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Has The Grand Experiment Killed Cycles?


Gregmal
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Ive been chatting with a lot of folks and most of the time the lens of investment is one of a value investor. I continue to be amazed by the abundance of traditional businesses that are "cheap" but troubled. Look at some of the threads here for example. DD, AMC, XOM, GHC, certain types of real estate...dont get hung up on the specific examples. The contrast between these businesses and the ones RuleNumberOne likes to talk about is incredible. But beyond that, it got me thinking. All the classic value investors and books about such things talk about cycles and buying when things are out of favor and then achieving these heroic returns from being a contrarian. The TBTF trade was really the last classic example of this that worked. But otherwise, everything now, for at least the last half decade if not a bit longer, IMO has just stayed out of favor and continued its decline. Almost as if cycles dont exist and just transitioned to permanent secular declines. Commodity names have sucked forever now. Miners too. Many different types of real estate. Financials, Insurance, media, healthcare, energy, auto....quite a lot here. In a market many describe as in a bubble, and a few percent off all time highs, the list of traditional businesses at shitty valuations and often described by rational investors as having "too much hair" is incredible.

 

So I guess the million dollar question is, do these ever become cyclical again(IE as in trade at premium valuations), or have we for some reason, maybe Fed induced, caused there to be a hitch in the way investments and businesses are valued? More or less rendering these things permanently challenged and essentially just part of some which ice cube can melt the slowest contest?

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So I guess the million dollar question is, do these ever become cyclical again(IE as in trade at premium valuations)

 

Historically yes. And that's all we can really go on, but when that happens...who knows?

 

FRB influencing interest rates I would argue does not fundamentally change anything. It raises the floor of asset prices but this is reactive and is a reflection of our environment. I would argue the true reduction in capital costs is not because of FRB action but because humans have become really good at obtaining and allocating resources: educating ourselves, improving technologies and efficiencies, and ultimately driving costs down for most things in life.

 

The really big factors on the horizon that I can think of are: global politics (i.e. Russia, China, etc. and how open these regimes will be); robotization/automation of labor and the impacts this will have; overall population dynamics (increasing lifespans, how many people the earth can support); changes in how we collect and use energy; and of course other stuff that i'm not smart enough to even conceive of.

 

But these are just guesses and I don't think anyone really knows what their effects will be.

 

It's trying to see 5 miles down the road at the bottom of a hill through a cloudy windshield in a downpour with no wipers right after an eye exam with your kids screaming and fighting in the backseat and your mother-in-law blowing up your phone.

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Indeed all true. One interesting theory Ive heard is the wealth gap explanation. The same premise regarding how the top 1% keep getting richer at the expense of the middle class while the poor stay stuck....in business terms, the wealth gap involves a select few companies basically controlling the avenues to resources the rest of business world depends upon, and just slowly erodes middle and lower class companies. I dont think theres a correct answer, but its just odd seeing so many once respected companies looking like shit and thinking, what does the market do to these companies if we see things turn south?

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That's a good thematic point as well. Long term impacts are difficult to foresee:

 

Will the majority classes (either of individuals or companies) rally together and change the rules to their benefits? E.g. pro-labor/union policies, monopoly-busting regulations, etc. After all they do have the numbers advantage.

 

Or will the Select Few Companies continue their dominance and go full-on global oligopoly? Perhaps they offer a compelling value proposition to prevent the above scenario from occurring.

 

If we turn to art, dystopian cyber-punk science fiction (which I have a sweet spot for) paints the latter picture :D

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Yeah, i have been thinking a lot about this too. Many questions on my mind:

 

- is it different this time?

- have valuations reached a permanently higher level?

- can central banks stave off recession forever?

- can EV/EBITDA of certain stocks keep going up forever?

- can venture capitalists fund loss-making businesses forever?

- can Europe inflate its housing bubble forever?

 

Some conclusions i have reached are:

- the ECB will die trying otherwise they will all be out of a job. This means keep Italy's interest rate as close to zero as possible, buy as much sovereign and corporate debt as it takes to do that.

- professional investors will keep buying otherwise they will be out of a job.

- it is easier for investors who have never gone through a bear market to believe it is different this time.

- if we ignore what Buffett, Klarman, Soros etc say, we have nothing else to go on. Better to listen to them than the newbie gunslingers.

- the Fed will not raise rates until after the election because the bubble is bigger now than in 2000 (record government debt, record US corporate debt, record worldwide debt to gdp implies higher rates will cause a big crash).

 

The nomination of Bernie Sanders adds to the complexity. It rules out some areas of the stock market because you never know what the new Hugo Chavez might decide to nationalize.

 

 

Ive been chatting with a lot of folks and most of the time the lens of investment is one of a value investor. I continue to be amazed by the abundance of traditional businesses that are "cheap" but troubled. Look at some of the threads here for example. DD, AMC, XOM, GHC, certain types of real estate...dont get hung up on the specific examples. The contrast between these businesses and the ones RuleNumberOne likes to talk about is incredible. But beyond that, it got me thinking. All the classic value investors and books about such things talk about cycles and buying when things are out of favor and then achieving these heroic returns from being a contrarian. The TBTF trade was really the last classic example of this that worked. But otherwise, everything now, for at least the last half decade if not a bit longer, IMO has just stayed out of favor and continued its decline. Almost as if cycles dont exist and just transitioned to permanent secular declines. Commodity names have sucked forever now. Miners too. Many different types of real estate. Financials, Insurance, media, healthcare, energy, auto....quite a lot here. In a market many describe as in a bubble, and a few percent off all time highs, the list of traditional businesses at shitty valuations and often described by rational investors as having "too much hair" is incredible.

 

So I guess the million dollar question is, do these ever become cyclical again(IE as in trade at premium valuations), or have we for some reason, maybe Fed induced, caused there to be a hitch in the way investments and businesses are valued? More or less rendering these things permanently challenged and essentially just part of some which ice cube can melt the slowest contest?

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Ive been chatting with a lot of folks and most of the time the lens of investment is one of a value investor. I continue to be amazed by the abundance of traditional businesses that are "cheap" but troubled. Look at some of the threads here for example. DD, AMC, XOM, GHC, certain types of real estate...dont get hung up on the specific examples. The contrast between these businesses and the ones RuleNumberOne likes to talk about is incredible. But beyond that, it got me thinking. All the classic value investors and books about such things talk about cycles and buying when things are out of favor and then achieving these heroic returns from being a contrarian. The TBTF trade was really the last classic example of this that worked. But otherwise, everything now, for at least the last half decade if not a bit longer, IMO has just stayed out of favor and continued its decline. Almost as if cycles dont exist and just transitioned to permanent secular declines. Commodity names have sucked forever now. Miners too. Many different types of real estate. Financials, Insurance, media, healthcare, energy, auto....quite a lot here. In a market many describe as in a bubble, and a few percent off all time highs, the list of traditional businesses at shitty valuations and often described by rational investors as having "too much hair" is incredible.

 

So I guess the million dollar question is, do these ever become cyclical again(IE as in trade at premium valuations), or have we for some reason, maybe Fed induced, caused there to be a hitch in the way investments and businesses are valued? More or less rendering these things permanently challenged and essentially just part of some which ice cube can melt the slowest contest?

 

I see several things going on that explain what we saw in the markets.

 

The two really major structural drivers of asset market returns over the past decade are

 

1. Internet

2. Low interest rates

 

Internet is to me on the same level as discovery/invention of fire/wheel, steam engines/electricity, etc.

 

Just as steam engines and electricity has fundamentally altered the economic/business climate, Internet is doing the same. Can you think of any of the CPG companies (Coke, PG, Nestle, etc) without the invention of steam engines/electricity? These companies laid waste to many smaller artisan type small scale businesses. Now Internet is negatively impacting many of the businesses that value investors are fond of.

 

Similarly low interest rates have elevated asset valuations and had different degrees of impact on different businesses. The impact to value investors in this case is that elevated valuations is leading them to holding on to lot of more cash (it seems like 6.5% real returns for stocks are divine right for investors) or go insane (Berkowitz).

 

Now you have the normal cyclical fluctuations in different industries. Didn't banking go through the cycle? Many of us benefited from that particular one. Airlines, Housing to name two also went though a cycle.

 

If you look at Shopping (Retail as well as RE), you can see the long term structural impact of Internet . But there is some cyclical stuff that is going on as well. Same with Energy. Longer term structural impact of many alternative energy and EV is overlaid with cyclical stuff.

 

So I do not think anything really changed in terms of cyclical fluctuations. There are structural changes that are overlaying with cyclical changes that is hiding the cyclical parts.

 

Vinod

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I was reading a book "Factfullness". In this the author pointed out how when we blame some person/establishment we stop thinking.

 

 

The blame instinct describes our tendency to find a clear, simple reason for why something bad has happened.

When things go wrong, it’s easy to assume it’s due to bad people with bad intentions.

 

Rosling writes, “We like to believe that things happen because someone wanted them to, that individuals have power and agency: otherwise, the world feels unpredictable, confusing, and frightening.”

 

“The blame instinct makes us exaggerate the importance of individuals or of particular groups,” writes Rosling. “This instinct to find a guilty party derails our ability to develop a true, fact-based understanding of the world: it steals our focus as we obsess about someone to blame, then blocks our learning because once we have decided who to [blame] we stop looking for explanations elsewhere. This undermines our ability to solve the problem or prevent it from happening again because we are stuck with over simplistic finger-pointing, which distracts us from the more complex truth and prevents us from focusing our energy in the right places.”

 

Look for causes, not villains. When something goes wrong don’t look for an individual or a group to blame. Accept that bad things can happen without anyone intending them to. Instead spend your energy on understanding the multiple interacting causes, or system, that created the situation.

 

Look at how many people blame Fed/ECB or Indexing. You don't have to ask their portfolio performance to know how they did.

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vinod, on interest rates:

 

Interest rates are not a structural cause of change. Something causes interest rates to have a long-term level shift.

 

The FRB sets the rates, yes. But they do so in response to economic reality. The question is, what is that reality, what are its implications, and how long will it persist.

 

What do you think?

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vinod, on interest rates:

 

Interest rates are not a structural cause of change. Something causes interest rates to have a long-term level shift.

 

The FRB sets the rates, yes. But they do so in response to economic reality. The question is, what is that reality, what are its implications, and how long will it persist.

 

What do you think?

 

You are absolutely right. No argument there.

 

I have no idea what is causing it. I hear so many reasons - aging, economic inequality, savings glut, etc. I really think it is a mystery. 

 

I pointed to interest rates because, regardless of causes, we know it is a critical variable in asset pricing. And it is going to have a major impact.

 

Vinod

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Weren't there plenty of cheap stocks during the dot-com bubble? I think stocks with real earnings and value started doing well after people tried to turn their "Pets.com" shares into real money and realized there's nothing there once the greater fool is exhausted.

At some point the cycle will turn unless maybe central banks step in big time and start buying stocks.

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3 main drivers ...

 

1) We're in a great depression, and have been for the last decade. The only reason we don't see dust-bowls is because of continuous QE, and ongoing TBTF bailouts. 2) We're aging, we don't buy as much anymore, and we increasingly buy experience vs stuff. Less demand, and more of it on things we don't make. 3) AI/automation/robotics. When we don't hire labor, how are they supposed to buy anything, or service their debt?

 

When everyone has capital, capital is worth squat, and interest rates (cost of capital) go to zero.

When nobody has labor, labor should be worth a lot. Except when nobody needs labor, because we're using automation instead.

 

Just a different POV

 

SD

 

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The central bankers stopped being effective a long time ago in Europe. Yesterday's GDP data shows Italy GDP shrank by 0.3%. The last 8 quarters, the percentage growth in Italy's GDP is:

 

0.1, -0.1, -0.1, 0.1, 0.1, 0.1, 0.1, -0.3.

 

https://tradingeconomics.com/italy/gdp-growth

 

The central planners/bankers whine that they want inflation. When these central bankers buy financial assets, they get asset price inflation.

 

If central planners genuinely want goods inflation, they should just buy chemicals, cars, planes, boats, clothes, toys etc instead of stocks and corporate debt.

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The central bankers stopped being effective a long time ago in Europe. Yesterday's GDP data shows Italy GDP shrank by 0.3%. The last 8 quarters, the percentage growth in Italy's GDP is:

 

0.1, -0.1, -0.1, 0.1, 0.1, 0.1, 0.1, -0.3.

 

https://tradingeconomics.com/italy/gdp-growth

 

The central planners/bankers whine that they want inflation. When these central bankers buy financial assets, they get asset price inflation.

 

If central planners genuinely want goods inflation, they should just buy chemicals, cars, planes, boats, clothes, toys etc instead of stocks and corporate debt.

 

No. If they must print money to manage inflation they should distribute it equally to the population. The inequality created by squirting money into asset markets - meaning asset owners and managers benefit, but others don’t - is an appalling and dangerous consequence of central bank experimentation.

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The central bankers stopped being effective a long time ago in Europe. Yesterday's GDP data shows Italy GDP shrank by 0.3%. The last 8 quarters, the percentage growth in Italy's GDP is:

 

0.1, -0.1, -0.1, 0.1, 0.1, 0.1, 0.1, -0.3.

 

https://tradingeconomics.com/italy/gdp-growth

 

The central planners/bankers whine that they want inflation. When these central bankers buy financial assets, they get asset price inflation.

 

If central planners genuinely want goods inflation, they should just buy chemicals, cars, planes, boats, clothes, toys etc instead of stocks and corporate debt.

 

No. If they must print money to manage inflation they should distribute it equally to the population. The inequality created by squirting money into asset markets - meaning asset owners and managers benefit, but others don’t - is an appalling and dangerous consequence of central bank experimentation.

 

Very, very true.

 

 

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Probably there is no such thing as an asset bubble anymore. Central bankers due to various locale-specific reasons such as political wrath (US) or job security (Eurocrats), have been providing non-stop asset price levitation.

 

Now there is a clamor for "rate cuts to combat the coronavirus." That really means we want to "justify a P/E of 60 instead of just 50, so you need to cut rates now."

 

The end-result is Europe: they are unable to get out of their years-long slump because they used up all the big monetary policy catalysts. Their economic plight is going from bad to worse but they are unable to change it. The financial assets there don't see any market pricing since the ECB has guaranteed to not let them fall.

 

Why would the Fed want to turn the US into something like the Eurozone by not saving rate cuts for when you really need it. The Fed really should have raised rates in 2017, 2018.

 

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I think the question is, "what is the eventual fallout of suspended low rates?" If there even is such a fallout.

 

In the past it's been inflation, right? Well, we don't really see that. If there is any consequence, I think we'll see it in terms of investment options. Asset prices can only be inflated so much, eventually we hit zero or negative rates. And yields can only be compressed so much, there's already junk out there priced at 3%.

 

So eventually the marginal investment trends to zero. Which if you're not investing that dollar, you will consume it. Perhaps then we may see inflation.

 

Obviously this is macroeconomic musings so take it with a grain of the tea leaves I'm reading.

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To buy anything at these inflated prices, we need a guarantee from the Fed that they are going to do "whatever it takes" to support asset prices forever. If the President guesses wrong and appoints a Fed Chairman with a backbone like Volcker, all the pent-up hell breaks loose. All sorts of debt-to-GDP measures keep going up relentlessly even if earnings have gone nowhere for 4 quarters.

 

 

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When the last potential buyer has bought, this is it: price heads down. There is really no need for a catalyst. Then hysteria turns into fear.

 

This feels so similar to 20 years ago it is almost scary. Main difference in my opinion is that the Fed is not tightening. This could soon change.

 

I think that one should not think too much in terms of fundamentals as market participants don`t care. Look at some of the big movers in market cap and then wonder how they really added that much in intrinsic value or net worth over the last 2 days to deserve such pop?

 

It is purely fear of missing out and greed.

 

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I guess one difference is that there's more money & liquidity after QE 1,2,3,4..

Also, with negative interest bonds & certain European countries charging interest on deposits. People are forced to spend or buy assets.

Things could get much crazier than 20 years ago.  8)

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One security blanket that current investors have is indexing. They feel they are diversified and the index averages a 15% return every year. All the people i talk to who are fully invested use indexing. They shovel all their savings into the index and stay fully invested at all times. They see everyone else doing the same thing and it makes them feel warm and cozy.

 

Europe is actually a bad sign of what can happen. They have had negative rates for years but the economy only keeps getting worse. They have no way of getting out of their slump and rates are already at -0.4%. And i suspect companies and people in Europe noticed that a few quarters ago - that they have no way of getting out of their slump.

 

I talked to someone yesterday who had been working in silicon valley during the dot-com bubble and was also investing in the stock market of 1999-2000. He was of the opinion the yield curve does not matter much. He thought panic could be triggered by either a tightening of venture capital or a layoff announcement from a prominent company.

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Strange times. DAX index is at an all-time high even as industrial orders keep going down. ECB chief Lagarde says the ECB has nothing left but that only makes the market go up even more. Hubris-filled central bankers have destroyed free markets.

 

 

https://www.bloomberg.com/news/articles/2020-02-06/lagarde-warns-ecb-has-limited-options-to-fight-lingering-threats

 

"The warning came just hours after data showed a huge drop in Germany factory orders, indicating the manufacturing recession in Europe’s largest economy is far from over.

 

Lagarde told European Parliament lawmakers on Thursday. “This low interest rate and low inflation environment has significantly reduced the scope for the ECB and other central banks worldwide to ease monetary policy in the face of an economic downturn.”

 

https://www.reuters.com/article/us-germany-economy-industrial-orders/german-industry-orders-slump-on-weak-euro-zone-demand-outlook-subdued-idUSKBN2000QA

 

Contracts for ‘Made in Germany’ goods fell 2.1% from the previous month, the Statistics Office said. That was the biggest drop since February and compared with the Reuters consensus forecast for a 0.6% rise.

 

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