Have We Hit The Top?

[Gregmal]

5 minutes ago, TwoCitiesCapital said:

Why the insistence on ignoring that equities have had a significant negative real return while inflation was present?

Because this largely isn’t true and short term cherry picked datapoints can be manipulated to say pretty much whatever one wants. If we pinch the timeline in here, then discard that, then only talk this subsector of an asset class, and then discredit that leg of the rally…..I mean it’s just all a little too far fetched and unproductive. I mean bottle all this up and summarize it and it’s basically “don’t own stocks cuz occasionally there’s short term periods where they do poorly or something else in the universe does better and every once in a while you get a big decline”….I mean just up thread you’re kinda of downplaying how poorly bonds have done because “they’re up across all accounts” and the goal is absolute returns, and then a few points later it’s like “oh 6.7% over a tough two year stretch sucked compared to other things”…wouldnt the consistent logic dictate that single digit bond returns are awful because you should’ve owned the Nasdaq for 2023? 
 

So again it all just kinda comes back to this generally obvious idea that unless you are hyper focused on the short term guessing games that likely don’t have probability of desired outcome any more favorable than casino games…stocks are what you wanna own?

[TwoCitiesCapital]

7 minutes ago, james22 said:

 

You could have bet on stocks at the beginning of the year, yeah? Yet you bet on bonds.

 

YTD, that bet isn't paying off:

 

 VMBSX (Mortgages) +.23%

 

VICSX (Corporate) +2.18%

 

VWEAX (HY) +5.46%

 

VEGBX (EM) +6.01%

 

VFIAX (S&P500) +18.71%

 

VITAX (IT) +36.43%

 

It may have been the smart bet ex-ante, but . . . 

 

 

Yes, in a year where equities are up nearly 20%, it's no surprise they've outperformed bonds. Short term bonds, money market, and i-bonds killed equities in 2022. And despite the performance this year, a lot of those are still ahead, or matching, equities performance over the 2 years with way smaller drawdowns and better forward looking prospects

 

What I see from your chart is HY, EM, and short-term bonds put up high single digit rates of returns despite 100 bps of rate hikes (and likely another 25 bps priced in). The higher yields go, the less sensitive bonds become to them. If rates go up another 1.00% I think bonds will be similarly unbothered given the YTMs priced in. Can we say that for stocks? 

 

It's almost mathematically impossible to get another 15% down year in fixed income. Rates would have to go up another ~200-250 bps for that to be the case intermediate IG. Equities could fall 15% next month and still be expensive relative to bonds....

 

 

[TwoCitiesCapital]

28 minutes ago, Gregmal said:

Because this largely isn’t true and short term cherry picked datapoints can be manipulated to say pretty much whatever one wants. If we pinch the timeline in here, then discard that, then only talk this subsector of an asset class, and then discredit that leg of the rally…..I mean it’s just all a little too far fetched and unproductive. I mean bottle all this up and summarize it and it’s basically “don’t own stocks cuz occasionally there’s short term periods where they do poorly or something else in the universe does better and every once in a while you get a big decline”….I mean just up thread you’re kinda of downplaying how poorly bonds have done because “they’re up across all accounts” and the goal is absolute returns, and then a few points later it’s like “oh 6.7% over a tough two year stretch sucked compared to other things”…wouldnt the consistent logic dictate that single digit bond returns are awful because you should’ve owned the Nasdaq for 2023? 
 

So again it all just kinda comes back to this generally obvious idea that unless you are hyper focused on the short term guessing games that likely don’t have probability of desired outcome any more favorable than casino games…stocks are what you wanna own?

Not true? I gave you the numbers?!?!

 

Pinch the data?!?! I went all the way back to April of 2021 to present. 2.5 years when inflation was occurring! How long do I need to give stocks to determine that they sucked as an inflation hedge over an inflationary period of time? 

 

A decade?

 

I did that too with the 70s. You just prefer to tell me I'm wrong with nothing supporting your stance. 

Edited September 15, 2023 by TwoCitiesCapital

[Gregmal]

Right so the goal “compounding capital as fast as possible” is somewhat contradicted by only seeking “absolute returns”, especially when the absolute returns pale in comparison to readily available alternatives. Like if the objective was to compound capital fast, and one hugely accessible, diversified and liquid option does 20% and the other does 0-5%….how is that anything but a failure? Or is that when we stretch the goalposts again? 
 

Historically, stocks are what compound capital the fastest over a medium to long term period of time. There’s numerous reasons as to why and most are sustainable phenomena in places like the US. Short term, if it ain’t obvious by now, people are just guessing and only with hindsite and a conveniently picked start and end date does the crystal ball exist. This year is evidence of that.

[Gregmal]

7 minutes ago, TwoCitiesCapital said:

Not true? I gave you the numbers?!?!

 

Pinch the data?!?! I went all the way back to April of 2021 to present. 2.5 years when inflation was occurring! How long do I need to give stocks to determine that they sucked as an inflation hedge over an inflationary period of time? 

 

A decade?

 

I did that too with the 70s. You just prefer to tell me I'm wrong with nothing supporting your stance. 

Because you have consistently limited the start points to first, only 2022. And now mid 2021. Inflation began in summer 2020. But even using your second starting point, the returns are positive during a period which many other things didn’t do well. So the argument here is essentially 1) 2022….occasionally stocks don’t do well(while ignoring some bonds but touting others…again cherry picking) or 2) there was this other 2.5 year stretch where stocks only did 7% and that’s awful but it’s been a good year in fixed income with 0-5% returns?

Edited September 15, 2023 by Gregmal

[Gregmal]

I also don’t really think it’s debatable either how the CPI lags. Been over this a gazillion times in this and the bottom thread. So not coincidentally, April 2021 is when it started lapping. Why? Because the initial COVID shock and declines occurred in March and April 2020. From there, it was off to the races as far as inflation went. Influenced by supply chains, stimulus, and different places taking different approaches to COVID. Commodities, equities, housing, etc all began their ascent very clearly around spring/summer 2020 which is why it took til mid 2021 to reflect in the data, largely fueled by the low base, but nonetheless a base that perhaps masked what was going on to the idiots at the Fed who only seem to follow CPI and things that lag.

[Spekulatius]

37 minutes ago, Gregmal said:

I also don’t really think it’s debatable either how the CPI lags. Been over this a gazillion times in this and the bottom thread. So not coincidentally, April 2021 is when it started lapping. Why? Because the initial COVID shock and declines occurred in March and April 2020. From there, it was off to the races as far as inflation went. Influenced by supply chains, stimulus, and different places taking different approaches to COVID. Commodities, equities, housing, etc all began their ascent very clearly around spring/summer 2020 which is why it took til mid 2021 to reflect in the data, largely fueled by the low base, but nonetheless a base that perhaps masked what was going on to the idiots at the Fed who only seem to follow CPI and things that lag.

Looks to me like inflation is picking up again due to rising energy and commodity prices. I think it's well possible that we have seen the bottom in inflation or are close to it.

[TwoCitiesCapital]

1 hour ago, Gregmal said:

Because you have consistently limited the start points to first, only 2022. And now mid 2021. Inflation began in summer 2020. But even using your second starting point, the returns are positive during a period which many other things didn’t do well. So the argument here is essentially 1) 2022….occasionally stocks don’t do well(while ignoring some bonds but touting others…again cherry picking) or 2) there was this other 2.5 year stretch where stocks only did 7% and that’s awful but it’s been a good year in fixed income with 0-5% returns?

 

I gave you the 70s as well. An entire decade that you ignore while accusing me of pinching data to 28 months while using only the last 9 months of a 15-20% rally to prove your point. 

 

CPI does lag. What inflation measure should we use to determine the efficacy of "inflation hedges" then?

And what levels does it need to get to that we consider "inflationary"? Or if we move back the starting point of S&P returns because it anticipated inflation, do we also get to move back the end point and exclude the current rally because of the anticipation of inflation falling? Give me a better benchmark, measure, methodology and we'll take a look. 

 

And yes - bonds can still be better than stocks even with trailing returns aren't attractive because the investment game is played looking forward. Would also say if you get -3% in bonds and -3% in stocks, bonds are still the winner because you took way less risk to accomplish the same return. 

 

I wasn't advocating for bonds in 2021. I started buying price insensitive iBonds in November of 2011 when they were yielding 7+%. Those have crushed the S&P over that time.

 

I started advocating for short-term debt when rates were 3.5-4% and for extending that duration when long term rates got above ~4%. Both of those occurred early in late 2022/early 2023. This approach would have bypassed ALL of the pain in equities in 2022, most of the pain on fixed income in 2022, and would have had you significantly ahead of the S&P 500 over that period of time even with the current equity rally.

 

Additionally , you would now have a short-to-intermediate portfolio with forward looking returns of 6-8% versus the S&Ps current forward looking return of ~4-5%. This is based on current earnings yields and expected "growth" (which is generous as growth is currently negative ATM) and no economic prognosis on GDP, recessions, current earnings contractions, inflation, etc. 

 

This isn't cherry picked in hindsight. It's what I did with my portfolio. The equities I held largely crushed the indices or were traded in a way that did so. The i-bonds? Crushed the S&P over that time. Nowoving from iBonds to short-term and intermediate term debt in 2023? Lagging over the last 9 months, but still outperformance overall with very strong look-forward prospects. My performance in 2022 was only hampered by a very large weighting to crypto which I don't actively manage and simply DCA. The crypto position is wholly unrelated to any views on the economy/inflation and largely just DCA'd/staked with the 

 

I don't know why it's so hard to believe there are periods of time bonds are better than equities. History is literally littered with examples. But I guess we can ignore all of those like we're ignoring all of the times equities sucked (either relative to bonds or commodities or both) during inflationary periods? 

 

 

 

 

 

Edited September 15, 2023 by TwoCitiesCapital

[Gregmal]

11 minutes ago, Spekulatius said:

Looks to me like inflation is picking up again due to rising energy and commodity prices. I think it's well possible that we have seen the bottom in inflation or are close to it.

Yup. The two unbreakable forces stand alone. Housing and energy. Not gonna be solved with rate hikes, only made worse by them.

[Gregmal]

27 minutes ago, TwoCitiesCapital said:

 

I gave you the 70s as well. An entire decade that you ignore while accusing me of pinching data to 28 months while using only the last 9 months of a 15-20% rally to prove your point. 

 

CPI does lag. What inflation measure should we use to determine the efficacy of "inflation hedges" then?

And what levels does it need to get to that we consider "inflationary"? Or if we move back the starting point of S&P returns because it anticipated inflation, do we also get to move back the end point and exclude the current rally because of the anticipation of inflation falling? Give me a better benchmark, measure, methodology and we'll take a look. 

 

And yes - bonds can still be better than stocks even with trailing returns aren't attractive because the investment game is played looking forward. Would also say if you get -3% in bonds and -3% in stocks, bonds are still the winner because you took way less risk to accomplish the same return. 

 

I wasn't advocating for bonds in 2021. I started buying price insensitive iBonds in November of 2011 when they were yielding 7+%. Those have crushed the S&P over that time.

 

I started advocating for short-term debt when rates were 3.5-4% and for extending that duration when long term rates got above ~4%. Both of those occurred early in late 2022/early 2023. This approach would have bypassed ALL of the pain in equities in 2022, most of the pain on fixed income in 2022, and would have had you significantly ahead of the S&P 500 over that period of time even with the current equity rally.

 

Additionally , you would now have a short-to-intermediate portfolio with forward looking returns of 6-8% versus the S&Ps current forward looking return of ~4-5%. This is based on current earnings yields and expected "growth" (which is generous as growth is currently negative ATM) and no economic prognosis on GDP, recessions, current earnings contractions, inflation, etc. 

 

This isn't cherry picked in hindsight. It's what I did with my portfolio. The equities I held largely crushed the indices or were traded in a way that did so. The i-bonds? Crushed the S&P over that time. Nowoving from iBonds to short-term and intermediate term debt in 2023? Lagging over the last 9 months, but still outperformance overall with very strong look-forward prospects. My performance in 2022 was only hampered by a very large weighting to crypto which I don't actively manage and simply DCA. The crypto position is wholly unrelated to any views on the economy/inflation and largely just DCA'd/staked with the 

 

I don't know why it's so hard to believe there are periods of time bonds are better than equities. History is literally littered with examples. But I guess we can ignore all of those like we're ignoring all of the times equities sucked (either relative to bonds or commodities or both) during inflationary periods? 

 

 

 

 

 

All this just seems like a market timing exercise and the results of market timing calls over the years generally wouldn’t be encouraging for an investor. Of course there’s periods where other stuff will do better than stocks. Bonds are no exception. The 70s is one example and there’s way more to it than just “oh inflation”. It’s not comparable to one year coming out of COVID where we had a knee jerk summer sell off derived from people trying to day trade CPI prints and guess what Jerry’s gone do. 
 

So I guess yea if you wanna be super actively managing stuff every few weeks or months then why not? But if your goal is to grow your pile over the long haul there just seems to be such a higher return on capital, and return on brainpower selectively buying quality stocks. Especially for investors getting started. I mean like can’t one only buy $10k of ibonds? Like that’s not even an allocation, why bother? Let alone actively jumping around. 

[james22]

2 hours ago, TwoCitiesCapital said:

Short term bonds, money market, and i-bonds killed equities in 2022.

 

They did. Did you bet on bonds at the beginning of 2022?

 

How did that inform your decision at the beginning of this year to hide out the forecast 2023 recession in bonds rather than equities?

 

 

[Viking]

1 hour ago, Spekulatius said:

Looks to me like inflation is picking up again due to rising energy and commodity prices. I think it's well possible that we have seen the bottom in inflation or are close to it.

The tricky thing about inflation is just when you think you have it licked it pops higher again. At least that was the experience in prior inflationary episodes. Central banks are starting to look and sound like they think they have inflation licked. I am not so sure.
 

Here in Canada we have record government spending.. that continues to increase. We also have a severe housing shortage so all levels of government are now rallying to try and get more housing units built (yes, at the same time the Bank of Canada is trying to slow housing). Rental prices continue to increase (at least in Vancouver) driven by record low vacancy rate. Minimum wages in almost all jurisdictions are up meaningfully year over year. Wealth effect has minted millions of millionaires (housing bubble) over the last decade - these people continue to spend. Much higher interest rates is spiking interest income of savers (like my mother-in-law) and that new meaningful income stream is leading to increased spending.  Oil spiking is now feeding through to increases at the gas station….

 

In my province we are building a massive hydro dam in the north east of the province. We are building two large pipelines (one to Vancouver and the other to Kitimat) thousands of miles long at something like triple the original cost. A LNG facility is being built in Kitimat. The Province is also doing a massive rebuild of the infrastructure destroyed by record flooding 2 years ago (all over the province). Forest fires just wiped out hundreds of expensive houses in the interior - now those all will get rebuilt. Oil and gas and mining is all doing well. I could go on and on. 
 

This is just my long winded way of saying that i agree with you. This suggests to me we might see higher for longer when it comes to interest rates. Like perhaps well into next year. And if inflation actually pops again perhaps we see central banks actually tighten even more. 
 

I really have no idea. So no strong conviction. But it is super interesting… 

Edited September 15, 2023 by Viking

[RichardGibbons]

8 hours ago, Dinar said:

@RichardGibbons, I grew up in the Soviet Union, you do NOT want to live in a place where everyone is equal.  The US does have serious problems and this is how I would begin to address them:

 

a) Stop immigration.  Immigration expands labor supply and depresses wages, particularly for unskilled and the poor.  Raises cost of housing, again impacting the poor and middle class the most.  

b) Fix public school system (just don't spend more money - NYC spends USD 40K per kid, and outcomes are awful, Newark tripled its spending per pupil, nothing improved.) and give vouchers for private schools to kids.  Break the monopoly of public schools.  Mandate personal finance classes in every grade starting with 5th in every school, and teach personal responsibility.  Classes how to choose a spouse, a job.  

c) End federal guarantee of student loans which just serve to enrich colleges.  Use the money to reduce budget deficit.  

d) End personal income tax on the first USD 50K of income of you are single, $100K if you are married, and say $100K if you are single + kids, $200K if you are married with kids.  End all personal deductions, including for charity and mortgage interest.  

e) Fix healthcare system which is dysfunctional and a cancer on the US.  Three quick solutions: 1) Every hospital/medical practice should have publicly listed price list and law of one price - you have to charge everyone, ensured and uninsured same price, no $50K bill but $10K if you have insurance (80% discount negotiated by your insurance company) and $50K if you pay cash.  2) Mandate that for every medicine in the US, pharmaceutical companies cannot  charge more than say 30% more than the same medicine costs in Canada.  3) Ban rebates and other abusive practice in the pharmaceutical industry in the US.  

f) Reform welfare and other social programs.  It should not be that in the US, a single mother with 2 kids gets so much generous support that she needs to earn $150K per annum in NYC before she is better off working than sitting on the dole.  

g) Stop the whole switch to solar and wind which is very expensive, particularly for the poor, and build nuclear power plants - cheap, environmentally friendly electricity.

 

I am sure that there are a number of things that should be done that I have missed.  

 

I agree that equality is awful. Much, much worse than the situation we have now. It's very clear and obvious that you have to maintain incentives or everything breaks.

 

a) I think reducing immigration is sensible, but stopping immigration completely is not good. I think immigrants are self-selecting to be much more likely to be hard-working, ambitious, and entrepreneurial than the average citizen. So, I think it makes sense to let in the immigrants with needed high-value skills, and block the others. Then you don't have the immigrants competing with the poor for resources and jobs, and but still get people that add more value than the average American. (Though this would likely be mildly inflationary.)

 

b) Works for me.

 

c) I agree with your analysis of the current situation, but if you do this, I'm not sure how you ensure that the economic bottom 50% have the ability to get a higher education. Education is highly correlated with income mobility. But I don't have a better solution than yours, either.

 

d) This is interesting, because I didn't think it was possible to do this without blowing up the national debt, but I think it is. I'd guess that you'd lose only about $200B in federal tax revenue doing that. Neat idea.

 

e) Very reasonable, though I'm not a fan of your second item because I think it would increase prices in Canada to the same as the USA, rather than the reverse.  And I'm a Canadian, so that would suck. LOL.

 

f) If that's the actual math, then that makes sense. It's critical not to break incentives.

 

g) Yep.

 

Thanks for the response.  I'm certainly going to adopt some of these as reasonable strategies I'll argue.

[thepupil]

I again think that the discussion on stocks vs bonds is overly binary. For me it's choice of 100% stocks 0% bonds or 60-80% stocks, 20-40% bonds. In my opinion no sane person is going to go 100% bonds/cash as that is clearly destructive to long term wealth and introduces a debasement tail risk. I'd really struggle to sleep at night having all my assets in nominal instruments.  bonds have historically generated positive real returns (and will going forward), but you still don't want to have everything in them if "the big one" (in terms of currency) ever happens. 

 

Rather than run a bunch of monte carlos or look at 1000's of historical scenarios, I prefer a more simplistic exercise. 

 

Over the last 10 years,  US stocks (defined as VTSAX) have returned 12.2%/yr.  (215% cumulative)

Over the last 10 years,  US bonds  (defined as VBTLX) have returned 1.5% / yr.  (15.6% cumulative)

Over the last 10 years, a 60/40 portfolio (defined as VBIAX) has returned 8.0%/yr (116% cumulative)

 

Notice how the 60/40 returned about what you'd expect. (12.2%*0.6=7.3%)+(1.5%*0.4=0.6%) = 7.3%+0.6% = 7.9%. the 60/40 portfolio did a little better in practice but there wasn't a lot of rebalancing benefit (like 0.1%/yr). the cost of decreasing volatility by investing in the balanced index has been pretty freaking huge. About 100% of starting value. Starting with $1mm, the 60/40 guy has $2.15mm and the 100% stocks guy has $3.15mm

 

What will that number be for the next 10 years? Well we know that absent defaults (the agg isn't going to have many defaults and neither are IG bonds), bonds will make their yield to maturity if held to the duration of the index. So the duration/maturity of the bond index isn't quite 10 years, but let's just say it is (one can buy 10 yr fixed income if one wants to). The barclays aggregate has a yield to maturity of 5.1%. So going forward, rather than make 1.5%/yr, bonds will make 5.1%/yr, if held for long enough. Let's say stocks defeat the naysayers and repeat the last decade's amazing returns, tey make 12.2%. 

 

So a 60/40 portfolio will make about 9.3%/yr vs 100% stocks at 12.2% (assuming no rebalancing benefit). This is $2.4mm vs $3.15mm for a $1mm starting nut. There's still a big difference and a high cost of "safety" of bonds, but it's 28% less than the prior decade. ($715K of wealth difference instead of $1mm). IF you think stocks do 8%/yr instead of 12% and assume no rebalancing benefit, then the wealth difference is $220K in favor of 100% stock portfolio. The cost of lower volatility of the balanced portfolio is 78% lower than the prior decade. Of course as you get closer to or even lower than the bond yield on forward equity returns, then there is no cost to having a substantial portion in bonds.. Portfolios with bonds will end up with better returns. 

 

So I'd frame it as something like this, 

 

If stocks make 12%/yr (repeat wondrous bull market), the cost of incremental safety from carrying bonds will be 30% less than the prior decade, but still substantial. 

If stocks make 8%/yr, then the cost of safety will be 78% less than the prior decade. 

If stocks make less, there will likely be little to no cost of safety. 

I can't really predict the market's next 10 years of returns. I don't know, but I think the above supports that holding bonds will have significantly less opportunity costs than it has in the past. In my view, the above logic supports a weighting to bonds significantly greater than the prior decade (which for me was basically 0). For now that's something like 20-25%, and going higher. Also, anyone who's been investing and saving for the prior decade should be many multiples richer in 2023 than in 2013. As you get richer, keeping the money instead of optimizing for absolute highest NW makes sense for many, but not all people. There are some people who are inclined to take more risk as they get wealthier. I am not one of those. My goal is to reduce dependence on my labor via accumulation of capital. my goal is not to have the highest possible net worth in 50 years. If someone who invest in all stocks ends up 10,20,30% wealthier than i do over the next decade because stocks do really well, I'm not going to care. If it's 50-100%+, I will care. But either way if stocks do very well for next decade, then I'll be just fine. 

 

I'd also posit the rebalancing benefit will probably be higher in the next decade than in the last. This tilts the math in favor of including some bonds. Also we haven't taken into account portfolio withdrawals and sequence of returns, which will tilt things further to the less volatile portfolio that has bonds. 

 

I don't really think the inclusion of bonds in a portfolio is about market timing or predicting doom and gloom. I think it's about bond yields (nominal AND real) being substantially higher than they have been and equity yields do not appear to be any higher today than they have been; owning more bonds today than in the past 10+ years seems like a rational response to changes in relative pricing. It's fundamental investing. The inclusion of bonds will probably have lower opportunity cost than it has and may even lead to better outcomes than all stock portfolio. the era of financial repression is over (at least for now). we have positive real rates. we aren't forced to invest in just risk assets anymore. 

 

the entirety of this ignores any potential value add from active management. it also ignores the more extreme upside/downside of longer term bonds, which I invest in to be a little more grey. A 20 yr IG bond at 6.2-6.5% is more competitive w/ equities, but also far less predictable in return over an intermediate horizon so the math isn't quite as clean as the above.

 

It's also very US centric. Prospective US bond returns look MUCH better if you think stocks outside the US repeat the prior decade's shittiness. tat wouldn't be my prediction, but just saying that US stock market participants have been incredibly spoiled of late relative to ex US. EM index has made 3.5%/yr for 10 years and developed international 5.1%. US bonds yields are higher today than either of those. I'd wager the ex US indices will do better going forward, but strictly backward looking. 

Edited September 15, 2023 by thepupil

[changegonnacome]

3 hours ago, Spekulatius said:

Looks to me like inflation is picking up again due to rising energy and commodity prices. I think it's well possible that we have seen the bottom in inflation or are close to it.

 

Yep agree with this...and as expected from my point view and flagged a number of months ago......the problem for the inflation is toast folks.......is that during this whole time as the headline mathematically fell MoM in a kind of super late transitory COVID inflation rollover glide.....what didn't go away,  in fact hasn't budged nearly at all in response to 500bps of monetary tightening is a very unpleasant fact....stuff that doesnt get on shipping containers in China but is rather produced domestically here in the US.........services......which account for 'only' about 70% of GDP......have been bubbling away consistently under the headline inflation is falling narrative at around 4% annualized....in the best month over month readings so more contemporaneously in mid/late-3's.

 

The issue at hand as the Fed knows all too well........is that those types of numbers create an inflationary floor of 3%-3.5% for the US.....what I would call a fair weather floor.......on top of which inflationary surprises known (energy, commodities) and unknown move you up very unpleasantly, surprisingly & quickly into the 4 or 5% ranges.

 

It will be interesting to see what happens next.......Fed Funds relative to inflation today.....has created 200bps of genuine monetary tightness......that tightness has emerged only recently and in response incremental modest rate rises (the last few 25bps rate rises) twinned to genuine falling in inflation. The big mystery is whom is actually feeling that tightness and is it enough to drive down aggregate nominal spending growth sufficiently...its not quite showing up.......corporates & a great many households fixed significant debt during ZIRP.......higher for longer has always been my base case......but its starting to feel like some more tightning might be required to end this inflationary cycle.......Fed funds perhaps needs to go higher at the short end.....but in fact the tightening may come from other sources....and that's an un-inversion of the yield curve in a way that folks haven't been predicting and that's an universion driven by the long end.

[james22]

9 minutes ago, thepupil said:

There are some people who are inclined to take more risk as they get wealthier.

 

It's not quite so simple.

 

If you consider the possibility of a one-time jump in equity valuations as investors increasingly recognize stocks aren't much riskier than bonds (followed by bond-like returns), there's risk in missing the move and then being unable to support a historical SWR with what has become an essentially 100% bond portfolio.

[dealraker]

2 hours ago, thepupil said:

I again think that the discussion on stocks vs bonds is overly binary. For me it's choice of 100% stocks 0% bonds or 60-80% stocks, 20-40% bonds. In my opinion no sane person is going to go 100% bonds/cash as that is clearly destructive to long term wealth and introduces a debasement tail risk. I'd really struggle to sleep at night having all my assets in nominal instruments.  bonds have historically generated positive real returns (and will going forward), but you still don't want to have everything in them if "the big one" (in terms of currency) ever happens. 

 

Rather than run a bunch of monte carlos or look at 1000's of historical scenarios, I prefer a more simplistic exercise. 

 

Over the last 10 years,  US stocks (defined as VTSAX) have returned 12.2%/yr.  (215% cumulative)

Over the last 10 years,  US bonds  (defined as VBTLX) have returned 1.5% / yr.  (15.6% cumulative)

Over the last 10 years, a 60/40 portfolio (defined as VBIAX) has returned 8.0%/yr (116% cumulative)

 

Notice how the 60/40 returned about what you'd expect. (12.2%*0.6=7.3%)+(1.5%*0.4=0.6%) = 7.3%+0.6% = 7.9%. the 60/40 portfolio did a little better in practice but there wasn't a lot of rebalancing benefit (like 0.1%/yr). the cost of decreasing volatility by investing in the balanced index has been pretty freaking huge. About 100% of starting value. Starting with $1mm, the 60/40 guy has $2.15mm and the 100% stocks guy has $3.15mm

 

What will that number be for the next 10 years? Well we know that absent defaults (the agg isn't going to have many defaults and neither are IG bonds), bonds will make their yield to maturity if held to the duration of the index. So the duration/maturity of the bond index isn't quite 10 years, but let's just say it is (one can buy 10 yr fixed income if one wants to). The barclays aggregate has a yield to maturity of 5.1%. So going forward, rather than make 1.5%/yr, bonds will make 5.1%/yr, if held for long enough. Let's say stocks defeat the naysayers and repeat the last decade's amazing returns, tey make 12.2%. 

 

So a 60/40 portfolio will make about 9.3%/yr vs 100% stocks at 12.2% (assuming no rebalancing benefit). This is $2.4mm vs $3.15mm for a $1mm starting nut. There's still a big difference and a high cost of "safety" of bonds, but it's 28% less than the prior decade. ($715K of wealth difference instead of $1mm). IF you think stocks do 8%/yr instead of 12% and assume no rebalancing benefit, then the wealth difference is $220K in favor of 100% stock portfolio. The cost of lower volatility of the balanced portfolio is 78% lower than the prior decade. Of course as you get closer to or even lower than the bond yield on forward equity returns, then there is no cost to having a substantial portion in bonds.. Portfolios with bonds will end up with better returns. 

 

So I'd frame it as something like this, 

 

If stocks make 12%/yr (repeat wondrous bull market), the cost of incremental safety from carrying bonds will be 30% less than the prior decade, but still substantial. 

If stocks make 8%/yr, then the cost of safety will be 78% less than the prior decade. 

If stocks make less, there will likely be little to no cost of safety. 

I can't really predict the market's next 10 years of returns. I don't know, but I think the above supports that holding bonds will have significantly less opportunity costs than it has in the past. In my view, the above logic supports a weighting to bonds significantly greater than the prior decade (which for me was basically 0). For now that's something like 20-25%, and going higher. Also, anyone who's been investing and saving for the prior decade should be many multiples richer in 2023 than in 2013. As you get richer, keeping the money instead of optimizing for absolute highest NW makes sense for many, but not all people. There are some people who are inclined to take more risk as they get wealthier. I am not one of those. My goal is to reduce dependence on my labor via accumulation of capital. my goal is not to have the highest possible net worth in 50 years. If someone who invest in all stocks ends up 10,20,30% wealthier than i do over the next decade because stocks do really well, I'm not going to care. If it's 50-100%+, I will care. But either way if stocks do very well for next decade, then I'll be just fine. 

 

I'd also posit the rebalancing benefit will probably be higher in the next decade than in the last. This tilts the math in favor of including some bonds. Also we haven't taken into account portfolio withdrawals and sequence of returns, which will tilt things further to the less volatile portfolio that has bonds. 

 

I don't really think the inclusion of bonds in a portfolio is about market timing or predicting doom and gloom. I think it's about bond yields (nominal AND real) being substantially higher than they have been and equity yields do not appear to be any higher today than they have been; owning more bonds today than in the past 10+ years seems like a rational response to changes in relative pricing. It's fundamental investing. The inclusion of bonds will probably have lower opportunity cost than it has and may even lead to better outcomes than all stock portfolio. the era of financial repression is over (at least for now). we have positive real rates. we aren't forced to invest in just risk assets anymore. 

 

the entirety of this ignores any potential value add from active management. it also ignores the more extreme upside/downside of longer term bonds, which I invest in to be a little more grey. A 20 yr IG bond at 6.2-6.5% is more competitive w/ equities, but also far less predictable in return over an intermediate horizon so the math isn't quite as clean as the above.

 

It's also very US centric. Prospective US bond returns look MUCH better if you think stocks outside the US repeat the prior decade's shittiness. tat wouldn't be my prediction, but just saying that US stock market participants have been incredibly spoiled of late relative to ex US. EM index has made 3.5%/yr for 10 years and developed international 5.1%. US bonds yields are higher today than either of those. I'd wager the ex US indices will do better going forward, but strictly backward looking. 

Agree with this pupil - although it has no affect on what I will do as to investing.

[SharperDingaan]

Couple of observations.

 

Price inflation. We aren't going to have significant inflation when folks are getting 5-10% wage increases every year. We're just creating future unemployment as the goods produced become too expensive to buy, we make less of them, & more of what we do make is done with machines vs people.

 

Asset inflation. It is quite obvious that in a Canada/US, at required immigration levels, the state is going to have to become the mass builder of affordable apartments; and in quantities similar to that at the end of WWII to house returning soldiers. With the flood of new supply, today's high house values can only fall. Asset & credit deflation.

 

Interest rates. Grandma eats a lot better when her 100K of capital pays a 5% coupon vs a 1% coupon. The money gets spent on necessities & travel; & with less program spend on seniors, there is less money goosing the economy. Deflation.

 

Stocks/Bonds, 60/40 split. The real measure is the Sharpe Ratio; there are routinely times when bonds are a lot better than equities. The distressed bond that returns to par, the high duration zero-coupon in a falling yield environment, etc. Bonds are bought to provide cash, stocks are bought to provide growth; apples to oranges comparison.

 

Oil/gas isn't the inflation builder it was; simply because the more the world's capital stock moves to EV, the less of an impact oil/gas has. It's still good to be the producer, but you're in run-off mode and net capital recovery (cash cow).

 

So what? Sure, the indexes could go 10% higher than they are today; but, they could also go down - & by more. Given the rapidly growing list of global problems, repeated climate change events, & easy availability of high coupon treasuries (avoiding the risk altogether), which do you think the more likely? 

 

SD

 

 

  

 

[Guest]

7 hours ago, SharperDingaan said:

Couple of observations.

 

Price inflation. We aren't going to have significant inflation when folks are getting 5-10% wage increases every year. We're just creating future unemployment as the goods produced become too expensive to buy, we make less of them, & more of what we do make is done with machines vs people.

 

Asset inflation. It is quite obvious that in a Canada/US, at required immigration levels, the state is going to have to become the mass builder of affordable apartments; and in quantities similar to that at the end of WWII to house returning soldiers. With the flood of new supply, today's high house values can only fall. Asset & credit deflation.

 

Interest rates. Grandma eats a lot better when her 100K of capital pays a 5% coupon vs a 1% coupon. The money gets spent on necessities & travel; & with less program spend on seniors, there is less money goosing the economy. Deflation.

 

Stocks/Bonds, 60/40 split. The real measure is the Sharpe Ratio; there are routinely times when bonds are a lot better than equities. The distressed bond that returns to par, the high duration zero-coupon in a falling yield environment, etc. Bonds are bought to provide cash, stocks are bought to provide growth; apples to oranges comparison.

 

Oil/gas isn't the inflation builder it was; simply because the more the world's capital stock moves to EV, the less of an impact oil/gas has. It's still good to be the producer, but you're in run-off mode and net capital recovery (cash cow).

 

So what? Sure, the indexes could go 10% higher than they are today; but, they could also go down - & by more. Given the rapidly growing list of global problems, repeated climate change events, & easy availability of high coupon treasuries (avoiding the risk altogether), which do you think the more likely? 

 

SD

 

 

  

 

 

Are you like 100% short, dude?

[UK]

https://www.bloomberg.com/news/articles/2023-09-15/beyond-the-ai-euphoria-is-a-worrying-stock-signal-on-us-growth

 

Look past the exuberance for all things artificial intelligence and you find a stock market backdrop where confidence in American growth is far less robust than it seems. It’s in the dispiriting performance of banks and industrial companies, barely eking out gains in 2023 while the likes of Tesla Inc. and Nvidia Corp. double and triple. Pessimism is visible in versions of major benchmarks that pare down the influence of megacaps, such as the equal-weight S&P 500, up a relatively paltry 4% so far this year. Also alarming is the performance of small-cap stocks, whose charts show worrying signals barely seen over the past two decades. The Russell 2000 has fallen behind an index of the 1000 largest-capitalization stocks for the second month in a row, on track for its second-worst annual underperformance since 1998.

[Cigarbutt]

On 9/14/2023 at 2:37 PM, RichardGibbons said:

...

The problem is that this stuff doesn't actually do what you want it to because it assumes a static world.  The world isn't static, and in a non-static world capitalism wins (for everyone, not just the rich) because incentives matter.

...

Thank you @RichardGibbons for your contributions in this thread.

The topic is concerning but i'm slowly getting around to a very optimistic outlook based on (still unseen in what appears to be very static) significant productivity gains to be achieved over time.

[UK]

13 hours ago, thepupil said:

I again think that the discussion on stocks vs bonds is overly binary. For me it's choice of 100% stocks 0% bonds or 60-80% stocks, 20-40% bonds. In my opinion no sane person is going to go 100% bonds/cash as that is clearly destructive to long term wealth and introduces a debasement tail risk. I'd really struggle to sleep at night having all my assets in nominal instruments.  bonds have historically generated positive real returns (and will going forward), but you still don't want to have everything in them if "the big one" (in terms of currency) ever happens. 

 

Rather than run a bunch of monte carlos or look at 1000's of historical scenarios, I prefer a more simplistic exercise. 

 

Over the last 10 years,  US stocks (defined as VTSAX) have returned 12.2%/yr.  (215% cumulative)

Over the last 10 years,  US bonds  (defined as VBTLX) have returned 1.5% / yr.  (15.6% cumulative)

Over the last 10 years, a 60/40 portfolio (defined as VBIAX) has returned 8.0%/yr (116% cumulative)

 

Notice how the 60/40 returned about what you'd expect. (12.2%*0.6=7.3%)+(1.5%*0.4=0.6%) = 7.3%+0.6% = 7.9%. the 60/40 portfolio did a little better in practice but there wasn't a lot of rebalancing benefit (like 0.1%/yr). the cost of decreasing volatility by investing in the balanced index has been pretty freaking huge. About 100% of starting value. Starting with $1mm, the 60/40 guy has $2.15mm and the 100% stocks guy has $3.15mm

 

What will that number be for the next 10 years? Well we know that absent defaults (the agg isn't going to have many defaults and neither are IG bonds), bonds will make their yield to maturity if held to the duration of the index. So the duration/maturity of the bond index isn't quite 10 years, but let's just say it is (one can buy 10 yr fixed income if one wants to). The barclays aggregate has a yield to maturity of 5.1%. So going forward, rather than make 1.5%/yr, bonds will make 5.1%/yr, if held for long enough. Let's say stocks defeat the naysayers and repeat the last decade's amazing returns, tey make 12.2%. 

 

So a 60/40 portfolio will make about 9.3%/yr vs 100% stocks at 12.2% (assuming no rebalancing benefit). This is $2.4mm vs $3.15mm for a $1mm starting nut. There's still a big difference and a high cost of "safety" of bonds, but it's 28% less than the prior decade. ($715K of wealth difference instead of $1mm). IF you think stocks do 8%/yr instead of 12% and assume no rebalancing benefit, then the wealth difference is $220K in favor of 100% stock portfolio. The cost of lower volatility of the balanced portfolio is 78% lower than the prior decade. Of course as you get closer to or even lower than the bond yield on forward equity returns, then there is no cost to having a substantial portion in bonds.. Portfolios with bonds will end up with better returns. 

 

So I'd frame it as something like this, 

 

If stocks make 12%/yr (repeat wondrous bull market), the cost of incremental safety from carrying bonds will be 30% less than the prior decade, but still substantial. 

If stocks make 8%/yr, then the cost of safety will be 78% less than the prior decade. 

If stocks make less, there will likely be little to no cost of safety. 

I can't really predict the market's next 10 years of returns. I don't know, but I think the above supports that holding bonds will have significantly less opportunity costs than it has in the past. In my view, the above logic supports a weighting to bonds significantly greater than the prior decade (which for me was basically 0). For now that's something like 20-25%, and going higher. Also, anyone who's been investing and saving for the prior decade should be many multiples richer in 2023 than in 2013. As you get richer, keeping the money instead of optimizing for absolute highest NW makes sense for many, but not all people. There are some people who are inclined to take more risk as they get wealthier. I am not one of those. My goal is to reduce dependence on my labor via accumulation of capital. my goal is not to have the highest possible net worth in 50 years. If someone who invest in all stocks ends up 10,20,30% wealthier than i do over the next decade because stocks do really well, I'm not going to care. If it's 50-100%+, I will care. But either way if stocks do very well for next decade, then I'll be just fine. 

 

I'd also posit the rebalancing benefit will probably be higher in the next decade than in the last. This tilts the math in favor of including some bonds. Also we haven't taken into account portfolio withdrawals and sequence of returns, which will tilt things further to the less volatile portfolio that has bonds. 

 

I don't really think the inclusion of bonds in a portfolio is about market timing or predicting doom and gloom. I think it's about bond yields (nominal AND real) being substantially higher than they have been and equity yields do not appear to be any higher today than they have been; owning more bonds today than in the past 10+ years seems like a rational response to changes in relative pricing. It's fundamental investing. The inclusion of bonds will probably have lower opportunity cost than it has and may even lead to better outcomes than all stock portfolio. the era of financial repression is over (at least for now). we have positive real rates. we aren't forced to invest in just risk assets anymore. 

 

the entirety of this ignores any potential value add from active management. it also ignores the more extreme upside/downside of longer term bonds, which I invest in to be a little more grey. A 20 yr IG bond at 6.2-6.5% is more competitive w/ equities, but also far less predictable in return over an intermediate horizon so the math isn't quite as clean as the above.

 

It's also very US centric. Prospective US bond returns look MUCH better if you think stocks outside the US repeat the prior decade's shittiness. tat wouldn't be my prediction, but just saying that US stock market participants have been incredibly spoiled of late relative to ex US. EM index has made 3.5%/yr for 10 years and developed international 5.1%. US bonds yields are higher today than either of those. I'd wager the ex US indices will do better going forward, but strictly backward looking. 

 

Thanks for comment.

 

While discussing bonds vs equities I somehow always tend to think in terms of very long term bonds, which could mislead and I do not like them most, especially for buy and hold. I admit, that under certain circumstances, depending on valuations and alternatives, I would go up to 30 per cent (or even more, but perhaps very unlikely) cash or short term bonds (or even longer term) and was in a such position for a quite few times in the past. 

 

But also, looking historically, 10 year rates were perhaps like 6 per cent and it was considered normal, while at the same time dotcom craze was going on successfully for quite a while. Just because now they are back to something more or less normal, perhaps does not necessarely mean the end of the world and I am not sure if it automatically merits large allocation, especially if absolute levels are still nothing special (and under required IRR, at least for me) and one can still find equities, providing at least 8-10 expected returns (even BRK still likely clears such a hurdle), if we are talking about longer term horizon. 

 

Edited September 16, 2023 by UK

[Gregmal]

1 hour ago, UK said:

 

Thanks for comment.

 

While discussing bonds vs equities I somehow always tend to think in terms of very long term bonds, which could mislead and I do not like them most, especially for buy and hold. I admit, that under certain circumstances, depending on valuations and alternatives, I would go up to 30 per cent (or even more, but perhaps very unlikely) cash or short term bonds (or even longer term) and was in a such position for a quite few times in the past. 

 

But also, looking historically, 10 year rates were perhaps like 6 per cent and it was considered normal, while at the same time dotcom craze was going on successfully for quite a while. Just because now they are back to something more or less normal, perhaps does not necessarely mean the end of the world and I am not sure if it automatically merits large allocation, especially if absolute levels are still nothing special (and under required IRR, at least for me) and one can still find equities, providing at least 8-10 expected returns (even BRK still likely clears such a hurdle), if we are talking about longer term horizon. 

 

This is pretty consistent with what I feel. Bond returns are mediocre based on historical levels. With no shortage of stocks that offer a whole lot more, it’s just hard to even consider them, let alone get excited. But like the virgin nerd who starts making six figures and realizes he can now get laid, initially it’s an exciting new world. 
 

5-7% rates are pretty much normal. We had the housing bubble on the back of these same mortgage rates, following a tech boom/burst, and you can go back even further to see the world existed under these conditions and even higher rates, actually. 
 

Over time too, I’ve found that there’s two types of investors. Ones who can not tolerate volatility and feel like world beaters avoiding drawdowns even if they fail to participate in eventual upside, and then people who just stay the course. During COVID and in 2022 really highlighted this to me. There’s two sides to the coin of “I didn’t lose much” and “I got some really great investments”. They almost always are happening at the same time. And your perspective will really shape everything in terms of your eventual fortunes. If you like something at $100 and are ok with it there, you should be elated if it’s presented at $70 or $40. Not sobbing about “most lost” that you shouldn’t have even needed if you were investing the right way it in the first place. 

[Gregmal]

17 minutes ago, dealraker said:

Yes Greg, that model of thought to program in your mind the downs in advance is my game and I've practiced it to the max.  It is as simple as saying, "Let's see...I have $3 million of investments in stuff that I think will do well over time and I can invision right now it showing up as $2.2 million...so can I deal with it or what holdings am I going to flee out of when it happens?"  I'm just not going to hold something that I'm fleeing from in the down cycle.  The only thing I've really predicted was the banking crisis of 2007-09 or whatever, to me that one was obvious.  Of course my portfolio went down 50% or whatever....and I didn't predict that whatsoever but it didn't phase me.

 

Over-confidence is most prevalent in people's thinking they'll stay the course, they simply do not in a lot of cases.  But I think Greg and Charlie will.

 

Much like 50 plus years of driving a car.  I've had a whole bunch of near death events but I drive right on down the road thinking, "Hell, don't spin your mind rehashing that one because another one is coming likely soon."  

 

Life is great...if you can stand it.

There is also just kinda that whole “thinking like an owner” thingy. To some I guess it’s natural, to most though I’ve gandered it’s hard to be there, mentally. The drawdowns on money you don’t need aren’t really troubling because I’m enthusiastic about my ownership in great businesses growing 10/20/1000%. Last year wasn’t troublesome at all. It was peaceful and even downright boner inducing being able to buy MSG entities at sub 10x earnings and fractions of a growing NAV. Because IDK Sphere was gonna cost $8b or something dumb. Or Joe at similarly spectacular and exciting metrics because people are land deniers or wanted to make up all these crazy things that were going to happen to one years earnings(which are shaping up to be spectacular).
 

You look at why so many people have done so well in Berkshire and outside of the obvious, and I think it’s because it draws in people who think long term, like owners. They appreciate the good and get giddy about the bad because the bad is where and when the magic happens and the long term value gets amplified. There is this feeling I get that most people have little to no real desire to own a business that trades publicly if they think it will go down 20% in the short term. They show up to a game that is almost 100% certain to be won playing it over the long haul and then on day 2 decide they’re going to guess black or red and then hedge the green zeros. Of course they convince themselves that they don’t always do this, just on exceptional occasions(I’ve over time had to catch myself with this sort thing) but then you realize that there’s always an exceptional scenario or risk in the markets, 100% of the time. 

[TwoCitiesCapital]

20 hours ago, james22 said:

 

They did. Did you bet on bonds at the beginning of 2022?

 

How did that inform your decision at the beginning of this year to hide out the forecast 2023 recession in bonds rather than equities?

 

 

 

I had short-term bond funds/money market that was from proceeds from equity sales in late 2021/early 2022. 

 

I was predominantly in commodity producers/energy outside of my Fairfax and Exor positions in 2021/2022. Most of those did exceptionally well, but I realize things don't move in a straight lines. Those valuations exploded and took a lot of profits. Given the mania in stocks that was occurring in 2021, I was concerned about downdrafts in equity valuations and earnings. 

 

We got some of that in 2022, but not as much as I expected. Those short term bonds funds were down ~4-6% during 2022, so I was negative on that portion. But compared to the 25-50% drawdowns on the commodity names I had sold and the 15-20% drawdown for the indices on general, it was an exceptional move to protect profits/values versus the alternative. Especially now that it's given me dry powder to redeploy into those same names again. 

 

My conviction in fixed income has only grown since then: 

 

1) Continued hikes have only improved the forward looking returns for fixed income investments which now can get you equity like returns in spread products 

 

2)) the yield curve inversion WILL choke off credit creation. Regardless of your views on the economy, this will slow it. It is inevitable in a credit based economy and banks don't really have the choice - they don't have the capital/liquidity to support additional credit creation at this time. 

 

3) equities have rallied significantly off of their lows and weren't exceptionally cheap to begin with. 

 

4) a bunch of economic indicators have slowed, reversed, and collapsed over that period of time warranting extreme caution. Basically only employment that continues to do well, but is a lagging indicators and has  ALWAYS peaked inside of the recession - not before.

 

I'm still buying stocks. Ive been repurchasing most of the commodity names that were sold in 2021/2022 at significantly lower prices. Have been selling bonds/money markets at gains to do so. And continue to have a ton of dry powder earnings low-equity like returns waiting for the tide to potentially go out. 

 

A receding tide will lower most boats. Equity markets trading at 26x earnings that are declining while credit/liquidity are contracting.  Every major leading indicator has spent the last year or more in contraction, PMIs are largely below 50, and GDI has been negative for 3 quarters now. All of this tells me the economy is slowing, but outside of a few cheap pockets, the equity markets are still pricing in sunny with a high of 75⁰.