TwoCitiesCapital

Copy/pasting the below from the Fairfax thread as it's relevant here too A cascading banking crisis will kill both inflation and employment AND tighten financial conditions. The measures put in place to allow banks to borrow liquidity instead of selling treasuries simply moves the pain to their income statement (due to the negative NIM) as opposed to the balance sheet. As consumers move cash deposits to productive allocations like money market, short term treasuries OR liability reduction/negative savings, banks lose deposits, accept negative NIM for the liquidity, and earnings get killed...but they remain solvent until such a time as rates more lower. Credit was already constrained and tightening - it's about to do even more of that and banks will have cratering earnings in response. The Fed has maybe one 0.25% hike in March left in it. That'll demonstrate their commitment to fighting inflation. Then, they'll hold short end rates higher for longer to further demonstrate that commitment. But rate hikes are basically done and inflation 12 months of out is already 0 to negative IMO. I'm going to go out on a limb and say the top is in for both the 2-year and the 10-year Treasury rate.

A cascading banking crisis will kill both AND tighten financial conditions. The measures put in place to allow banks to borrow liquidity instead of selling treasuries simply moves the pain to their income statement (due to the negative NIM) as opposed to the balance sheet. As consumers move cash deposits to productive allocations like money market, short term treasuries OR liability reduction/negative savings, banks lose deposits, accept negative NIM for the liquidity, and earnings get killed. Credit was already constrained and tightening - it's about to do even more of that and banks will have cratering earnings in response (but not solvency issues ). The Fed has maybe one 0.25% hike in March left in it. That'll demonstrate their commitment to fighting inflation. Then, they'll hold short end rates higher for longer to further demonstrate that commitment. But rate hikes are basically done and inflation 12 months of out is already 0 to negative IMO. It IS too early to say they missed it, but I doubt they did much in Q1 since they didn't in Q4 and I'm gonna go out on a limb and say the highs are in for long term rates. Probably the 2-year as well.

+1 Even staying on the short end, they have underperformed inflation - so that's a terrible strategy for a secular inflationist. And by not extending duration, they lose any chance of outperforming inflation on the way down via capital gains/duration. Owning short duration worked for the last 18 months. With rates at 15+ year highs while economic data deteriorated? Yea, it was obvious it was time to start locking it in. 4 years wouldn't have been imprudent and would still have largely been very short relative to liabilities and fixed income benchmarks. We'll see if they extended in Q3, but I'm not optimistic.

Typically morningstar or a fund fact sheet. At this point, I dunno if the extra yield from spreads will counteract the credit spread widening that I expect, but the equity-like returns without the equity risk was too attractive to turn away - especially if I'm wrong about a recession and we keep grinding slowly towards one. Will probably only be adding to the Treasury fund going forward though - cascading bank failures strikes me more as the start of an economic event as opposed to the end of one.

I've been buying short-term bonds funds because I wanted the mortgage exposure too. I just purchased a pretty large slug of JSCP at a 6.4% YTM last week. Have been DCA'int into JSDUX for months in my 401k which has a ~6.25% YTM. Not quite the same as a Treasury since both own credit and mortgages too, but each is about ~2-3 year avg maturity/duration. Each with a 6+% YTM. Have also been DCA'ing RGVGX in my retirement accounts, but that's more intermediate straight duration exposure.

2-year is now off by nearly 1.25% in less than a week. 10-year is still at 3.5% but curve is massively bull flattening. Unless if Fairfax acted fast in Q1, I'm gonna guess we missed the duration extension again Best hope now is they make it up on the back end with some savvy purchases in credit turmoil like they did in 2020, but still not as good as going into this thing with duration and still making those same plays.

I deleted my prior comment because the number of days supply calc was off base and I didn't have time to correct. But I agree that oil prices being flat in the face of China having rolling closures most of that time and the release of SPR down to historic levels says a lot. Oil prices have the potential to go much higher when those factors aren't present - or may stay elevated through an economic contraction. I'm bullish on intermediate/long term oil too. That's some of my equity exposure I kept. I am just pointing out that you can't say "there's no inflation - oil isn't up" while ignoring massive temporary increases in marginal supply and the world's largest consumer of oil being economically constrained at the same time keeping prices flat. Flat oil prices during that is a small miracle.

Yup and 1) has never occurred without a recession and 3) is also very, very likely to cause a recession. Other indicators also confirm recessionary like conditions already exist today. Lastly, unemployment typical doesn't rise until you're already in the recession. The Fed is publicly acknowledging they'll be late to the ball, intentionally, when it comes time to cut.

Treasury bills? You know, the old stand by risk-free asset. As far as why people wouldn't hide out in crypto, they didn't in 2018, or 2020, or 2022. Eventually we'll get there, but BTC is a risk-asset for now AND has had excessively high correlation with equities since 2020 so I don't think it's obvious that it would be the safe-haven people flee to when bank failures are happening... particularly when everyone is relating those bank failures to crypto institutions like Silvergate and Signature.

Curious to me that while "crypto" banks are failing, and stablecoins depegging left and right, that Bitcoin (and many tokens) are absolutely on fire. Is this where BTC breaks its correlation of the last two years with traditional markets?

Not when that 5.7% is shrinking. And not when you can get mortgages and high yield bonds paying 6-8% YTMs.

The 10-year treasury is less about hedging insurance liabilities (in which case you'd probably want to opt for corporates and mortgages for the spread). It's about locking in the benefits of the previous underweight in duration by locking in exposure now so if rates fall we don't backtrack on all of interest income growth we've seen. Additionally, it provides consistency and transparency to forward interest income so the market can put a multiple on future earnings and rerate the stock (good for TRS swaps too;). Lastly, it can hedge a prolonged equity drawdown/economic event. Leading indicators are at levels that have previous been consistent with -4 to -6% GDP growth. What happens to equities on that environment? What happens to interest rates? 10-year bonds immediately add duration to an excessively short duration portfolio and help hedge that event while locking in rates near their highest levels in 15+ years. I would love to see duration of at least 4 before rates start cratering.

For the last several months they have been consistent. And if you've listened, Powell has all but said he's intentionally driving us into a recession to fight inflation and inflation expectations. I think 3,000 on the SPY is base case. 2,500 is likely on the table as earnings and margins fall if inflation/rates prove to be even stickier than now expected.

It's true that it's hard to predict the exact path of all these things. What's easier is to use those predictions to chart out where you want to be positioned. I was wrong on how long inflation would stick around and the ultimate end point on rates. But my caution on equity multiples, rate hikes despite the weakening economy, and recognizing the potential to be wrong on inflation where equities and bonds could get wrecked guided my positioning. I sold a large portion of my non resource/non EM/non-Fairfax exposure. I used proceeds to buy gold, short duration fixed income, and iBonds to avoid price risk. Later, I started adding intermediate allocations and mortgages. All of those have turned out to be basically the right positioning barring outright shorts over that time period. And I'll continue to do well if equity/economic weakness continues. I'm sitting on a ton fixed income yielding 3-7% while equities/economy look worse with each passing day suggesting it might work again in 2023. For someone who has consistently made the case that "small" moves of 0.5%-0.75% in rates don't matter, it's a little shocking to me that you think all of this is the result of us being at 5% instead of 4%.

2-year treasuries are off recent highs (yields) by over 0.80%. that's a pretty big move - especially when more rate hikes were expected. Historical Fed action has basically just followed the market rate for the 2-year. Is this the end of the hiking cycle? Without knowing what Fairfax did in Q1, we won't know if they added duration. But seeing as they didn't buy 10-years at 4.25%, I doubt they're buying them today at 3.5%. It's possible they locked in more 2-years near 5% which would be nice, but I'm afraid even that will roll off quickly in a rate cutting scenario.

Weird how a regional banking crisis would occur AFTER the bottom for equity markets, right? We all know the Fed basically just follows the 2-year rate and that it's the reversion of the curve from rate cuts AFTER an inversion that typically signals equity weakness. With the 2-year ~0.80% off its highs from just days ago, will this be the end of the rate hiking cycle and the admission that the economy is weakening at a dramatic pace? Duration starting to look reallllll attractive.

I think that is far too simplistic. If that was the case, you'd have expected these things to fail after the FTX fall out, or the Terra Luna failure, or the bankruptcies of Voyager and Celsius, or when crypto was making new lows. Not several months removed from negative catalysts when most crypto is up significantly off its lows. These were bank runs driven by panic over access to deposits - not fear of their involvement in crypto. That business was profitable for all 3 banks even after the 70-90% declines in Bitcoin/tokens and the multiple bankruptcies rocking the space.

I'm confused. Other than their involvement in the crypto space, what does crypto have to do with any of this? It's not like these banks went under because of bad loans. These banks went under due to liquidity mismatches and depleting capital from forced treasury sales. It's not like they were investing in Bitcoin - they were investing in treasuries. Blame the Fed, regulatory requirements, accounting standards, and fear for these failures. Not crypto.

Probably at 1.01 as people panic and sell USDC for alternatives

Lol. Never mind. We'll just see how the liquidation plays out and if there's anything left for equity.

Saw something today that suggests something like 80% of the free-float is currently held short. Anybody familiar with cases of distressed equity investing know if that's high for 'going concerns' or not? Just seems like another potential meme stock/stock squeeze experiment waiting to happen regardless of liquidation or continuing on as a going concern.

Jeff Gundlach has a podcast today. For the last several years, he's been pointing to the copper/gold ratio being a pretty good indicator or where the 10-year yield should be. The general argument is that inflation/economic growth impact copper significantly more than gold. When copper is rising faster than gold, you need higher rates for inflation/growth and when its falling faster than gold you need lower rates. Historically it's been pretty accurate. As of today, it suggests 10-year yields are about 1% too high.

If the equity is worth anything, the preferred are worth $25. Exposure is still pretty minimal, but just trying to be somewhat responsible about adding given that it does seem like they're losing institutional customers at a very fast clip.

Speaking of exposure to minerals/metals/mining - they also have $100 million in Altius from converts that were exercised after moving into the money.

Hard to know exactly what the reset rate will be, but it's looking like it'll be in the ballpark of 2.25 - 2.75%. Quite a bit less attractive than the 6.9 - 9.2% returns of the last 15 months. I think I'll be liquidating a good portion of these as they roll into those lower rates and I'm only taking a 3 month penalty on a sub-3% rate. Not a bad time to be rolling them into 2-year treasuries @ 4.9% with similarly limited duration risk.