1999 again?

[SharperDingaan]

The political hope is that the Dow either continues rising through November, or at least doesn't fall too much. 

Enron demonstrated that even if you didn't believe, the smart thing was to keep buying and pushing the price higher - while also taking $ off the table, and covering a portion of the rest with puts. The run-up to the 1929 crash similarly demonstrated that the smart thing was to sell the broader index, take $ off the table, and pile into the nifty-fifty.  Margin where you could, and take the $ out - in expectation of wide-spread brokerage and bank failures, ultimately removing your debt. Smart.

 

The Robin Hood phenomena largely mirrors the margin lending of 1929, everybody in the market, and talking up the crowd for fame and glory. Back then it was being the swell at a better speakeasy, today it is posting for likes on social media. Same overall effect, different mechanics. Can't take $ of the table, unless there's a patsy to sell to.

 

Every ponzi scheme eventually collapses under its own weight.

The market drops, the patsies can't meet their margin calls, and history repeats. Only this time the rich get richer, 'cause put options are a lot more efficient and effective than shorting. Once the run starts, it doesn't suddenly stop .... it keeps going.

 

When it happens, people need someone to hate - before they can move on.

The upcoming election result is a natural break.

 

SD

 

 

 

[UK]

https://www.bloomberg.com/news/articles/2020-08-03/chinese-tech-stocks-soar-as-u-s-measures-spur-support-hopes

 

 

[Cigarbutt]

Follow-up to investor flows to or from public equities with some added perspective from:

https://www.morganstanley.com/im/publication/insights/articles/articles_publictoprivateequityintheusalongtermlook_us.pdf?1596549853128

 

TL:DR version:

Investor flows out of equity mutual and ETF funds is for real even if it tends to constitute only a very small amount compared to overall market value changes but it has been more than compensated by funds going to private equity. There are differences with 1999 but there are parallels. If higher valuation ratios, higher leverage ratios, lower interest rates, adjusted EBITDA parameters and institutional drive persist, investors' expected returns (p.53) will be realized.

[wabuffo]

I think the parallel for today's market is the late 60s go-go markets (and the rise of the Nifty Fifty vs today's FAANG) which were then crushed in the early 1970s by a dollar crisis (and currency debasement) both in nominal and real terms.

 

This market could be setting up for a crushing whipsaw (though the timing could still be a ways off).  Low rates are encouraging high multiples and very large terminal values in DCFs.  The Fed has already said that they will run through all inflation stop signs because they want higher inflation.  When the day comes that Mr. Market realizes that he/she has been driven into a dead end by false long-term discount rates, the reversal will be nasty.  This outcome is not a certainty, but as gold keeps rising, the probabilities associated with this outcome are also rising.  "Gold bugs" and their warnings are so discredited for crying wolf, that the warnings aren't being heeded now.

 

If you believe gold is a measure of the real value of the dollar, then S&P Total return year-to-date is down 31% (vs gold) in real terms instead of being up 4% nominal.

 

wabuffo

[Spekulatius]

It should also be considered that the USD has devalued ~10% against most major currencies (EUR,GBP, JPY) and almost 20% against Gold since about May 2020 ( unfortunately I just have a small tracking position in IAU).

 

Some of this is reversal of prior appreciation, but still.

[Cigarbutt]

I think the parallel for today's market is the late 60s go-go markets (and the rise of the Nifty Fifty vs today's FAANG) which were then crushed in the early 1970s by a dollar crisis (and currency debasement) both in nominal and real terms.

 

i like your it-often-rhymes approach but history rarely repeats. Great people like the Wrays and Roches of this world can explain things directly and what's left for ordinary people like me is to use analogies, often temporal ones. Holding the barbarous relic has paid off lately but most assets have become so much more correlated it's hard to tell the fundamental direction. Compared to the 70s, i wonder to what people will run to?

 

The Fed has already said that they will run through all inflation stop signs because they want higher inflation.

 

You keep harping on the Fed but it's getting confusing as i had understood that it was the Fed-Treasury Industrial Complex. 8)

 

 

[benchmark]

"Gold bugs" and their warnings are so discredited for crying wolf, that the warnings aren't being heeded now.

 

If you believe gold is a measure of the real value of the dollar, then S&P Total return year-to-date is down 31% (vs gold) in real terms instead of being up 4% nominal.

 

wabuffo

Interesting, what's the best way to track/play 'gold'?

[valueinvestor]

BigCommerce IPO shot up 292% in a day. Not sure if this has to do with exuberance or the bankers underpricing their share by a HUGE margin.

[UK]

https://www.bloomberg.com/news/articles/2020-08-06/goldman-says-time-to-think-about-a-shift-in-market-leadership?srnd=premium-europe

[wabuffo]

You keep harping on the Fed but it's getting confusing as i had understood that it was the Fed-Treasury Industrial Complex

 

I meant in the context of not raising interest rates - the only job the Fed can do.  They may also execute a more aggressive attempt at Treasury yield curve control by swapping more reserves for US Treasury debt.  To the extent that the yield curve provides the input for the risk-free rate to apply to the terminal values of go-go stocks...

 

wabuffo

[TwoCitiesCapital]

So let me ask this - since everyone seems to be on the "low rates = high multiples" train of which I'm still yet unconvinced:

 

If inflation goes to 5% per annum, but the Fed represses all interest rates to continue being below that nominal figure, do equities rally because interest rates are low? Or collapse because a 3-4% nominal earnings yield is still a negative real return to equity investors?

[rb]

Ok. I'll answer. If inflation goes to 5 with rates low the market will crater. But really with all the stuff that's going on who the hell knows what the market will do.

 

Anyway that's just so bs answer above, to a bs question. I say that with no disrespect or sneer towards twocities because it is legitimate way to think. But the Fed will never let inflation go to 5. The Fed is actually is a very conservative institution, often referred to as the borg, It is where creative ideas go to die.

 

Powell in particular wasn't a revolutionary, that's why he got the job. Yellen and Bernake were way more revolutionary economists. I think a lot of what is missed is that Powell isn't doing these things because of the Dow, he's doing them because he looks at the world and he's scared shitless. The idea that Fed actions are meant to support stock market levels is a bit ridiculous. But people are happy to bid up multiples based on that. We'll see how it works out.

[Guest]

If inflation is at 5% and interest rates are at 0%, stocks still seem like a better bet to me than bonds or cash. Though something like gold might do even better.

[Guest cherzeca]

if inflation spikes and short term rates are kept low, real assets will do very well.  financial assets as well, though I think you will see at last some transition from financial to real assets

[TwoCitiesCapital]

Ok, now that we've had a few responses, what about the another scenario.

 

Instead of 5% per annum, inflation is now 15% per annum. Interest remain @ the lower bound. Do equities continue to do well due to low interest rates? Or do they crater due to negative real rates?

 

Does your answer differ from the 5% scenario? If so, why? What makes a -2% real return dramatically different from a  -12% real return when it comes to comparing and changing your preference for investable alternatives all impacted the same way?

 

 

[Gregmal]

Would 15% inflation not more or less guarantee a massive socialist policy change? Deflation/crashes they print money. Runaway inflation they'd have no choice but to take control of resources and "fairly" distribute/regulate them. Regardless of "the stock market" I see that scenario as what could ultimately cause America to implode.

[Xerxes]

I ll throw my 2 cents:

 

I think while inflation was expected post QE in 08-09 nothing came of it (in the expected form) due to the fact that the world operated on an open trade system. Said differently globalization had a deflationary impact that capped the traditional CPI like metrics ... but you still had too much money, so

 

as we all know that went to lift asset prices. So while inflation in its traditional since didn’t happen it happed on a different dimension.

 

What is different this time ?

We are past peak globalization. We are retrenching back to our borders and the pendulum is swinging back. It has been years in the making and has been accelerated by Trump, COVID and populism. Perhaps this time around we ll get our inflation in a more traditional sense.

[Spekulatius]

Ok, now that we've had a few responses, what about the another scenario.

 

Instead of 5% per annum, inflation is now 15% per annum. Interest remain @ the lower bound. Do equities continue to do well due to low interest rates? Or do they crater due to negative real rates?

 

 

Imagine running a pension fund in this scenario. Liabilities increasing by 15% annually and bonds get zip interest. There is no alternative but to yolo.

[Guest]

Ok, now that we've had a few responses, what about the another scenario.

 

Instead of 5% per annum, inflation is now 15% per annum. Interest remain @ the lower bound. Do equities continue to do well due to low interest rates? Or do they crater due to negative real rates?

 

Does your answer differ from the 5% scenario? If so, why? What makes a -2% real return dramatically different from a  -12% real return when it comes to comparing and changing your preference for investable alternatives all impacted the same way?

 

I think the scenario of zero interest rates and 15% inflation is highly, highly unlikely. I'll still say that gold > stocks > bonds/cash. But the gold difference would be a lot bigger.

[vinod1]

So let me ask this - since everyone seems to be on the "low rates = high multiples" train of which I'm still yet unconvinced:

 

If inflation goes to 5% per annum, but the Fed represses all interest rates to continue being below that nominal figure, do equities rally because interest rates are low? Or collapse because a 3-4% nominal earnings yield is still a negative real return to equity investors?

 

Low interest rates are contingent on low inflation.

 

IF one believes inflation is going to be a low and further interest rates are also going to be low, say for the next 50 years. Who knows, but if you assume both of these, why should stock market as a whole not trade at very high multiples?

 

Really the key is low inflation and low interest rates for a long time. But if this turns out to be true, then why shouldn't stocks be worth a lot more?

 

To put some hypothetical numbers:

 

Inflation of 1%

Interest rates of close to 0%

10 Year Treasury yield of 0.5%

GDP growth of 1%

 

If we know for sure this is how the next 100 years are going to look like, what multiple would make sense for the S&P 500?

 

I would think a PE of 40 times normalized earnings is going to be pretty reasonable. A 2.5% earnings yield with say 20% retention that is a 2% payout, add in a 1% GDP growth and 1% inflation, that is a 4% nominal return or 3% real return.

 

The overall bond market is going to return something like 1.5% nominal (1% more than 10 year Treasury) or 0.5% real.

 

That is an equity premium of 2.5%. It would not make sense for equity holders to be getting 5%-6% real returns while bond holders make only 0% to 0.5% real returns. We should not expect bond holders to stupidly allocate money that way.

 

The real fly in the ointment is inflation. People got used to low inflation for a long time and expecting it to continue. I am agnostic on this. Who knows if and when inflation rises? So I would not pay up for 40x as it leaves little margin of safety, but I can understand why many would be willing to pay if there is a very high probability of low inflation.

 

Vinod

 

[Cigarbutt]

Ok, now that we've had a few responses, what about the another scenario.

Instead of 5% per annum, inflation is now 15% per annum. Interest remain @ the lower bound. Do equities continue to do well due to low interest rates? Or do they crater due to negative real rates?

Imagine running a pension fund in this scenario. Liabilities increasing by 15% annually and bonds get zip interest. There is no alternative but to yolo.

The pension CIO job these days is quite challenging it seems (if one is into scenarios (alternative) analysis).

How to determine the "discount" factor for liabilities will likely be very challenging. Instead of the typical questioning between the market-based approach and the expected return-based approach, some actuaries have started to suggest a probability-of-ruin approach. i think they should change the name because it's an approach that makes a lot of sense conceptually and is not necessarily all doom and gloom. It's simply an approach that tries to integrate how various scenarios could impact the capacity to pay future (and promised) benefits in the reality that the return on various assets is far from promised (especially at this point).

Anyways, some pension CIOs have been looking into investment postures that are specific to a low interest/high inflation environment:

http://pensionpulse.blogspot.com/2020/06/calpers-80-billion-leverage-plan.html

"SWIB {Wisconsion public pension} officials discovered that, like many pension funds, Wisconsin's exposure to equity risk comprised 90% of the fund's volatility. The pioneering change also would position the fund to endure a period of high inflation and low economic growth, a scenario of growing concern for many investors."

The Calpers' CIO, for various reasons, recently left and interesting times suggest that Calpers will not do well going forward.

At least, in an inflationary environment, the rise in future benefits is usually capped unlike the deflationary scenario where (at least with present rules) CPI-derived calculation cannot give a negative number.

[SharperDingaan]

Inflation is just incremental $ chasing the same TOTAL quantity of goods.

$100 spent over 10 items is an average $10/item, $105 (5% inflation on $100), over the same 10 TOTAL items, and the average price/item is $10.50 (105/10). Pretty straight forward.

 

So where's the inflation?

Covid-19 and the global trade war, have reduced the TOTAL quantity of goods. Current spending (Covid-19 related) is clearly higher than it was months ago. If total spend is up 15% ($115)  and total quantity is down 10% (9), the average price/item should be $12.78 (115/9) - and inflation should be 27.8%/yr (((12.78-10)/10)x100). ie: very high.

 

There are only 3 possibilities ....

1. Current spend is not that much higher than it was under successive rounds of QE. Sure, there IS large incremental spend - but divided over the very large (QE spend inflated) base spend? % wise, it's just not that much.

2. The current total quantity of goods available is HIGHER than it was. Very unlikely, as there are shortages of goods all across the US and Canada. The US/Canada border has been closed for some time, and anything non-essential can only be met from existing inventory.

3. The inflation has been absorbed in global foreign exchange devaluations. If the US, and the Euro debase at the SAME rate, the RELATIVE US/Euro FX rate doesn't change much (what we see), if the compared country is debasing faster - we see a worsening in their FX rate (3rd world currencies)

 

Gold is often viewed as a hedge against fiat currency debasement.

Pick a date, as to when you think the adverse Covid-19 lock-down effects started. March-31-2020?

The closing price of gold, 3/31/2020 was USD 1583/oz. The closing price yesterday was USD 2069/oz. If the total supply/demand of gold available for trading over the 4 months (Apr, May, June, July) did not change significantly - the price change must be due to inflation About 31% PTD ((2069/1583)-1)x100 - guess where the inflation went!

 

If PTD debasement is this large - shouldn't you have heard about it elsewhere, as well?

You have - all the discussion on US loss of reserve currency status, and any cursory scan of 3rd world FX rates over the last 6 months. The real question is why is it that 'retail' can see this - when apparently institutions cannot?

 

SD

 

 

 

[Broeb22]

Inflation is just incremental $ chasing the same TOTAL quantity of goods.

$100 spent over 10 items is an average 10/item, $105 (5% inflation on $100), over the same 10 TOTAL items, and the average price/item is $10.50 (105/10). Pretty straight forward.

 

So where's the inflation?

Covid-19 and the global trade war, have reduced the TOTAL quantity of goods. Current spending (Covid-19 related) is clearly higher than it was months ago. If total spend is up 15% ($115)  and total quantity is down 10% (9), the average price/item should be $12.78 (115/9) - and inflation should be 27.8%/yr (((12.78-10)/10)x100). ie: very high.

 

There are only 3 possibilities ....

1. Current spend is not that much higher than it was under successive rounds of QE. Sure, there IS large incremental spend - but divided over the very large (QE spend inflated) base spend? % wise, it's just not that much.

2. The current total quantity of goods available is HIGHER than it was. Very unlikely, as there are shortages of goods all across the US and Canada. The US/Canada border has been closed for some time, and anything non-essential can only be met from existing inventory.

3. The inflation has been absorbed in global foreign exchange devaluations. If the US, and the Euro debase at the SAME rate, the RELATIVE US/Euro FX rate doesn't change much (what we see), if the compared country is debasing faster - we see a worsening in their FX rate (3rd world currencies)

 

Gold is often viewed as a hedge against fiat currency debasement.

Pick a date, as to when you think the adverse Covid-19 lock-down effects started. March-31-2020?

The closing price of gold, 3/31/2020 was USD 1583/oz. The closing price yesterday was USD 2069/oz. If the total supply/demand of gold available for trading over the 4 months (Apr, May, June, July) did not change significantly - the price change must be due to inflation About 31% PTD ((2069/1583)-1)x100 - guess where the inflation went!

 

If PTD debasement is this large - shouldn't you have heard about it elsewhere, as well?

You have - all the discussion on US loss of reserve currency status, and any cursory scan of 3rd world FX rates over the last 6 months. The real question is why is it that 'retail' can see this - when apparently institutions cannot?

 

SD

 

I would push back on bullet point 2. In industries where there have been capacity constraints, like toilet paper, companies such as KMB and PG have intentionally reduced SKUs to enable their factories to produce more, and one representative from KMB said they saw 10-15% production increases from limiting SKUs. In POST's earnings release this AM they noted a reduction in SKUs to limit capacity constraints on machines.

[wabuffo]

 

One of the things about currency debasement is that most folks (even educated PhD Economist folks) get confused about is that they think what's going on now with the USD and gold is a reflection of the US's monetary policy and the US Dollar's role in the world.  They look at the forex value of the USD vs the Euro, the Yen, the Canadian dollar and talk about a slight "weakness" of the dollar - as if the other currencies are stable.

 

The analogy I make is that forex rates are like riding a carousel and looking across the carousel to another seat or to the seat in front of you only -- and not sensing much relative movement.  But pick a stationary object off in the distance and you realize, you are all spinning.  That's what gold is.  Leaving aside all the emotion, gold supply is INCREDIBLY STABLE - all the gold ever mined is still in above ground stocks (in some form) and so it has the most stable supply/inventory ratio of just about anything mankind can know.  Mining supply grows the total global amount of gold inventory by 1.8% per year, every year.  So that's what the gold price is telling you (over the medium and long run).  If it is rising in price, it really means there are too many dollars being created by the US Treasury vs the amount of gold being discovered.

 

Back to other currencies, then.  Guess what, they are all weakening vs gold - every single one.  They look stable to us when viewed from a forex POV (just like if they are riding the same carousel with the USD).  But they are all weakening much like the USD is.  This is a global phenomenon.

 

Here's the Canadian dollar vs gold (over the same time frame - 2020 ytd):

Now the Euro:

and the Japanese Yen:

finally, here's the British Pound:

Don't these charts all show the same trend?  I think its because all central banks (and sovereign governments) follow the same advice from the same economics textbooks.

 

We'll see how this all turns out - but the Fed is hinting at a major September policy announcement.  I think they will leave the short-term rate they control at close to zero for a long time.  They are saying that they will leave it there even if inflation overshoots and goes to 4% (their thinking is like a hedge fund manager who's underperformed their target - they will take risks to get their CAGR back to their 2% cumulative CAGR target over the recent past that they undershot).  They will also probably make some attempt at yield curve control - which means they will try to buy enough long-term Treasury bonds to create a shortage. The Fed's balance sheet will grow and thus bank reserves will grow to a high level.  The huge Fed balance sheet will smother the US commercial banking sector's balance sheets with an extremely high percentage of bank total assets in cash stuck on deposit at the Fed.  None of this will work, won't affect inflation, and will be a drag on economic growth (the opposite of what the Fed claims is its goal).  The only thing that stokes inflation is what the US Treasury is doing in its very high deficit spending.  And no - the Fed buying Treasuries doesn't help the US Treasury with their massive debt issuance at all - its a non-event.

 

wabuffo

[SharperDingaan]

I hear you, but for Canada/US border crossing purposes, TP is classified as an essential product along with food, medical, some manufacturing, minerals, and energy. Everything else is non-essential, even if it is a Canadian good (or imported into Canada) for Canadian use, just passing over US Rail as the most efficient way of getting from A to B. Try getting your hands on quantity of either cedar or pressure treated dimensional lumber, east of Manitoba - trees everywhere, yet shortages of wood!

 

SD