Fed can't keep the rates low

[LearningMachine]

25 minutes ago, no_free_lunch said:

On inflation, I was looking at commodities and quite a few have stepped back.  Lumber is down almost 50%, steel is down, oil pulled back a touch.   It seems very predictable that you will get some inflation given pent up demand and low levels of production but I feel that the market will solve this and we will move back to surplus in most commodities.  The only one that concerns me is oil, just due to the low levels of drilling , environmental laws, ESG investing, return to growth, etc .  I can see SDs point that if there is inflation it's probably oil that will cause it.  Outside of some oil spike pushing on inflation, I just find it hard to believe.

 

I think the other source of inflation is minimum wage inflation.   Unlike lumber, where increased supply will bring prices back down, we can't decrease wages back down. 

 

 

[no_free_lunch]

You can set the minimum wage wherever you want but you can't make businesses hire. You can't control the minimum wage in China either.  Even for the local businesses that it applies to, that labor expense is only one of their costs, they are a subset of the inflation basket and it should be partially mitigated by productivity measures.  Isn't there high minimum wage in a lot of the EU countries and what is CPI there?  I speculate it will definitely push up on prices but only by so much.

[LearningMachine]

25 minutes ago, no_free_lunch said:

You can set the minimum wage wherever you want but you can't make businesses hire. You can't control the minimum wage in China either.  Even for the local businesses that it applies to, that labor expense is only one of their costs, they are a subset of the inflation basket and it should be partially mitigated by productivity measures.  Isn't there high minimum wage in a lot of the EU countries and what is CPI there?  I speculate it will definitely push up on prices but only by so much.

 

Once you start doubling minimum wages, everything starts almost doubling. 

• Goods & services with labor as a big component almost double, e.g. haircuts, nannies, maid service, restaurant meals, construction costs, etc.
• Mass Goods & services that are consumed by all, where minimum price is determined by what lower-income folks can afford go up, e.g. fast-food prices double over time.
• Those geographically-bound workers will compete for the same restricted housing supply with a third of their fruits of labor, causing rents for those workers to double over time, unless effective supply increases due to geographically-mobile higher-income folks spreading out to bigger estates, far out water-view, etc., which is a possibility.  So, maybe high-density rent doesn't double.

 

Doubling over 5 years is 15% per year inflation.  Even it that inflation figure shows up once in five years, it will be deadly. 

Edited June 19, 2021 by LearningMachine

[LearningMachine]

34 minutes ago, no_free_lunch said:

Isn't there high minimum wage in a lot of the EU countries and what is CPI there?  

 

Yes, if you go to McDonald's in Luxembourg with high minimum wages, McChicken is more than double compared to U.S. 

 

Imagine mass market goods & services doubling in price in the U.S. 

Edited June 19, 2021 by LearningMachine

[Gregmal]

I don't think you need to be loaded with 30 year mortgages to own real estate. Multi family, Single Family, mobile home operators should all do well regardless with the ability to annually raise rents. Having long duration debt would be a strength, but its hardly necessary. Just avoid anything in a rent controlled area and you're good. 

 

I'd say 3-5% is definitely much more likely than 5-10%. The latter being pretty outrageous and really only something that occurs in unstable third world countries. Sustained inflation IMO would have to be driven by wage increases, which if that occurs there's a playbook for how to handle it. Bring it on. 

[Gregmal]

18 hours ago, no_free_lunch said:

LM, Avalon Bay AVB has an avg duration of 10 years and a long history of slowly growing the yield per share. I don't know if you will find 30 year duration on a REIT but let me know if you can.

 

It's not just REITs , any company with physical assets or even just pricing power should make it. Of course I have the perspective that I have no idea what the future holds so I want even my inflation hedges hedged.  Hence a focus on assets that don't require inflation to make some gains.

 

I think telecom could do ok as well.  They have enough pricing power, lots of debt and physical assets.

Most REITs/institutional RE operators dont use 30 yr mortgages. Its not the same as Joe Schmoe buying his home. Typically 10 years is the standard in CRE or with REITs, and often its 10 yr IO. 

 

Oil may not historically have a 100% correlation, but when I draw out the Venn diagram, there's more than enough overlap for me to conclude that "if this, then that", with respect to future inflation and the price of crude. 

[Gregmal]

18 hours ago, LearningMachine said:

 

I agree if interest rates hit 10%, REITS without 30-year mortgages will go down, and also CAP rates will track interest rates, lowering valuation of CRE.

A cap rate is just a function of NOI. If you can raise rents annually to track inflation, all else should remain equal. How wouldnt you be just fine with a 5-10 year mortgage vs a 30 year in such case? In fact, your rate and also cost(as I said earlier, many 10 year mortgages are IO) would be locked in and even lower. If you unload the property before term is up, no issue there. If you refi its at a higher rate but one thats been tracked and covered by your annual NOI growth. If they keep heading higher, you continue to capture spread, and if they come back down...you can refi. There's a reason MF RE has basically been the institutional t-bill for decades. Its pretty durable in almost any situation.

 

That said, the 10 year is currently ripping....at 1.45. I think we're closer to talking about 2 caps than we are 10s. 

[SharperDingaan]

1 hour ago, LearningMachine said:

Of course, you want cash taken out at low long-term interest rates, and in the long run that should do fine.

 

I'm talking about how you invest that cash, some of which is taken out at low long-term interest rates.  You could either just put it all in long-term holdings that will do well over the long run, or save some for taking opportunities that might arrive. 

 

This is the whole reason you buy the maximum house you can afford (even at an inflated price), finance it with a fixed rate long-term mortgage, and simply live in it. The house price rises with inflation, while the mortgage either stays the same or gets smaller. Sell upon the refinancing date, and the inflation difference is monetized into cash.

 

SD

[SharperDingaan]

1 hour ago, no_free_lunch said:

You can set the minimum wage wherever you want but you can't make businesses hire. You can't control the minimum wage in China either.  Even for the local businesses that it applies to, that labor expense is only one of their costs, they are a subset of the inflation basket and it should be partially mitigated by productivity measures.  Isn't there high minimum wage in a lot of the EU countries and what is CPI there?  I speculate it will definitely push up on prices but only by so much.

 

We had a recent discussion with our employees as to their preference around new hires - do we go with maximum hours possible and overtime, or add a new person? Almost universally, the preference is to delay new hires as long as we possibly can - so that staff can put as much in the bank as possible. As soon as we start paying overtime, we will begin feeding cost push inflation.

 

SD

 

[no_free_lunch]

LM, I asked what is the CPI in Europe not the difference in price. The point I am trying to make is these wage increases and their impact on inflation have been one off.

 

Hasnt housing seen a huge surge?  In parts of Canada prices are up probably triple over last 15 years and yet we have anemic CPI reported.  I think it plays out the same with minimum wage boosts.

 

You didn't really address my point that minimum wage affects a subset of the  economy, a subset of the costs where it's relevant, and is partially mitigated by productivity, replacement and imports.  If you double minimum wage prices will go up but not by double.  

 

The other factor is the fed can simply say Fu and stay pat so long as the dollar doesn't crash.  It's happening today with the transitory inflation narrative. 

[LearningMachine]

1 hour ago, Gregmal said:

A cap rate is just a function of NOI. If you can raise rents annually to track inflation, all else should remain equal. How wouldnt you be just fine with a 5-10 year mortgage vs a 30 year in such case? In fact, your rate and also cost(as I said earlier, many 10 year mortgages are IO) would be locked in and even lower. If you unload the property before term is up, no issue there. If you refi its at a higher rate but one thats been tracked and covered by your annual NOI growth. If they keep heading higher, you continue to capture spread, and if they come back down...you can refi. There's a reason MF RE has basically been the institutional t-bill for decades. Its pretty durable in almost any situation.

 

That said, the 10 year is currently ripping....at 1.45. I think we're closer to talking about 2 caps than we are 10s. 

 

By cap rate is a function of NOI, I understand you mean cap rate = NOI/Price of CRE.

In other words, Price of CRE = NOI / cap rate

 

Value of CRE with $100K NOI with cap rate of 3%= $100K/3% = $3.333 million

 

Let's say inflation hits 10% and NOI goes up 10% to $110K, and interest rates follow, and cap rates follow

Value of CRE with $110K NOI with cap rate of 10% = $110K/10% = $1.111 million.

 

I understand things won't be this drastic, but even if they are half as drastic, not great. 

 

I understand if you're saying you don't need to refinance or sell during that time, and can ride the inflation and hold, you might do fine.  For that, you need long term mortgage.  

 

To be balanced, better to have some cash ready to also buy.

Edited June 19, 2021 by LearningMachine

[LearningMachine]

30 minutes ago, no_free_lunch said:

LM, I asked what is the CPI in Europe not the difference in price. The point I am trying to make is these wage increases and their impact on inflation have been one off.

 

@no_free_lunch, I understood your question, but my point is that even a single-time doubling of minimum wage is drastic, and hence I switched to the comparison between U.S. and Luxembourg.  I am not claiming that minimum wage will continue to double all the time.  

 

Single-time doubling of minimum wage over 5 years results in 15% sustained inflation over five years in some goods/services.  

 

My point is if that 15% figure shows up even once in a wide range of goods/services, it will be drastic. 

Edited June 19, 2021 by LearningMachine

[LearningMachine]

38 minutes ago, no_free_lunch said:

You didn't really address my point that minimum wage affects a subset of the  economy, a subset of the costs where it's relevant, and is partially mitigated by productivity, replacement and imports.  If you double minimum wage prices will go up but not by double.  

 

It impacts a subset, but a big part of the economy that is measured by CPI.  It also has downstream effects.

 

Long-long term, I understand it will be mitigated by productivity increases. 

 

I'm saying it increases the probability of us seeing high inflation figures within the next few years. 

Edited June 19, 2021 by LearningMachine

[Gregmal]

10 minutes ago, LearningMachine said:

 

By cap rate is a function of NOI, I understand you mean cap rate = NOI/Price of CRE.

In other words, Price of CRE = NOI / cap rate

 

Value of CRE with $100K NOI with cap rate of 3%= $100K/3% = $3.333 million

 

Let's say inflation hits 10% and NOI goes up 10% to $110K, and interest rates follow, and cap rates follow

Value of CRE with $110K NOI with cap rate of 10% = $110K/10% = $1.111 million.

 

I understand things won't be this drastic, but even if they are half as drastic, not great. 

 

I understand if you're saying you don't need to refinance or sell during that time, and can ride the inflation and hold, you might do fine.  For that, you need long term mortgage.  

 

To be balanced, better to have some cash ready to also buy 

How do you conclude that 10% inflation means a 10% cap rate? For instance right now people are saying theres about 5% inflation. We have a 1.45 10 year and the highest quality NNN and MF stuff trading near a 3 flat. 

 

Its been expected that year over year we see massive jumps and increases in everything simply because of how much of an outlier last year was. But you arent really saying you see consistent, 5-10% PER YEAR! inflation for a sustained stretch, are you? Let alone for so long that a 10 year fixed is in trouble? You have this as a 65% likely if I read your earlier post correctly?

 

Im just trying to understand because I think a lot of what you're digging at is important. But I feel like it also may be getting into the category of folks who won't buy stocks because they consistently think a 50% decline is right around the corner. Perhaps a bit too extreme in terms of pessimism or assignment of odds to low probability events. 

 

 

[LearningMachine]

9 minutes ago, Gregmal said:

How do you conclude that 10% inflation means a 10% cap rate? For instance right now people are saying theres about 5% inflation. We have a 1.45 10 year and the highest quality NNN and MF stuff trading near a 3 flat. 

 

 

10% inflation --->10% interest rates ---> 10% cap rates

I'm saying 10% inflation should lead to 10% interest rates, which should lead to 10% cap rates. 

 

I understand the first arrow hasn't been happening even for 5% inflation because of intervention from Fed, and Fed calling it intermittent.  However, I think either Fed will lose credibility or Fed will have to start admitting that it is not intermittent, and interest rates will likely move up. 

 

 

Edited June 19, 2021 by LearningMachine

[LearningMachine]

14 minutes ago, Gregmal said:

But you arent really saying you see consistent, 5-10% PER YEAR! inflation for a sustained stretch, are you? Let alone for so long that a 10 year fixed is in trouble? You have this as a 65% likely if I read your earlier post correctly?

 

Im just trying to understand because I think a lot of what you're digging at is important. But I feel like it also may be getting into the category of folks who won't buy stocks because they consistently think a 50% decline is right around the corner. Perhaps a bit too extreme in terms of pessimism or assignment of odds to low probability events. 

 

Here is how I worded my Scenario 2: "High inflation in 5-10% or higher range at some points in the next 5 years (p2= 65%?)"

 

I'm not saying don't buy stocks at all.  I'm saying Scenario 2 has a 65% probability of happening, and interest rates have a high likelihood of following at least at some points during five years if that scenario happens, and discount rates have a high likelihood of following if that scenario happens, and that we will likely get some opportunities if that scenario happens.

Edited June 19, 2021 by LearningMachine

[Spekulatius]

I would be careful with NNN leases or NNN Reits. Most of these leases have annual escalators that are capped at some not so high value. If inflation really would go to even 5%, this would probably exceed the cap and then you own basically a long duration bond with an coupon below inflation, and some risk.

[Gregmal]

Ok yea. Dont totally disagree. Ive been prepping for some of this stuff myself for a good bit now. But I also think the assumptions are too draconian. My analogy about the 50% decline in stocks folks wasn't meant to indicate you are saying that, as I know you're buying some stocks...but what I meant is that there's folks who get so wrapped up in such a kind of low probability event that it paralyzes them to an extent that realistically they're better off just discarding the fear as irrational. I know this because I had a German client who I had to fire because from 2013-2018 he was so negative and every 1% down day in the market got loud and obnoxious about how this was the start of the big crash. And it just got stupid and was a distraction and he has been in CDs for almost the entirety of the past decade. I think to a certain degree fearing a treasury thats currently at 1.5% going to 10 while the rest of the developed world remains between 0-1%(if not negative) is probably equally detrimental. 3% I could see. 5% I can see. 

 

While I get there are measures that claim to track this sort of stuff, what really is 10% inflation(just using a number). Year over year a pork belly or corn contract can see 10% increases. John and Jane Smith can see 10% wage growth. How does this mandate a 10% treasury? I mean again, I'm being told we're at 5-6% or whatever, which I am not sure I believe based on what my eyes are seeing, but trying to now imagine "this"(the 5-6% print and corresponding everyday prices...IE $10 2x4 and $8 12 pack of Coke) ballooning into an extended long term trend....I think the probability of that is the same as Berkshire Hathaway filing bankruptcy....

 

If the extreme inflation is only expected to occur for a few years, the market would price that in. Everyone always jumps to the 70s but the situations I dont think are really comparable. Right now we have a real bottleneck which is throwing prices of most everyday things out of whack. I mean theres scenarios where used cars are selling for more than the MSRPs on new ones! But I also think this pulls back and then while there is inflation, its more controlled. You can say the Fed is going to "lose control"....and thats possible. But what does that mean and how do we quantify it and what do we translate this to? There is also of course, this saying...something about not fighting the Fed...and its kind of been good advice. 

[Spekulatius]

A 50% decline in stocks is not a low probability event. It is more like a once in a decade event. We have sen those in 2002 and in 2008 and I think we will see one this decade too, but one can’t know for sure.

 

High inflation typically hope so when their is political upheaval in combination with some economic stress factor (both are typically related to each other). I think a value like 10% is possible if the political stability of the US takes a severe hit  and the financial markets lose confidence. It is a low probability scenario, but it is not impossible Imo.

 

FWIW, the best inflation hedge is a 30 year fixed rate mortgage. To hedge yourself, you would want to have as much fixed rate 30 year mortgage debt as possible on your property.

It also comes with a free call option to refinance (without penalty if you are in the US) if you are wrong.

Edited June 19, 2021 by Spekulatius

[Gregmal]

8 minutes ago, Spekulatius said:

I would be careful with NNN leases or NNN Reits. Most of these leases have annual escalators that are capped at some not so high value. If inflation really would go to even 5%, this would probably exceed the cap and then you own basically a long duration bond with an coupon below inflation, and some risk.

Yea I don't own much, and by and large its contract specific, which at least with most public companies, I am not sure is even disclosed for investors. But many times its CPI+ a few %, or the other common ones are ~10% increases every 5 years or something. One is ok and the other is not good and there's some variations in between. Was just pointing out how despite the craziness of what we are seeing today, a 20 year Chick-Fil-A or Chase NNN is currently a 3 cap asset. It makes sense lazily that a 10% inflation print should equal a 10% treasury and subsequently lets say a 12% cap rate for a good asset. But its not really that simple. What do we base 10% inflation on and come to that conclusion? I view inflation as the loss of purchasing power. But even there...where and how does this get measured? Is it CPI? What if CPI is wrong? Do investors just ignore it even though they're really predicating these rates on a faulty moniker? If CPI says 3% but its really 10...who determines the market? I mean again, everything I see looks like its at least 10% more expensive, probably even closer to 20. Local baseball stadium the other day had hiring signs up starting at $20 a hour to works the concessions. And signs at the concessions apologizing for being short staffed....So again this kind of leads me back to the idea that productivity/consumption and wage increases will really be a driver if this plays out. Which bodes really well for crude. 

 

I think if nothing else, I hope I've read wabuffos analysis largely right, at least in terms of the spigots analogy. Which makes sense. You have this kind of one time disruption and discombobulation. Its created one hell of a distortion. 10 year should probably be a good bit higher than 1. But to have this sort of hyper inflation you need more than one off stimulus making its way into the hands of the public. My expectation, which isnt worth a whole lot, is probably that we will see a good healthy sized jump in rates, and then stabilization. 2-4, maybe 5% on the 10 year type stuff. 

[Gregmal]

5 minutes ago, Spekulatius said:

A 50% decline in stocks is not a low probability event. It is more like a once in a decade event. We have sen those in 2002 and in 2008 and I think we will see one this decade too, but one can’t know for sure.

 

High inflation typically hope so when their is political upheaval in combination with some economic stress factor (both are typically related to each other). I think a value like 10% is possible if the political stability of the US takes a severe hit  and the financial markets lose confidence. It is a low probability scenario, but it is not impossible Imo.

 

FWIW, the best inflation hedge is a 30 year fixed rate mortgage. To hedge yourself, you would want to have as much fixed rate 30 year mortgage debt as possible on your property.

It also comes with a free call option to refinance (without penalty if you are in the US) if you are wrong.

The problem on the 50% decline in stocks position is that you sit on the sidelines for an entire decade waiting for an entire decade when theres plenty of easy low hanging fruit. And I am not sure its as frequent as once in a decade. Tech burst in early 2000s but quality businesses I dont think went down that much. 2008 was definitely unique, but even during covid 50% wasn't seen in most quality names. So being 50-100% in cash is IMO unequivocally dumb. There's also the fact that most of the time, those folks waste years waiting, and then when it happens are too busy screaming how they were right  and its only going to get worse...rather than being opportunistic. I recall some dipshit in 2008 made the papers saying the S&P had another 20-30% to fall when it was at 700. The doomsday stuff is just a losers mentality. If something thats gone up 5 fold goes down 50%, where you really better off not buying it? A BRK B share was like $90 in 2012. 

 

Agree on the 30 yr fixed. Love em. 

[Gregmal]

https://www.wealthmanagement.com/multifamily/us-apartments-have-risen-top-foreign-investors-wish-lists?NL=WM-056&Issue=WM-056_20210617_WM-056_322&sfvc4enews=42&cl=article_2&utm_rid=CPG09000011488665&utm_campaign=32894&utm_medium=email&elq2=2ca6806f518c43ab80e8dd9cc74cac39&oly_enc_id=0563H6121845H6E

 

"Currently multifamily is seen to be an extremely effective inflationary hedge, given that the leases mark to market on an annual basis. Going into what many predict will be a period of higher inflation, that is an extremely attractive investment characteristic."

[Spekulatius]

Interesting chart regarding valuations and equity multiples:

 

[LearningMachine]

Inflation expectations are at highest they have been since 2004. 

 

So, both (1) monetary supply and (2) inflation expectations criteria are now being met to get inflation going...

 

https://trends.google.com/trends/explore?date=all&geo=US&q=inflation

[DooDiligence]

I haven’t been reading this thread in a while so apologies if this has already been discussed.

 

The Fed isn’t printing as much money as you think - Morgan Housel