mattee2264

The market is definitely being distorted by the Big Tech leaders which have rebounded a lot from last year's lows due to a) belief that we are close to a pause/pivot b) excitement about AI Old economy stocks do seem to be discounting a recession of some sorts. But still feels as though a lot of Big Tech is overvalued. The pandemic showed that as they've matured they have become utility like (i.e. essential to daily life/business and recession resistant) and also still have some growth options (e.g. cloud/AI). And increasingly investors look at Big Tech as a safe haven so it has become a risk off trade as well as a risk on trade. But multiples still look very high relative to the 4% or so you can get on bonds and growth has stalled and I think it has less to do with the economic slowdown and more to do with the fact they've saturated their markets and the pandemic has pulled forward a lot of future growth.

I think demand/supply are factors we often forget in investing. Retail participation is still a lot higher than normal as a lot of retail investors discovered stocks during the pandemic and are very confident buying the dips. TINA as well as a long long bull market probably has caused most retirement portfolios to drift towards much higher equity allocations relative to bonds. That was the express purpose of unconventional central banking policies. But if we do see a proper bear market (rather than the V shaped ones that have characterised this long cycle) that accompanied with higher bond yields might encourage people to take less equity risk. Obviously we all know equities do a lot better than bonds in the long run. But sequence of return risk and other factors do not make 100% equities or even 80% equities optimal for many investors especially retired investors trying to live off their savings and having to withdraw more than usual because of the elevated cost of living. But I think this will all play out in a sideways market over the next decade or so as enthusiasm for equities slowly wanes.

I think some of the market strength is because ROW is holding up a lot better than expected and so far is avoiding recession. And of course US employment is still very strong. And the Fed has expanded its balance sheet to deal with the fallout of the banking crisis which has created additional liquidity in the system. But again it is what lies in the future once interest rates hikes fully transmit to the real economy and we see the impact of tightening lending and so on.

There is a lot of talk about negative sentiment in the markets and most professional fund managers are privately or publicly expressing bearish views. But ultimately it is not what investors think but what they do that matters. And based on the current level of stock prices it seems most investors are holding on to their stocks and in many cases buying more. And we are seeing the familiar pattern of people seeming to think that during times of economic weakness that Big Tech is a good safe haven and I think that is why the banking crisis has been seen as bullish as it is seen as discouraging further rate hikes by Central Banks and bringing the inevitable pivot forward and that is bullish for growth stocks whose valuations are very sensitive to the discount rate used. And with most money managed by institutions there is a career risk to selling before everyone else. Much better to go off the cliff with everyone else than risk selling too early and losing AUM if the bull market gets extended a few more quarters. We are also in unfamiliar territory. We are heading for a policy-induced recession that is following a policy-induced boom. And they will be asymmetrical. Because you can very quickly inflate the economy by printing a lot of money and giving it to people to spend. But releasing the air takes a little longer as interest rate rises take time to feed through the system and until they start to cause real pain businesses have no reason to cut employment and high levels of employment can sustain spending and with most people on fixed rate mortgages and under no pressure to sell their houses we aren't seeing much in the way of pressure on consumer spending from higher mortgage costs or negative wealth effects. And while we are sitting on huge amounts of public debt politically it is very difficult to raise taxes or cut welfare even though it would have a much quicker effect in terms of inducing a recession and bringing inflation back down to trend. And a lot of the correction has been in real terms. In cumulative terms prices have gone up 20-30% since the pandemic. So in real terms the stock market is probably back to pre-pandemic levels. And while nominal interest rates are a lot higher since the pre-pandemic average real interest rates are similar at around -2%..

Will this figure not revert back towards the mean of 6%, be it through lower earnings or higher corporate taxes? (Higher corporate taxes would help to pay down the record levels of US national debt, around 120% of GDP) Not necessarily. Higher profit margins to some degree reflect changes in the structure of the economy and also the degree of competition/concentration in industries. Technology especially has a winner takes all set up so that the success stories can make incredible profit margins while their dominance lasts. Competition law has become completely toothless and lots of mergers and acquisitions have been allowed that shouldn't have been. And of course technology companies generally have good pricing power, are asset and labour light etc. But of course some of the operative factors are reversing such as on-shoring, potential for higher corporate taxes, higher interest rates resulting in higher finance costs, and if workers learn to flex their muscles to get inflationary pay increases they might be able to bargain for a bigger share of the pie going forward and so on. So I think profit margins could fall below 10% but remain well above 6%. What could it possibly mean for the US stock market overall? Revenues won't grow much more than nominal GDP say 5% a year. If profit margins are declining then corporate earnings will be growing much slower. Especially if it is a lot harder for companies to do the ZIRP trick of buying back vast quantities of stock financed by borrowing at near zero interest rates. So I would say the set up is for lower returns going forward until margins stabilize at a new normal. What additional thoughts do you have on the subject? Be very careful about opining on what is normal based on historical evidence. There is always a new normal. Also even if a situation looks unsustainable it can persist for uncomfortably long periods of time. And even when we do reach a new normal it will take a number of years until you can say with any certainty you have reached it. And then conditions will change again.

I think where Berkshire excel is that they make big bets where the downside risk is low and the upside potential is above average returns for many years. They are also very good at adding to positions over time as their conviction grows. It is true that people become multi-millionaires by concentrating most of their funds in a small business of which they are the owner-managers. But it is also true that a lot of people put blood, sweat, time and money into their business and either it fails or returns are pretty mediocre. I would also dispute that a passive investor can get the same kind of results by identifying such businesses poised to succeed especially as they lack the inside knowledge/industry expertise/management control etc. Also small cap growth is a treacherous field to invest in and it is easy to be deceived by fast growth rates that rarely last and they often tend to be overvalued and when they do hit a bump in the road and get cheap they don't have the same resources that big companies have to pull through and emerge stronger. And worth noting that a lot of Berkshire's success is identifying mature growth companies that still have a long growth runway and an enduring competitive advantage. But again that is a difficult judgement to make and the risk is you misjudge things and the next stage of the company life cycle is decline which will mean little further growth or even negative growth and declining PE ratios and incredibly disappointing returns that are amplified by concentration. I guess the point I am making is that it isn't as easy as it looks. The good thing is that even owning 15-20 stocks is a sufficient level of concentration to give you a real chance of beating the market by a good margin over time if you are a patient and disciplined and most of all competent investor. And some concentration will develop as a consequence of letting winners ride and cutting losses when something is clearly not working out. But this is very different from saying that you should start with 30-40% positions from the outset. Rather you start with say 5-10%. And you might over a period of years build up the cost basis to approaching 20%. But on a cost basis in most instances even if you make a really bad mistake (and even the best investors do) it won't destroy your results. Also something I think is a great compromise for most investors is a core and explore type approach. Your default strategy is to be invested in a global diversified index fund. Say 70-80%. And then with that diversification underpinning your profile you can make some moderately big bets on a handful of stocks where you feel the odds are stacked in your favour and you are well within your circle of competence. I also agree with the simple thesis idea. It shouldn't require a 100 page power point presentation and an excel model encompassing hundreds of tabs to make a good investment. I think for most of the no-brainers or relatively sure things that most individual investors should be looking to invest in a back-of-the envelope calculation supported by a good understanding of the qualitative factors gleaned from reading annual reports/financial news/trade journals/cloning etc and a relatively basic financial analysis of trends in KPIs and financial condition etc should suffice. And if that analysis does not result in relative confidence or is too difficult to put together then probably the idea is too complicated or dependent on too many moving parts or outside your circle of competence etc.

Makes sense. Hedge funds tend to crowd in and out of positions. Amazing to think people are willing to pay their fees when they have such a herd mentality.

What I struggle to understand sometimes is the influence of traders on the oil price. Obviously right now they are massively pessimistic as they think that with the banking sector travails we are heading for a deep recession and that is driving the price way down. Just as prices went to the moon when Russia invaded Ukraine. But demand is quite inelastic so won't fall massively during a recession and you'd imagine that OPEC would cut production if it did. Meanwhile China have reversed zero COVID and the SPR releases should halt. Also if it is a lot harder to get money from the banks and everyone is worried about a recession that is a disincentive to drill and therefore production is likely to fall which will offset to some extent any decrease in demand. But tell that to the segment of my portfolio in oil stocks!

Oil definitely pricing in a recession.

I think the current strategy of letting stuff break and let that contribute towards the tightening of financial conditions while patching up the cracks with the various methods learned during the GFC is the most palatable solution right now. Clearly interest rates do not really have much room to go higher and the sooner the economy goes into recession and brings inflation way down with it the better as that will allow a moderate pivot which buys more time for institutions to clean house and adapt to a higher interest rate environment. Real estate will be the next shoe to drop. The banks aren't headed for a financial crisis but they won't be able to lend in the same way they used to and will exercise a lot more caution. And if real estate takes a tumble that will help push the economy into recession and have far more far reaching negative wealth effects than a modest correction in stock markets. And I still maintain this is a multi year process. When you've had such a long long long bull market then you need a bear market for a few years to wring out some of the excesses and the optimism and get the market down to a healthy starting point for another multi-year expansion. People are very much geared to historical comparisons e.g. average major bear market lasts about 2 years this one started beginning of 22 so we are most of the way through. But I think it will continue well into 2024 because this is something very new: a policy-induced recession which has followed a policy-induced boom and monetary policy operates with long and variable lags and aside from bursting the tech bubble it had relatively minor effects in 2022. 2023 we are seeing a harder hitting impact with the bank troubles and the jobs market and the housing market will surely follow and start a negative downward spiral which will only start to reverse as inflation plummets allowing the Fed to pivot.

I think a healthy dose of humility is needed. If you look at the "best ideas" of professional investors even those with good track records eg as found in Outstanding Investor Digest/Value Investor Insight/Sum Zero/ Roundtables of the various magazines like Fortune/Barron's and hedge fund letters and then see how they worked out a few years down the line the results tend to be mediocre at best. Also even Buffett & Munger freely admit most of Berkshire's wealth comes from a few investments. And part of their genius and an essential factor in a concentration strategy is that when they get it wrong which is often they rarely lose much and then when they get it right they let their winners ride. Also goes without saying that often returns and risks are often correlated and in mostly efficient markets they usually are LOW RISK LOW RETURN. As a reductio ad absurdum example you could go 100% into Treasuries. Concentrating in bond like proxies and certain types of real estate gets a similar result but because of leverage (which done well can greatly magnify returns without resulting in too much risk in most normal environments) this can be quite a good way to make money in real estate. MEDIUM RISK MEDIUM RETURN. This is where most professional investors settle and end up with market type returns regardless of how concentrated they are but with greater volatility of returns if they do concentrate HIGH RISK HIGH RETURN. These kind of bets can make hedge fund reputations and also make amateur and professional investors think they are the next Buffett but often lead to overconfidence and blow ups. Note that there are deep value type investments where if things work out you get a ten bagger and if they don't you get a zero but with these special situations you need to keep position sizes small and pick your spots carefully. LOW RISK HIGH RETURN. This is the holy grail but much harder to identify than you'd think. And also to really judge a strategy and your success in implementing it you need to have experience of a proper bear market as well as a long bull market and a lot of amateur/professional investing careers only date back over the last decade when concentrating in quality growth (with Big Tech the obvious example) was the winning strategy. I cannot say with the same confidence that quality growth investing will do so well over the next decade and may well lag the market significantly especially if you concentrate in companies that confronted with the test of time turn out not to be as nifty as originally believed. And to some degree we've already seen that to some degree with the FANG stocks.

Re the fundamentals my understanding is currently there is some oversupply which along with recession fears is weighing heavily on prices but markets are expected to tighten later in the year. It does feel like a buying opportunity as I think that the marginal cost of oil production probably is not that much lower than the current price. Shale is nowhere near as prolific as it used to be. ESG is making it very hard to develop new reserves and companies are much more focused on capital discipline and cashflow. China hasn't had the same rebound that the West had because of the ridiculous zero COVID policy so that should offset any recession driven decrease in demand in the West and people forget that oil demand is more inelastic than demand for other commodities as planes still fly, people still drive cars etc. and also OPEC cooperation has been a bit better since the cartel broke down March 2020 and without US production growth it is easier for them to restrict global supply. And also I think it is dawning on people that the energy transition isn't going to happen overnight and we are going to need oil for at least the next 20-30 years. And of course if you don't have to replace reserves because of the energy transition that is very good for cashflows too.

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.