RuleNumberOne

Interesting. Reminds us how crazy professional investors can get. On July 25th, Draghi will have to show us how he plans to sustain the insane momentum in the bond market. At some point, it will become clear even to an orang-utan that buying $1 for $1.2 today, $1.22 tomorrow, $1.25 the day after, and so on (i.e. "negative-yield bond") is not sustainable. https://en.wikipedia.org/wiki/IKB_Deutsche_Industriebank "Only a week earlier the bank had released a statement saying it expected to meet its earnings goals for the year. "Rhinebridge", a structured vehicle operated by IKB, had invested heavily in the U.S. subprime market." In Germany: IKB (Industriekreditbank) and Hypo Real Estate AG were nationalized. https://en.m.wikipedia.org/wiki/Hypo_Real_Estate

The downside with residential RE is limited or non-existent. If there is a bear market, one can sell the RE at a small loss in the worst case and buy stocks at rock-bottom prices. If tech stocks go up X%, I think residential RE can capture a lot of that because there is no vacant buildable land in the central locations.

IMO, the size and number of the IPOs this year is so huge, it can lift RE in a big way after the lockups expire. The local politics are not nutty, just common sense. Only new entrants want more high-rise apartments built so that they can live 4 per apartment with over-flowing schools and roads. Instead of blaming long-term residents, I think these new entrants should instead look into buying bunk-beds so that 8 of them can fit per apartment.

@John I wouldn't invest in any European bank - either long or short. The ECB and regulators/Eurocrats can cover things up forever. In 2008 many American banks failed. But I haven't heard any European bank fail yet. Would people on this board invest in Silicon Valley real estate irrespective of the blowback from the eventual unwinding of the bond bubble? I think if the US stock market and tech IPOs keep going for another 2 years, there can be some great risk-adjusted returns in Silicon Valley real estate as employees buy homes with IPO proceeds. Any unwinding of the bond bubble would hit US stocks. But the hit may not be enough to cause a bear-market/recession. Residential real estate in the best neighborhoods in SiliconValley stayed flat during even the 2008 bust. What do people think?

If the browbeaten Fed has lost its spine and will continue to let the markets inflate, the way to participate in "tech" IPOs or tech in general with low downside may be real estate in Silicon Valley: https://www.bloomberg.com/graphics/2019-silicon-valley-real-estate-boom/ But what scares me is we have crazy momentum in the European bond market. Professional investors have to pay ever-higher prices for bonds in the hope of flipping it later to a greater-fool. I guess if professionals don't keep buying bonds at ever-negative yields they will lose their jobs by the end of the quarter. They are forced to keep driving without brakes. What do people think? Strangely, real estate has deflated here over the last year even as tech stocks (that don't have a P/E) are booming.

I founded a new corporation rated AAA by the ratings agencies. All it does is issue "corporate bonds" that carry an interest rate of -0.05%. This has a wide-moat and no competitors: when I pitched the idea to VCs, they threw me out saying the big profits meant I could never IPO in today's market. Everybody wants to build and invest in the next WeWork. Junk bonds in Europe carry a negative yield. So do Nestle's bonds with a negative yield of -0.15%. Why go to all the trouble of making products? Just issue more corporate debt and get paid to sit on the money. At my new AAA-rated corporation, everyone just drinks at the beach all day. This Charlie Munger quote explains the current bond market: "I have heard of one such example. Colin Camerer of Caltech, who works in “experimental economics” devised an interesting experiment in which he caused high I.Q. students, playing for real money, to pay price A+B for a “security” they knew would turn into A dollars at the end of the day. This foolish action occurred because the students were allowed to trade with each other in liquid market for the security. And some students then paid price A+B because they hoped to unload on other students at a higher price before the day was over."

If I were to run a bank in a negative-rate economy, I would not make any mortgages. I would just keep the deposits in a -10bp fee account, where the 10bp pays for expenses and profits. On 900billion, that is 900 million per year. All that the bank would do is accept direct deposits of paychecks, wire transfers, checks. It would also provide ATMs for a fee. The above setup is very profitable. No loan risk, just a nice fee like Visa/Mastercard. If you want, don't even call it a bank. Call it a cash management company. I presume the government in a negative-rate economy has to force banks and insurance companies, pension funds to buy bonds and make loans. Kind of like a dictatorship, otherwise the economy would look worse than the Great Depression. You're certainly up to something right here, RuleNumberOne, This post is only about Danish conditions. The answer to your question here is : They don't [buy these bonds with negative yields]. The outcome has been that the Danish banks are literally swimming in cash - some of them are almost drowning in it. The more conservative the bank is run, more worse it gets. I have read somewhere, that the Danish banks holds retail [household] deposits of ~DKK 900 B. What does a Danish bank do with all its cash, when it gets "punished" by Danmarks Nationalbank [The Danish FED] with an interest rate of minus 0.65 percent if it deposits its liquidity there, when it can't expand its loan underwriting/loan book because of very strict lending policies surveyed by the relentless and pretty brutal Danish FSA with inspections of the loan book, giving orders and fines and such when things aren't done OK? -Furthermore the actual demand for credit from Danish households has been languishing for many years - in general, the Danes have been paying down their debt, and accumulating funds for a rainy day. The banks only alternative is to buy bonds. So there are large bond positions on the balance sheets of Danish banks - to varying degrees. To at least get some yield from these bonds, the banks have to buy bonds with at least some duration. That again requires capital buffers to withstand [sudden?] rate spikes in the bond market, or else the bank may be forced to reduce its balance sheet [by selling bonds] at the exact wrong time [the price bottom]. - - - o 0 o - - - Some data: So far, I haven't been able to find some data from what I consider a reliable primary source for Danish retail [household] deposits in banks, that I'm sure of, and understand with precision. So here comes a rough, quick & dirty estimate of that figure: Source: Danske Bank A/S Factbook Q1 2019. Deposits [section 1.7.2 at page 11] : Retail : DKK 208.0 B Wealth Management : DKK 70.9 B Total : DKK 278.9 B Market share [section 4.1 at page 41] : Retail : 28.5 percent, Thus : Total retail [household] deposits in Danish banks ~ DKK 278.9 B / 28.5 percent ~ DKK 978 B - - - o 0 o - - - An extreme example of a Danish bank in this situation : Fynske Bank A/S [ticker : FYNBK.CPH] : [source : 2019Q1 10-K]. Equity : DKK 1,053 M Loan book : DKK 3,255 M Deposits : DKK 5,406 M Bonds : DKK 2,495 M. Some days I really can't decide if this bank is a bond portfolio with a bank glued to the bond portfolio, or "just" a bank with a big bond portfolio. - - - o 0 o - - - The above cash deposits estimate has to be judged relative to total mortgage loans in the Danish mortgage institutions of DKK 1,609 B in Danish homes and recreational homes, plus second layer house financing provided by the banks to households. What matters for the financial stability of the whole system is naturally how these assets and liabilities are distributed among the citizens of the nation.

Danske Bank also publishes English statements. They do have deposits, though they also have an equal amount of mortgage bonds. Either way, this is a forced transfer from bondholders or depositors to homebuyers. It is like a bondholder buying a house for $2million, selling it to the homebuyer for $1.7 million, and paying the bank $100,000 in commissions. The cost of this negative rate stuff in creating these distortions is greater than the benefits (I believe a housing bubble is the benefit?). ECB is out of ammo.

https://www.bloomberg.com/news/articles/2019-07-09/a-lehman-survivor-is-prepping-for-the-next-credit-downturn This money manager is one of those with "active mandates". "“There’s an art to knowing when to leave the party,” said the director of fixed income for Europe in an interview. “In fact it’s over -- people are desperate and they’re hunting down the after-party. We probably only have a few hours left.” Like even outspoken naysayers at the time, she didn’t anticipate the violence of the downturn. Still in May 2007, Gomez-Bravo became cautious on U.S. risk and issued warnings on corporate health -- which bear echoes with the intense hunt for yield today. “Everything was bid indiscriminately,” she recalls. “I knew things were heating up; there were telltale signs. It’s always difficult to leave money on the table, but as a result we avoided the blow-ups.”"

If Danish mortgage rates are at -0.43%, are deposit rates even more negative? If they are not, on a 30 year mortgage, the bank would lose -13% (since the negative rate is implemented by forgiving -0.43% of the loan every year.) I really liked that Bloomberg article headline about the stimulus - "won't say when or how." Not sure if the bears will continue to believe there are bullets in Draghi's gun. The bond bears can make a killing, duration has increased so much that a one percent interest rate increase results in $2.4 trillion in sovereign debt losses alone. Not to mention home price implosion.

The big difference between now and 1999 is the ECB has no ammo left. I wish the market calls Draghi's bluff. The ECB is destroying free markets, hurting the banking system, fueling housing bubbles. If the market senses Draghi is waving an empty gun, it will be an enormous bond bubble bursting. My own sense is that the ECB's latest stimulus threat is their last jawboning effort. The French central bank governor doesn't sound confident in my opinion: ECB Officials Ready to Add Stimulus But Won’t Say When or How https://www.bloomberg.com/news/articles/2019-07-08/ecb-officials-ready-to-add-stimulus-but-won-t-say-when-or-how

The reason for the contradiction is "mandates." The same Bloomberg article I linked above says: "JPMorgan Chase & Co. estimates U.S. mutual funds with active mandates have recently increased long-duration exposures after turning underweight last month." Bullard and Kashkari are undermining US investors with their calls for rate cuts, pushing mutual funds farther on the precipice. "US mutual funds with active mandates" are forced to play Russian Roulette. Buffett of course can buy whatever he pleases, but these "mutual funds" have "active mandates", they are forced to increase long-duration. Bullard refused Fed Governorship, doesn't mean he will refuse Chairmanship.

In my opinion, they can't push rates down anymore. For example, only a central bank can buy a -5% yielding bond (real investors don't want an offer where their net worth will be wiped out 5% per year.) Denmark's negative rate mortgages don't make sense at more negative rates either - the bank forgives -0.4% of the loan every year. Would it make sense for the bank to forgive 4% of a mortgage every year? The bank would go broke. But if rates were to go back up just a bit, the bond losses would cause a recession. The ECB is currently fueling housing bubbles in most of Europe. How are they going to retreat from zero rates? Meanwhile, WFC and BAC have an earnings yield of 11% and are returning 14% to investors this year. What a contrast, investors can't get enough of negative rate debt, but they run away from WFC and BAC. Whoever identifies the snapping point can make a ton of money. The setup is similar to 2008. Can individual investors buy CDS?

I think the central bankers see the IPO bubble as a smaller worry compared to the gigantic bond bubble in Europe. I was looking for some data on possible losses, and found this Bloomberg article (thanks to heisenbergreport) https://www.bloomberg.com/news/articles/2019-06-26/trillion-dollar-monster-lurks-as-bonds-price-out-duration-risk "Investors riding easy-money policies are breeding a trillion-dollar monster in the bond market, the likes of which has never been seen in decades of history... Bloomberg Barclays sovereign-debt index is near a record high of 8.32 years, meaning just a one-percentage-point increase in yields would equate to more than a $2.4 trillion loss. “At one point the market may start challenging central banks about the effectiveness of their monetary policy,” said the chief investment officer. “They may start pricing in credit risk, and that’s going to push yields higher.”

jschembs, We can include all the constituents if we use their earnings yield or FCF yield. E.g. if X has an earnings yield of -10% it means we would lose all our money in 10 years. E.g. if Y has an earnings yield of +10% it means we would get back our money in 10 years. If we invest equal amounts in both, it means we stay flat. I wonder how the average earnings yield of the Russell 1000 compares with 1999. Back then, we had wide-moat, wide-GAAP-profit-margin companies like MSFT and CSCO and QCOM. These companies had wide profit margins right from their IPO. MSFT/CSCO/QCOM sales (EV/S) were very high-quality from an investing point of view when compared with the current crop of low-moat, never-profitable, low-barrier-to-entry IPOs. I'd love to see the underlying data. Even when you exclude industries like REITs, financials, and O&G E&P companies, whose cash flow statements are not comparable to other operating companies, you still have data integrity problems. I pulled the Russell 1000 data from CapIQ. Excluding the above industries, the average / median P/FCF is 30x / 21x (25x / 22x if excluding SBC). The valuations go down when excluding SBC because of the numerous FCF negative companies, where deducting SBC makes their valuations less negative. If you exclude negative FCF companies, average / median P/FCF is 48x / 22x (46x / 24x excluding SBC - 46x is lower than 48x because a number of companies have positive FCF, but negative if deducting SBC). Remember, these valuations EXCLUDE the highly valued growth stocks like TWLO (24x revenue, negative FCF) and NFLX (9.5x revenue, negative FCF). Those are the ones most susceptible to the 50+% declines. It's always hard to compare valuations over time, particularly when accounting rules change (no longer amortizing goodwill, now expensing SBC). Here's the data. I also excluded a few names that recently reported earnings where CapIQ hadn't updated their LTM financials, but the impact is insignificant. More food for thought - given the prevalence of negative earnings / FCF constituents, EV/sales perhaps more enlightening? At least you can include more of the constituents in the data set.

Fear you say? Maybe they meant the "fear of missing out." This is what WSJ found: https://www.wsj.com/articles/wework-to-raise-billions-selling-debt-ahead-of-ipo-11562524614?mod=hp_lead_pos4 "The money-losing office-space manager is seeking to raise as much as $3 billion to $4 billion in coming months through a debt facility that could grow as big as $10 billion over the next several years, the people said. This debt offering—independent of the money WeWork will raise in its initial public offering—is designed to fund WeWork’s growth until its business is profitable, the people said. WeWork, which confidentially filed for an IPO late last year, has aspirations to be more than a real-estate company. Mr. Neumann and his deputies have said investors should treat WeWork more like a tech company, pointing to its rapid growth and various services it eventually hopes to offer that cater to its tenants." I’ve never bothered researching this, but the USA Today story above refers to the “Bank of America’s fund manager survey” and “American Association of Individual Investors’ weekly survey.” Those might be worth looking into.

@JimBowerman I propose an even simpler exercise for some aspiring economist/intern. 1. Call up 2 real estate agents in the Bay Area, we can get their numbers from mlslistings.com. Ask them: - How much was the construction cost per sqft in 2011? How much is it today? Gone up 2x? 2. Call up 2 apartment complexes in the Bay Area. Ask them: - How much was your rent in 2011? How much is it today? Gone up 2x? 3. Then ask Jim Bullard why the CPI for the San Francisco - San Jose metro area for the last 8 years is so low when rents and home prices went up so much? Housing is > 40% of the US CPI basket. If housing is 42% of the CPI basket, and rents went up even 7% per year, housing alone would contribute 2.94% to CPI. What tricks did the BLS use to whack it down to 1.5%? W.r.t your point about S&P revenues, I think S&P domestic revenue fluctuations (both upwards and downwards) have a larger inflation component than government figures (think about it from the viewpoint of bubbles and busts, a chart of S&P sales over time shows this.) W.r.t your point about rgdp, the gdp figures get revised for many years afterwards because the government has no idea. The gdp figures at any given time are nothing but a guess. The inflation component in nominal gdp is likely larger than what is currently claimed. BTW, off-topic, but I don't pay any attention to what Sumner/Schiff/shadowstats say. I look at first-hand data myself and come up with first-principle explanations.

There is plenty of inflation right now. This can be proven with a simple exercise. Take the historical CPI reports of the last 10 years for the San Francisco-San Jose-Oakland metro area. In June 2017 this was 1.7%. Assuming an average of 2% for the last 10 years, it compounds to a total of 22% (I don't have the time to dig through all the 10 years of reports, but we don't need to.) The cost of living in Silicon Valley has more than doubled in the last 10 years. Constructions wages, restaurant wages, tech wages, every kind of private sector wage has doubled or more. Construction costs used to be $150 per square foot earlier this decade, now it is at $350/sqft. Apartment rents have doubled. Home prices have more than doubled. But the inflation reported by the government for this metro area would be a cumulative 25% over the last 10 years. Another example: If Dutch or German home prices are increasing 10%/year, and housing is 40% of the CPI basket like in the US, home prices alone would contribute 4% to the final inflation figure. Even if the rest of the CPI basket stays flat, we should be seeing 4% inflation. But these crooks use "imputed rents", and "imputed" everything wherever they can. They keep imputing 1-2% in rent inflation. Then they set monetary policy based on these imaginary "imputed rents." They never measure the inflation in home prices or stock prices or bond prices when justifying their monetary policy. Instead they point to stuff of their imagination - such as "imputed costs", "imputed rents", "hedonic adjustments", "substitution effects" and such other nonsense used in inflation calculations. I bring this up to help us identify inflection points. When we have misallocation of capital, and things get completely out of wack, the bubble has to pop. Identifying the dislocation before it happens can save or make a lot of money. I don't see how the home price boom can continue in Europe for long while the governments wring their hands about "inflation less than 2%" and keep rates negative. Reality becomes unmoored from the fake inflation figures. Not sure about Amsterdam, but would guess the same applies.... But in New York, SF etc, construction costs (after removing costs from extra studies, etc) are relatively minor compared to final sale price Its possible to build 40 story apartment buildings for $300/square foot. However apartments in NYC/SF commonly sell for over $1200/square foot. Its the constricted supply/air rights/etc that make up much of the cost, and thats only getting worse in SF/NYC (and i presume Amsterdam) That said, price rises in a certain industry don't imply inflation for an economy as a whole and really don't have anything to do with monetary policy (which is the only way to create long term inflation) EU and US are very unlikely to see economy wide inflation in the near or medium term, despite rises in prices in certain sectors like housing/health care/, rising oil prices/wage pressure, etc. The oil price rises in the 1970s, and other "cost push" inflations aren't really what causes inflation. It can put pressure on the monetary authorities to print more money so unemployment doesn't rise, but its ultimately the "printing more money" which causes inflation, not the oil price rise, or the rise in housing prices, etc. The monetary authorities are too scared of inflation to let it get out of control. Will likely have to wait for the next generation of central bankers who didn't grow up in the 1970s inflation edit: To borrow from Einhorn's analogy...imagine rising oil prices, housing costs, etc as jelly donuts. Imagine the central banks inflation target as your body weight target. Now housing costs, rising oil prices etc will certainly put pressure on inflation just as eating only jelly donuts will also put adverse pressure on reaching your weight goal. However it is not the jelly donuts themselves that made you miss your goal weight (Some guy a few years ago actually lost weight eating only twinkies). Now eating only twinkies/jelly donuts isn't healthy and having rapidly spiking house prices isn't healthy for an economy either (all else being equal). But it's credibility of "the goal weight" which is paramount. It's the credibility of the inflation target which is paramount. The other stuff (i.e. jelly donuts, oil prices, house prices, etc) is just details.

https://www.bloomberg.com/news/articles/2019-07-05/amsterdam-housing-market-gets-some-help-from-dutch-government?srnd=premium "Construction costs in Amsterdam have risen 25% over the last two years. median home price in the Dutch capital soared 80% in the past four years to €448,000 ($505,000)."

Frankfurt home prices grew 15%/year in both 2018 and 2017. So that would be a 32% rise in 2 years. https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000460528/The_German_housing_market_in_2018.PDF https://www.dbresearch.com/PROD/RPS_EN-PROD/PROD0000000000488315/German_property_and_metropolis_market_outlook_2019.pdf I thought Germany was scared of inflation, but maybe they enjoy housing booms just like anyone else. The author of those DB reports (Mobert) predicted rates rising in 2019 to 0.4% from -0.1%, but instead they have fallen so far in 2019 to -0.4%. The rising rents in Germany were at least partly caused by immigration. All of a sudden, Germany has 1 Million more people they need housing adding in a short period of time. With full employment and starting with a shortage in larger cities to begin with, and little new construction, it’s easy to see why demand outruns supply. The stop gap measure of rent control certainly will not solve the problem, but make it worse. Adding to the supply is what is needed.

mcliu, This is a European bubble being exported to the US by European investors buying US bonds. USD/EUR = 0.89. US government debt is a far far far greater value than any European government debt. Regarding asset inflation: that is why inflation calculators use "imputed rents", because they can "impute" whatever they please. Housing bubbles don't show up in the CPI. But the ever-honest Bundesbank revealed that rent inflation in Berlin has been running at 7-10% and some politicians responded with a 5-year rent freeze in Berlin. That is why no Bundesbanker will ever be the head of the ECB. Instead the job of ECB chief is reserved for former or aspiring politicians. Probably, rent freezes will be put in place in other German cities? Frankfurt rents have also gone up a lot.

The 5-year return in my wife's IRA accounts is 38% (I invest the money.) My own IRAs have moved between WellsFargo, BofA-ML, Schwab to get a mortgage rate reduction, and on top of that I have Fidelity, Vanguard accounts that have been moved and merged etc. But my returns should not be too different (same portfolio contents and decisions.) Actually, upon checking my returns more closely, they are lower because of some losses - took more risks with my money. The returns should comfortably be above 25-30% though.

I'm not so certain. Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings. I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S. What's the end game to free money? I think the end game is some hedge fund hotshots like Michael Burry or Paulson getting rich via CDS or other derivatives. If we really have a "global recession" like the news media claims, will the Greece 10-year yield remain at 2%? Maybe the Euro falls hard or the CDS goes up? How do I find such a hedge fund to invest in?

The problem is not the interest rates or yield curve. Banks can lend at zero rates in Europe because they assume the ECB will cover defaults. Banks in the US know the Fed is not going to cover defaults. So they have to charge a high enough NIM to generate income to account for defaults. WaMu, Wachovia, Lehma, Bear, and many other bank shareholders/bondholders lost money in 2008. There is market discipline here. US banks have to generate enough income to be able to handle defaults, there is a free market in the US. In Europe, Draghi is a hero. "Whatever it takes" for the "European Project." Rent freezes in Germany to curtail 10% housing inflation? "Whatever it takes" means it is OK for the ECB to buy up all defaulting homes in a recession. Why would a borrower who can make payments pay in such a scenario? Everyone would default. (A 1% NIM is fine if default rates are 0, or if the recovery rate is 100% - e.g. high downpayments. OTOH if default rate is 10%, a 5% NIM is not going to save you. US banks set 20% downpayment with high NIM, European banks have interest-only loans and don't care.)

I think the reason is the Central Providers at the European Collectivism Bank (ECB) will buy homes at 120% of market value in a recession. Banks lend to homeowners at negative interest rates without bothering about credit risk. In normal banking, they would have to charge a sufficiently high interest rate to compensate for default rates. But the European Collectivism Bank provides everything - lavish pensions to whoever needs it by buying Greece 10-year at 2.1%, Italian 2-year at 0%. At the current time, the Central Providers have bought corporate bonds, but it would be a stretch for the Central Providers to enrich stock market "speculators". If you interview for a job at a European bank, make sure you say you don't know the meaning of the term "credit risk" I'm not so certain. Sure most people don't use debt to buy equities, but the equities themselves have every opportunity to to lever up, refinance at lower rates, acquire competitors, fund capital projects, etc to grow revenues and earnings. I agree the effects might become more apparent more quickly in mortgages, but to have the evidence in one area of the market and not another that should be similarly impacted calls into question the assumptions that it's interest rates driving that. Particularly where the only place globally upholding the "low interest rates = high equity multiples" mantra seems to be the U.S.