mattee2264

Something I was a little too late to figure out was that foreign investors use London property as a bank and store of value so affordability means nothing to them. So that is a supportive factor. But what is different between London property and USA property is we don't have 30 year mortgage rates. Most people are on 2/3/5 year mortgage rates and these are all getting reset to much higher rates. Sure some buy-to-let investors have tried to increase rents dramatically to cover this which works in the short term but eventually people will either move further out/move back with their parents/move into flat shares/downsize to smaller properties etc. leaving landlords with vacant properties. If affordability didn't matter at all you wouldn't have seen prices rise 20-30% during the pandemic because interest rates and mortgage rates hit rock bottom levels. And it is quite typical for a lag because people at first react by holding off selling when prices start to fall which arrests further declines and volumes instead plummet. But eventually there is some forced selling. And then foreclosures. And then people get fed up waiting for prices to recover when they want to move house. And slowly that drives prices down.

Not as familiar with the US housing market as I am with the UK housing market. But even if mortgage interest rates come down a little they will still be considerably above the rock bottom pandemic rates that sent house prices soaring 20-30%. And certainly in London house prices are still well above pre-pandemic levels even though affordability is worse than it has ever been. And housing price declines tend to be multi year because for a while people can hold off selling which prevents prices falling off a cliff the way they do in the stock market but eventually some forced selling emerges and so on.

Fed has pretty much confirmed they are pretty much done and from now on it will just be a bit of additional firming as required. So the rates story is over. Focus is now on earnings and what kind of impact tightening lending standards has on consumer and business spending. And increased liquidity is clearly a positive for risk assets as we discovered during the post GFC era even if it isn't inflationary. The banking sector issues will create tighter credit conditions which will have a negative impact on consumer and business spending. But if the Fed expands its balance sheet and increases liquidity in the financial system it is generally supportive to stock prices.

S&P 500 forward earnings are declining relative to three months ago; The yield curve is inverted (or has been over the last 12 months); Unemployment is below average; US Manufacturing PMIs are below 50; and More than 40% of US banks, on net, are tightening lending standards Some commentary from Morgan Stanley showing that having all these five conditions in place at once is rare and never good for stock markets. But markets are still high on the idea that the more stuff breaks the more stealth QE will be unleashed and the closer we are to a pivot.

All Powell is really doing is making up for being far too slow to normalize interest rates after COVID was managed. We are just seeing the tide come in and therefore seeing who has been swimming naked. And while the headline news looks bad it is nothing that cannot really be handled. It is a good thing if banks exercise a bit more caution with lending. Especially when you consider how many crappy companies have been able to keep the lights on thanks to easy money and cheap credit. There is always QE by stealth to plug any holes and this is a war that the Fed is quite capable of fighting given its experience during the GFC and banks are far better capitalized than back then. Markets certainly aren't worried. We are still close to 4000 on the SPY and most major banks are well above their various lows in 2015, 2018, 2020 and so on. If people struggle to get mortgages for overpriced properties and a few zombie businesses go bankrupt and we continue to sort the wheat from the chaff in the tech sector it is pretty healthy. I'd be a lot more worried if markets were down 50% and unemployment was hitting double digits and Powell was turning a blind eye and continuing to press forward with interest rate increases. But that is a million miles away from what is happening here.

Even with an asset influx I think all the big banks will have to offer better deposit rates to keep people on board which will squeeze margins. There is also some exposure to credit risk as we go into recession. Silicon Valley Bank took the biscuit in making crappy loans to start up tech companies but I am sure most major banks have some exposure to businesses that are only really viable in a zero interest rate world. Housing market also looks likely to take a tumble. And all the banks are sitting on unrealised losses on bonds so equity is somewhat overstated on a GAAP basis. I'd say Bank of America looks the best bet. 1.3x tangible book value looks pretty cheap even allowing for the above. Although probably the strongest of the regional banks is where you are more likely to find the bargains given the market has tarred them all with the same brush.

Markets generally bottom quite some time after the end of a Fed tightening cycle (long and variable lags in action). So wouldn't surprise me at all if the bottom was in 2024 probably midway through the recession that is likely to begin later this year.

The Fed has a 2% inflation target based on CPI. Therefore in measuring progress against target you obviously need to look at US CPI which on a year-on-year basis is around 6%. Core CPI which strips out food and energy prices is 5.5%. Very little difference. And still well above target. There are always going to be arguments about whether CPI is an accurate measure of inflation. But for many years the argument has been that CPi UNDERSTATES inflation especially relative to old measures such as RPI. So it is difficult to make the argument that the Fed is overstating inflation. You can try and argue that a lot of the inflation is "transitory" and will disappear without any action from the Fed. But it is difficult for them to make that argument again after being so wrong last time round. But I agree that these problems in the banking sector will speed up the tightening of financial conditions especially if it results in more caution from stock market investors and lower stock prices. I think the right course of action is for the Fed to keep interest rates around 5% and keep them there for a year or two and let the long and variable lags work through the system. Credit Suisse down over 20% today and markets taking another tumble today.

The average might be 5%. But the stuff like matters like food, rent etc is up way more than 5%. I'd say 20-30% over the last few years.

I don't see a financial crisis brewing. But at the very least deposit flight is going to make it harder for banks to lend and continue to tighten credit conditions to the detriment of the real economy. And I wouldn't be holding banks either as they'll have to raise deposit rates now reducing their net interest margins and they are also likely to face credit losses as we go into recession. What is annoying as hell is that across the board prices are around 20% higher since pre-COVID and prices aren't going to fall back down. So you can understand why the Fed is determined to establish its credibility and anchor inflation expectations even if they have to break a few things in the process.

Obviously focus on this thread is primarily S&P 500. But European markets have been on a tear and are back at all time highs. Helps that they have a pretty high concentration in commodities and financials which have benefited from the increase in interest rates and growing optimism that there will be a soft landing and they don't have as much exposure to tech stocks and other interests sensitive growth stocks. How do people rate the prospects? Traditionally if the US has a good decade then EAFE tends to have a good decade the following one

Worth pointing out that these estimates are still ABOVE 2021 peak earnings which were juiced by stimulus

I'm more invested in American natural gas producers e.g. EQT, Antero, Range and bought summer 2020 so made hay although have given up quite a lot of those gains over the last six months. Weather hasn't helped and there is oversupply although not to the same degree as in Europe. And then you have a recession to worry about. So I wouldn't say the outlook is great.

I am referring to the next "bottom" before a new bull market resumes. That does not rule out future bear market rallies which might take markets higher. Is it possible that we will never see the S&P 500 fall below 4000 i.e. a V shaped recovery similar to the one we saw in 2019 and 2020? Well anything is possible especially if sentiment trumps fundamentals or the Fed/US government launch massive stimulus packages. But the latter seems unlikely and even the positive sentiment lately has been based on economic data that looks rosy on the surface and reading too much into Fed comments so I expect sentiment to sour as the Fed holds firm and we start to see job losses, stickiness to inflation and corporate earnings continue to decline.

If history is any guide markets will bottom some months before the economy bottoms and some months AFTER the Fed pivots. I don't think anyone has bragging rights at this point because it is too soon to tell whether there will be no landing, a soft landing or a hard landing and that is ultimately going to drive what the next bottom is and whether it will be above or below the bottom we saw autumn 2022 at around 3400 on the SPY. But if I had to hazard a guess I would say a soft landing might see us get close to 3400 and a hard landing would get us close to 3000 and no landing might get us close to 3800 as I suspect with no landing rates go a little higher. But of course all bets are off if there is a massive bailout from the Fed/US government

To add another point to the equity risk premium discussion: the bond yield is the bird in the hand while the birds in the bush are uncertain. Even the current earnings may well disappoint. So if you think you are getting a 5% earnings yield and earnings fall as they are prone to do during a recession you may well be disappointed and part of the reason for demanding a risk premium is to insure against such possibilities.

Agree that it is ridiculous to try to be so precise with the timing. But I don't think any of the fundamentals have changed and if anything they have deteriorated. What has changed is that markets seem a lot more confident there will be a soft landing and a lot more confident that we are near the end of the rate tightening cycle and the Fed will soon pivot. And forgetting that a soft landing isn't going to help bring inflation down and will probably necessitate further rate increases. In other words it seems likely it is a sentiment driven bear market rally.

For the past decade the Fed has been bailing investors out at the first sign of trouble and interest rates have been persistently low and a low growth low inflation environment has been very favourable to secular growth companies who've been able to juice returns by buying back lots of shares. And they even admitted that they were deliberately suppressing interest rates to encourage investors to chase returns and bid up risk assets such as equities to generate positive wealth effects. We had a soft landing in 2015 and 2018. In 2020 unprecedented monetary and fiscal stimulus saved the day. And somehow even with successive rounds of QE and persistently low interest rates inflation remained low. Until it didn't. So ignoring the noise and buying the dips was the winning strategy and the higher your equity allocation the better the results. So understandable that markets are somewhat complacent and assuming there will be an immaculate disinflation with a soft landing and even if something does break the Fed will go back to QE and all will be well. But who knows perhaps a decade from now it will seem obvious that the Fed withdrawing liquidity through QT and taking interest rates from zero to 5% or higher and keeping them there longer than the market initially expected would result in a lost decade with negative real returns.

Agree if you are picking your spots it matters less. Value stocks for example often do quite well during inflationary periods. But of course the big winners this bull market that still dominate the indices are the growth stocks which are quite sensitive to interest rates and inflation and have seen a pretty big rebound because markets seem to be quite confident about an immaculate disinflation and a Fed pivot. And as a lot of the long bull market has been driven by multiple expansion based on low interest rates and the idea that TINA to equities then a moderation of market multiples and a re-allocation towards bonds doesn't feel like a supportive environment for equities especially if earnings fail to hold up. And interestingly it is a similar dynamic. At first people were reluctant to price up equities even though interest rates were near zero post GFC because they thought zero interest rates were temporary. Then they got comfortable with the idea that interest rates would stay low and the Fed would cut at the first sign of trouble and multiples drifted above 20. Now even though interest rates are a lot higher people assume it is just transitory and they will fall back down once inflation is tamed and are still pricing based on a low interest rate environment. Perhaps again it will take time before people start to believe that higher (but still quite moderate by historical standards) interest rates are here to stay and adjust multiples accordingly.

Buffett always hedges his opinions on market levels by saying it depends on interest rates and interest rates are like gravity on financial assets. But we don't really seem to be seeing that to a large degree. 30 year US treasuries have increased from 2% at the end of 2021 to almost 4% today and could well head higher than 5% as most of the so-called disinflation just reflects energy prices coming down because the US are draining their SPR. The SPY peak was around 4800. That represents around 23x TTM earnings of $210 a share. To justify that you'd have to believe that those earnings were sustainable and interest rates would stay low and the 2% equity risk premium while below the historical average could be justified because of future growth potential or continued faith in the Fed put. Currently the SPY has fallen only 15% to 4100. Even if you use 2021 earnings that is still almost 20x earnings. This seems consistent with the idea that markets are pricing in an immaculate disinflation which will allow a Fed pivot so that interest rates fall to a 2% level which can be used to justify 20+ PE ratios AND that there will be a V shaped recovery of earnings to 2021 levels or higher within the next year or two.

On a related point, how well do people think banks are positioned for a hard landing? Obviously net interest margins are a lot better (although eventually they will narrow as they have to pay depositors more to attract their money) and most of the major banks have been adding to their credit provisions. But it is a long long time since we saw any credit stress and there is a lot of debt in the system predicated on the idea that interest rates would stay forever low. And not to mention a potential housing market crash as mortgages reset and people struggle to make payments.

I think the bull vs bear debate centres around whether autumn 2022 was the low (at around 3500 on the SPY) or whether there is a new low within this market cycle within the next year or so. Markets were correct in calling the March 2020 low. But you had a huge amount of stimulus that continued far longer than most would expect and also the rapid discovery of a vaccine and a pandemic environment which was very favourable to tech companies pulling forward years of future earnings and it was a man-made recession to the extent that the economy was put on pause and re-opening was a clear catalyst for recovery. This time it feels a bit different. There isn't as much room or appetite for stimulus. The Fed still has inflation to worry about and while the government will want to spend it won't be able to hand out widespread transfer payments which did a lot to ease the damage of the pandemic. And if consumers and businesses fall behind on their payments there won't be forbearance and the government is no longer backstopping bank loans and credit is becoming a lot tighter. And we have yet to feel the full effect of the interest rate rises (monetary policy operates with long and variable lags) and there are various vicious cycles that operate in a recession and prolong the pain until the economy recovers naturally. Perhaps a good analogy is when someone catches the flu. You can treat it by pumping him up on meds so that he recovers faster and doesn't really experience much in the way of symptoms. Or you can let him recover naturally which takes longer and results in more suffering and pain but is perhaps better for long term immunity and health.

How much of the disinflation and better-than-expected economic data can be attributed to falling energy prices? Early in 2022 the energy crisis was the talk of the town and was projected to plunge Europe into a deep recession and exacerbate the cost of living crisis. That doesn't seem to have materialised. But with zero COVID ending and US running out of strategic reserves to drain a soft landing could sow the seeds for its destruction by pushing energy prices to uncomfortably high levels.

Are yield curve signals valid when the Fed is manipulating Treasury note and bond prices to a large extent first by making massive purchases and now by starting to unload those purchases?

Charlie: in fairness Buffett always suggests the average investor should stick to index funds. As for Lynch the concept that a lay person can beat the pros by investing in what he knows shows a lot of hindsight bias especially as most of his examples are small cap growth companies. For every Chipotle or Domino's Pizza there are plenty of similar fast food concepts that crashed and burned. Even for professionals with great track records if they are running a concentrated portfolio it only takes a few big mistakes for things to go to hell. While if you are running a very diversified portfolio you end up doing factor investing (i.e. statistical value) which may give you a slight edge over very long periods of time but can also result in very long periods of underperformance that can make you question your faith just at the time that the factor is due for a prolonged period of outperformance. And of course as many individual investors have found during a bull market it can be easy to make money especially if you take a lot of risk and start to think that you are the next Buffett. Personally I am a fan of the core and explore approach. Within your equity allocation: 70-80% index invested to minimize future regrets/unforced errors etc. and ensure you benefit from the long term upwards trend of markets. 20-30% reserved for big pitches or kept in cash if there seem to be no obvious examples of undervaluation within your circle of competence.