shock. And the 50% decline during the GFC and dot-com bubble were so extreme and so long ago that they are being dismissed as outliers. And of course the usual bearish pundits look stupid as they keep crying wolf and no one takes them seriously anymore.

Buffett has only a limited ability to time the market and to the extent he can it is not because he uses simple metrics like earning yield compared to bond yield or trends in corporate margins, market cap to GDP etc. And he has a habit of oversimplifying things and failing to mention all the other factors he would take into consideration as well as his general intuition he has developed from walking talking breathing markets for most of his adult life. And I think he is a lot more careful about making market prognostications as a result as well as knowing people take his advice at face value and rely too heavily on it because of his fame and fortune. Interest rates are related to stock prices. But it is not as simple as saying if interest rates double then stock prices will halve. The risk free rate is just one input into equity valuation. An increase in the interest rate can be offset by more confident investors (i.e. a lower equity risk premium), better growth prospects (and inflation actually increases growth prospects for companies with pricing power) and changing composition of the market. And market cap as a percentage of GDP and corporate profits as a percentage of GDP are useful but not conclusive because they also are not time consistent and there are reasons why they are a lot higher such as increased market power, change in the composition of the economy towards technology and services, and lower tax rates etc.

Charlie is obviously more cerebral and intellectual. But Warren is the human computer and has the money mind and understanding of businesses. The reason they work so well is that Charlie is probably a great sounding board and with his legal background is able to play devil's advocate and challenge Warren's ideas. And of course the great contribution Charlie made was to recognize Warren's investment genius and stop him limiting himself to buying simply by the numbers the way Graham taught him.

Agree that it is foolish to be scared off by PE ratios over 20. For most of a bull market the PE ratio can comfortably stay above 20 with growing earnings taking markets higher such as in the 60s and 90s and second half of this bull market. Problem is that corporate earnings are falling. And the overall market PE ratio is 28x and even if you exclude the Magnificent 7 (with an average PE ratio of 43x) the market PE only falls to 24x which is pretty rich by any measure. So feels as if not only is market expecting a soft landing but it is also expecting a lot of future growth. Whether it is from an AI productivity miracle, some kind of green economy investment boom or these continued trillion dollar government deficits actually enhancing future growth rather than just keeping the economy afloat.

Yeah I meant the current market level can be easily justified if earnings stabilize and resume growing (i.e. soft landing) and interest rates moderate (i.e. disinflation continues). You'd then end up paying just over 20x growing earnings relative to 3-4% interest rates which would make equities look pretty attractive so long as earnings growth rather than multiple expansion can do the heavy lifting from hereon out. Most of the recovery so far has been driven by multiple expansion as sentiment has swung from pessimistic back to optimistic. Corporate earnings for the market as a whole are continuing to decline albeit more moderately than was initially expected. Outside Big Tech I agree things are pretty meh. I think a little too much optimism is being baked into the financial sector as it is interest rate sensitive and we still haven't seen all the fall out and especially in relation to commercial real estate which is under a lot of strain. Commodities I think are a bit undervalued as supply is still incredibly tight and Biden can't drain the SPR forever. And there is some economic sensitivity so if we do go into recession some further downside there. And consumer staples/utilities etc are still trading as bond proxies and perhaps haven't fully reflected the end of ZIRP. Big Tech is too hard for me. But if you are commenting about the overall market you do need to form an opinion. Main questions I am thinking about are: 1) Is there a potential for an investment slowdown similar to dot com bubble? During the pandemic a lot of technology investments in cloud etc were pulled forward and that provided a major boost to earnings. But what if this investment spending slows down or goes into reverse? 2) In a weakening economy where the cost of new debt is very expensive how much appetite will there be for non-technology companies to invest in AI? And until they are willing to make those investments how will the technology companies monetize their own AI investments? 3) How will Big Tech pass the test of a more garden variety recession? Google and Facebook are reliant on ad spending. Amazon is reliant on online retail spend. Apple is reliant on people upgrading their phones and renewing subscriptions to apps etc. Tesla is reliant on people buying cars and so on. COVID was unusual because Big Tech were major beneficiaries. But if there is a fall in consumer spending and investment spending then we might see that Big Tech is more cyclical than people are expecting.

Agree that so far the market as a whole has been able to grow earnings in line with inflation and have been relatively unaffected by the increase in interest rates. And if that continues to be the case and inflation remains low and interest rates can fall back to around 3-4% (above pre-COVID levels) but very manageable in a growing economy then there is nothing much to worry about. But there could be a false sense of security explaining some of the seeming complacency in markets. -Cutting the excess fat accumulated during the boom years before falling demand hits prices and margins can help maintain or even grow profits. And it is a nice story to sell when earnings disappoint slightly and buys companies a bit of time. -Similarly it is easier to keep pace with inflation when consumer demand is still resilient and you can put through cost increases without impacting volumes. Especially as there is some inertia in spending patterns and wage bargaining when there is unexpected inflation -As you mentioned companies still have low cost debt entered into during COVID and are benefiting from higher interest income giving a boost to earnings -And consumers still have some excess savings and so far job cuts have been quite limited -And energy prices have swooned which has taken a lot of the edge off. Although there are signs this trend may reverse -Also even the Dow still reflects the concentration in Big Tech and the AI story has helped investors overlook near term softness in revenues and earnings. But already some of the hype has died down and companies are trying to manage near term expectations. And during a bull market it is easy to have a longer term horizon and get excited over such things. But investors have a tendency to become very short term oriented when sentiment reverses. Case in point dot com bubble when some very good companies who would clearly benefit from the internet changing the world in much the same way AI eventually will still sold off massively. Anyway time will tell -

Is a soft landing, interest rate cuts and productivity led growth driven by AI wildly bullish for markets or has it been largely priced in at this point? It is the companion error of getting bearish at the point when things are obviously bad in the economy and stock prices have already fallen significantly.

US GDP 2.4% in Q2. CPI inflation latest reading 3.1%. Still at pretty much full employment. Fed supposedly near the end of their rate hiking cycle and saying they could decrease rates before inflation returns to target. AI promising improved productivity and an extended growth runway for Big Tech. No wonder sentiment is pretty bullish right now and we are not that far off all time highs.

Yeah you can still get rich and clearly you are better off holding real assets than cash. It will just probably take a lot longer and a higher savings rate and a longer working life (especially as with higher life expectancy you need to fund a longer retirement and need to self-fund rather than getting a nice final salary arrangement from your employer).

I think it is the case in a lot of Western countries that people with respectable middle class jobs are struggling to get on the property ladder, afford to raise a family and save enough for retirement. Especially hard for youngsters who missed out on the double digit real returns of the last 15 years. Pretty clear that ZIRP has massively increased wealth inequality and therefore intergenerational equity. But unfortunately even with the Fed pulling the rug away there hasn't really been any meaningful change in sentiment and people continue to chase Big Tech and maintain very high equity allocations. And markets know that if something looks like breaking the Fed will simply expand its balance sheet to mop things up. And it is a typical late bull market phenomenon that even as interest rates rise investors continue to see equities as far more attractive because the greater risk of equities isn't really showing up either in the underlying earnings or the quoted prices. It will take falling earnings and falling prices for investors to appreciate more the attractiveness of a fixed but certain return.

Microsoft to charge $30 a month for add-on generative AI features. Markets obviously reacting very positively. But I think if Big Tech try to be too quick to monetize generative AI before it actually adds any value it is a risky move. Obviously they might get a lot of people signing up because it is a fun fad. But if the reality doesn't live up the hype which seems to be inevitable then people will cancel pretty quickly. And unlike something like cloud which pretty much came as a freebie to Big Tech they will need to invest a lot of money into AI and if the returns on these new investments do not match their historical returns then any growth from AI will come at a considerable cost and not necessarily be value generative. Really it would have been a lot better I think to tease the future possibilities and talk up the investment and the wonderful returns they expect from it. And wait until they actually have a solid value-add offering before trying to monetize too aggressively.

12m of straight CPI declines from a peak of 9.1% to the current 3.1% and it is understandable that markets are being a bit complacent especially as we are still at full employment and not in recession despite 500bps of rate increases. Agree that there is a possibility of a stagflationary recession that could catch markets by surprise and tie the Fed's hands so they can't bail markets out the way they usually do. Market is very much positioned for disinflation and lower rates favouring growth companies.

The best correlation is actually between Big Tech and inflation. CPI inflation fell from a peak of 9.1% to the current level of 3.1% and over the same time duration Big Tech roughly doubled recovering the majority of its earlier losses from the inflation shock. And essentially Big Tech investors are frontrunning interest rate cuts they see coming. Also when sentiment is still bullish equities with their theoretically unlimited upside will always seem more attractive than bonds even if the latter offer a much better current income. While last summer/autumn should have been a reminder that stock prices can go down as well as up instead it reinforced the lesson that every dip is a buying opportunity and any losses are quickly recovered if you hold on which again gives equities seemingly attractive option value (heads you win big tails you don't lose much (or at least not for long). And unlike dot com bust earnings haven't fallen off a cliff and with AI in prospect investors can assume that the stalling of earnings growth or modest declines represents a lull and can look through to an economic recovery and an AI boom.. What might ruin this pretty story is a stagflationary recession that ties the Fed's hands and results in a meaningful decline in corporate earnings the market finds hard to ignore and brings into question their rosy future assumptions and brings into play a higher for longer narrativev that probably will require an adjustment to valuations

BoA did a more nuanced report which makes good reading. They suggest investors need to consider 5 questions 1 ) What caused the market concentration? (ultra-low rates and a lacklustre economy in 2010s combined with indexing and pandemic-driven tech adoption with AI the latest boost) 2) Has this happened before and how did it end? (bubbles fuelled by excessive leverage, democratization or markets and rampant speculation tend to end badly) 3) is today's Big Tech different from prior bubbles? (yes. bigger might be better today versus 2000. Big Tech has $200b net cash versus SMID Tech had net debt. For AI scale matters) 4) What are the important catalysts to watch for? -saturation in ownership (more overweight the stock the more acute the selling pressure around negative surprises) -changing competitve landscape (tech trends can shift quickly) -policy/politics (regulation) -rate risk (higher real interest rates may hurt growth stocks ) -demand (pull forward in tech capex during COVID similar to that ahead of Y2K which was followed by sequential years of negative top line growth) 5) How can equity investors navigate these risks? (seek opportunities outside Mag 7)

I bought Microsoft and Apple quite early last decade when they were selling for about 10x earnings because Microsoft was seen as ex-growth because of its exposure to the declining PC market and Apple was seen as a hardware company selling overpriced phones. After they doubled in price I sold! Lesson learned was that you can leave a lot of upside on the table if you ignore growth and long term prospects. Buffett made the same mistake early on with Disney when he was still very much influenced by Ben Graham. Other mistake I have made a few times is not doing enough work on financial position so got caught up in the Sears and Chesapeake bankruptcy. Lesson learned there was that in a turnaround situation and for cyclicals you don't want to be on borrowed time! And the other mistake is being a bit too influenced by market history and expecting that valuations and margins will revert to the mean. When probably there is a case for higher margins and higher valuations in a New Economy.

Bloomberg article isn't quite correct IMO as it understates the importance of inflation which was devastating to long duration assets such as bonds and technology stocks. Big Tech bottomed around the time that CPI inflation peaked at around 9.1% end of June. Since then there have been 12 straight months of CPI declines and that resulted in a V shaped recovery. And actually it is quite typical for there to be V shaped recoveries when bear markets are a result of shocks rather than structural factors such as recessions. Earnings were a secondary factor. But AI has helped investors overlook declining near-term earnings in Big Tech and partly because the recession was postponed we saw more of a stabilisation of earnings rather than a collapse in earnings (the way earnings collapsed during the dot com bust). The problems for the future outlook are that: 1) We aren't yet out of the woods. So what so far looks like an immaculate disinflation could still turn into a hard landing accompanied by a new surge of inflation which would put the Fed in a very difficult position. 2) The AI hype is already starting to die down a little. And more balanced and more informed experts are going to start to pour a bit of cold water over it. 3) Even if we avoid an economic recession there will be a continuing corporate earnings recession and while markets may look through the next few quarters of weak earnings we have still seen on a company by company basis that earnings disappointments especially for the market darlings can result in severe punishment.

Peak inflation was 9.1% CPI in June 2022 and closely coincided with the market bottom and devastating losses for Big Tech. Since then inflation has more or less fallen in a straight line to the current reading of 3.1% CPI. And aside from some jitters in the autumn there has been a V shaped recovery especially for Big Tech who bore the brunt of the market decline as a response to the inflation shock. So no surprise really that investors are very bullish. Inflation back to the 20 year pre-GFC average. Economy still at full employment and yet to fall into recession. No contagion from the regional banking crisis. Add AI to the mix and it is easy to look through any near term softness in corporate earnings. The question is what next? Will the economy overshoot and fall into recession? Will something break that the Fed is less equipped to fix? Has inflation bottomed (and it would be typical for peak inflation to mark the cyclical low and trough inflation to mark the cyclical high) and could it start to rise even as the economy continues to slow down? Will corporate earnings over the next few quarters disappoint more than expected?

I was wondering if anyone has considered the impact of a falling US dollar on the market. I assume some boost to EPS given that a good amount of S&P 500 revenues are earned in foreign currencies and also inflation will give a further boost to nominal earnings. So perhaps a combination of 5% inflation and a falling US dollar along with the continued AI hype and crowding into Big Tech could be an offset to the negative headwinds from a deteriorating economy and higher interest rates.

https://www.wsj.com/articles/it-isnt-just-boomers-lots-of-older-americans-are-stock-obsessed-ca069e1a?mod=hp_lead_pos8 1/5 of over 85s are fully invested in stocks!

I think certainly for the higher quality names within the Enormous Eight you are trading off valuation risk for the other types of risk which are far lower for them than the run-of-the-mill S&P 500 company. For example: -Inflation risk: well they have fantastic pricing power -Recession risk: they provide essential products and services people cannot live without -technology risk: they are innovators at the forefront of emerging developments -competitive risk: they completely dominate their markets and can simply buy up any emerging competitors -financial risk: they generate huge amounts of cash, have huge amounts of cash on their balance sheet and little need for debt and higher interest rates actually benefit them to the extent they can earn more money on their cash So little wonder they are seen as a safe haven in an increasingly uncertain and fast changing world. But of course the reason high valuations are dangerous is because they are largely psychological and reliant on investors willingness to pay a 50-100% premium to the market multiple (and a much higher premium if you take the market multiple ex Enormous Eight) because of their desirable qualities. I think a particular challenge to watch out for is how they'll do if we do go into recession. They are cyclical to some degree and investors have been used to their earnings going up every year at a rapid clip and while that hasn't been the case over the last few years they've at least managed to maintain their earnings. But if earnings start to decline then that could spook investors.

2023 First Half Returns... The Enormous Eight... $NVDA: +190% $META: +138% $TSLA: +113% $AMZN: +55% $AAPL: +50% $NFLX: +49% $MSFT: +43% $GOOGL: +36% Everyone Else... S&P 500 Equal Weight ETF $RSP: +7% S&P Small Cap ETF $IJR: +6% This is a pretty good summary of the first half of the year. Any predictions for what the corresponding second half numbers might be?

I think it is possible to identify mini-bubbles and bubble stocks. The stay-at-home stocks (e.g. Zoom, Peloton) obvious examples from the pandemic. And more recently Tesla and Nvidia valuations clearly defy logic and to make any sense require incredibly optimistic assumptions about market shares and market growth and future profits. And yes AI is likely to result in a mini-bubble as well that will burst at some point. But this is more helpful in staying away from such situations (or at least not overstaying your welcome). I am not convinced it is incredibly helpful in timing the market as often bubbles burst and overpriced stocks fall back to earth without much of a market impact. 2000 was a bit different because of the extent of the bubble (encompassing technology and communications) and also the fact that even for the more mature and higher quality companies their revenues and earnings simply weren't sustainable and once the internet and associated communications networks had been built out they'd made most of the money they could hope to make and became ordinary companies again. And of course the dot com start ups with no earnings and not much more than an exciting story mostly went bust. This time round within the S&P 500 the very high valuations are mostly limited to Big Tech. And ignoring Nvidia and Tesla for now they may well be justified. These are very profitable companies with very strong competitive advantages and their earnings look sustainable even if they may not grow as fast as they used to and they are also very innovative as their exploitation of cloud/data analytics etc. showed and are likely to enjoy a large share of whatever market opportunity there is in AI going forward. They also have defensive qualities as they are essential to the global economy and businesses and consumers cannot do without their products/services (recession hedge) and enjoy pricing power (inflation hedge). And valuation risk alone is generally a bad reason to avoid holding high quality companies or indeed the market as a whole (especially given it the S&P 500 is stacked with high quality companies). And as for the recession talk. Recessions are very difficult to predict. And it is even harder to predict the timing or the magnitude/duration. Or the impact of the recession on different sectors e.g. manufacturing, services etc. Let alone the impact on the overall stock market. The chances of a hard landing are probably a lot higher than is currently priced into the market. And if there is a hard landing then corporate earnings may fall by 20% or so which would have a market impact. But not necessarily a proportionate impact as markets may decide to look through a recession. And they may also cheer if a hard landing brings inflation down and raises the prospect of a Fed pivot. And while cyclicals may sell off even more investors may decide to continue to follow the COVID playbook of rotating into Big Tech rather than rotating into bonds.

Nasdaq best first half in four decades. Irrespective of what you think about the economy betting against the market means betting against Big Tech and that may have worked last year but this year it is a way to lose your shirt.