Is The Bottom Almost Here?

[Spekulatius]

Yes, when you have a 401k, then your option are limited. Often the only options aren't even index funds, they have higher cost funds. over time this has improved, but even large companies have surprisingly crappy options.

 

I have talked with several benefit managers about this - they could easily do better, but they don't care - all they care is compliance.

 

If you think about it in this way, less options mean compliance becomes easier for them. brokerage window - oh now - possible compliance leak - don't want this. Even with index vs higher cost funds - as long as it's not grossly negligent - they don't care.

 

I also think there is some sort of kickback scheme at work where higher cost funds are pushed in exchange for reducing the administrative cost for the sponsor company.

Edited February 15, 2023 by Spekulatius

[mattee2264]

I think the bull vs bear debate centres around whether autumn 2022 was the low (at around 3500 on the SPY) or whether there is a new low within this market cycle within the next year or so. 

 

Markets were correct in calling the March 2020 low. But you had a huge amount of stimulus that continued far longer than most would expect and also the rapid discovery of a vaccine and a pandemic environment which was very favourable to tech companies pulling forward years of future earnings and it was a man-made recession to the extent that the economy was put on pause and re-opening was a clear catalyst for recovery.

 

This time it feels a bit different. There isn't as much room or appetite for stimulus. The Fed still has inflation to worry about and while the government will want to spend it won't be able to hand out widespread transfer payments which did a lot to ease the damage of the pandemic. And if consumers and businesses fall behind on their payments there won't be forbearance and the government is no longer backstopping bank loans and credit is becoming a lot tighter. And we have yet to feel the full effect of the interest rate rises (monetary policy operates with long and variable lags) and there are various vicious cycles that operate in a recession and prolong the pain until the economy recovers naturally. 

 

Perhaps a good analogy is when someone catches the flu. You can treat it by pumping him up on meds so that he recovers faster and doesn't really experience much in the way of symptoms. Or you can let him recover naturally which takes longer and results in more suffering and pain but is perhaps better for long term immunity and health.

 

 

 

 

 

 

[mattee2264]

On a related point, how well do people think banks are positioned for a hard landing? Obviously net interest margins are a lot better (although eventually they will narrow as they have to pay depositors more to attract their money) and most of the major banks have been adding to their credit provisions. But it is a long long time since we saw any credit stress and there is a lot of debt in the system predicated on the idea that interest rates would stay forever low. And not to mention a potential housing market crash as mortgages reset and people struggle to make payments. 

Edited February 15, 2023 by mattee2264

[Gregmal]

Frankly I don’t think the big banks are even allowed to be stressed anymore. They’re kind of indestructible from the systemic shock angle due to regulation. They’re basically utilities with some upside. The smaller ones….yea I’d be a little more careful. 

[Spekulatius]

15 minutes ago, mattee2264 said:

On a related point, how well do people think banks are positioned for a hard landing? Obviously net interest margins are a lot better (although eventually they will narrow as they have to pay depositors more to attract their money) and most of the major banks have been adding to their credit provisions. But it is a long long time since we saw any credit stress and there is a lot of debt in the system predicated on the idea that interest rates would stay forever low. 

A hard landing - however that is defined-  is never good for banks. Results will depend on exactly how hard and what exactly comes down, but it generally means consumer stress (CC and car loans defaults) as well as commercial real estate defaults  and spreads blowing out.

 

For a real hard landing, the annual stress test results give you an idea what a 2008 GFC like scenario looks like. It's not pretty but the major banks would survive. That said, you don't want to own banks in this scenario.

 

I consider such a hard landing very unlikely however.

[TwoCitiesCapital]

1 hour ago, SHDL said:

 

This may be of interest to you:

https://www.bloomberg.com/news/articles/2023-01-04/pioneering-yield-curve-economist-sees-us-able-to-dodge-recession#xj4y7vzkg

 

Just to be clear I don't have a strong view on this matter one way or the other. 

 

Behind a paywall. Care to summarize the argument? 

[fareastwarriors]

4 minutes ago, TwoCitiesCapital said:

 

Behind a paywall. Care to summarize the argument? 

here you go:

https://archive.is/PQSFB

[SHDL]

Thanks to @fareastwarriors for the link.

 

The reasoning isn't so clear to me from the article but it sounds like the gist is that the yield curve inversion we're seeing now is largely driven by the "inversion" in inflation expectations (meaning short term inflation expectations are much higher than long term inflation expectations) and therefore it is not as strong an indicator of an upcoming recession as it normally is.

 

Anyhow I thought it was interesting that this was coming from the man who invented the indicator.

[Red Lion]

1 hour ago, Spekulatius said:

Yes, when you have a 401k, then your option are limited. Often the only options aren't even index funds, they have higher cost funds. over time this has improved, but even large companies have surprisingly crappy options.

 

I have talked with several benefit managers about this - they could easily do better, but they don't care - all they care is compliance.

 

If you think about it in this way, less options mean compliance becomes easier for them. brokerage window - oh now - possible compliance leak - don't want this. Even with index vs higher cost funds - as long as it's not grossly negligent - they don't care.

 

I also think there is some sort of kickback scheme at work where higher cost funds are pushed in exchange for reducing the administrative cost for the sponsor company.

I’m the plan admin for my small business and there are a bunch of 401k plans with almost no fees but nothing but garbage high fee funds. 
 

I’m paying a lot more admin fees to get a Schwab brokerage account. So far I can trade anything, but not cash secured outs which irritates me. Hopefully by next year we will have enough plan assets to justify the higher administrative fees. 

[TwoCitiesCapital]

1 hour ago, fareastwarriors said:

here you go:

https://archive.is/PQSFB

 

His primary arguments are below

Quote

One of the reasons is the fact the yield curve-growth relation has become so well known and widely covered in popular media that now it impacts behavior, he said. The awareness induces companies and consumers to take risk-mitigating actions, such as increasing savings and avoiding major investment projects — which bode well for the economy. 

 

This gets said EVERY time the yield curve inverts. Its observable, but people ignore it because its observable, which is probably, in part, why it still works as a leading indicator (otherwise would likely more be more of a coincident indicator).  

 

Just b/c its observable doesn't mean main street people pay attention to it. Just because its observable doesn't mean it doesn't stifle credit creation which is now a money losing proposition. And lastly, what IS observable is that the exact opposite of what he supposes happens - savings are being drawn down VERY quickly while revolving credit balances are going up. People aren't becoming more anti-fragile in response to the inversion - they're racing to become more leveraged. 

 

Quote

Another boost to the economy is coming from the job markets, where the current excess demand for labor means laid-off workers will likely find new positions more quickly than usual. In addition, he said, given the largest job cuts so far have been in the tech sector, those highly skilled recently fired workers are also not apt to be unemployed for very long.

 

I agree here. But I don't think a resilient job market means a recession is avoided. Just that it might take longer to get to one and that it will be shallower than otherwise. Employment overall is remaining strong - but the underlying trends are for losses in full time positions and gains in part time positions. Hardly as resilient as it first seems. 

 

Quote

Harvey’s model was linked to inflation-adjusted yields and he said the fact inflation expectations are inverted — meaning traders see price pressures easing through time — also eases odds for a recession ahead.

 

The level of real yields also casts doubt on the recession signal. US 10-year yields adjusted for inflation are likely well above corresponding three-month ones. While there are no three-month break-even rates, cross-referencing the latest annual CPI reading with one-year break-evens would return a negative real rate for the tenor, compared with 10-year real yields above 1.5%.

 

I like the idea of using real yield curves on the surface - but would want to take a look at the historical predictive power to know if that improves the signal or not. 

 

What I would say is I do NOT believe 1.5% real yield on the 10-year is the right number.  Right now, 10-year yields are 3.7%. This suggests that inflation will average ~2.2ish% for the next 10-years. Basically not far off from the last 10-15 years which was a deflationary/disinflationary theme. As has been discussed ad nauseum by many here, the next decade is unlikely to look like that. The energy transition, commodity shortages, inventories moving from just-in-time to just-in-case, rising political tensions and near-shoring/friend-shoring becoming dominant, and demographics all point to an elevated inflationary environment in the U.S. relative to the last decade.

 

If we assuming that 2% inflation isn't the right number, but rather something more like a modest 3-4%, you have a real yield curve that is pretty flat already and becoming close to inversion with each subsequent hike. If you think it's higher than 3-4% on average, then we're already inverted on the real yield curve too. 

 

Quote

One wildcard, he said, is if it the Fed after being late to raise rates last year proves to push them too high. 

 

“I believe the time to end the tightening is now,” Harvey said.

 

 

This I agree with. Would only add that I think the Fed probably should've stopped awhile ago if the goal was to successfully manage the business cycle. It takes months for rate hikes to filter though to the economy. Just 8 months ago, effective Fed Fund rate was 1%. Now it's 4.75%. We're probably only just now feeling the full effects of that 1-1.50% level and many economic indicators have been contracting for months.  The Fed's priority isn't to avoid a recession - it isn't to support the stock market - it has become to regain credibility in the fight against inflation even if that means fighting inflation from 9 months ago today. 

Edited February 15, 2023 by TwoCitiesCapital

[Viking]

What i find interesting is the Fed has taken short term interest rates up to 5%. At the same time, QT is like another 100 to 200 basis points of tightening. So over the past 12 months interest short term rates have effectively increased 6-7%. And they will be moving higher in the coming months… probably another 50-75 basis points. So that gets us to short term interest rates of 7 to 7.5%. 
 

And the impact on the economy? Not much. Yes, interest sensitive sectors, like housing, have taken a hit. But the economy appears to be digesting higher rates and chugging along. THAT IS AMAZING. Given the amount of tightening over the past year.

 

What the hell is going on? That is the million dollar question. Has basic economic theory been turned on its head? Fed tightening no longer matters?

 

Perhaps the economy is still experiencing the ‘benefits’ of:

1.) 10 years of zero interest rates (i.e. it takes much longer than just 12 months to get this out of the economy).

- a decade of asset inflation made lots of people multi millionaires… with asset prices rebounding as we start 2023, last years fall in assets was a minor dent for most of these people. 

2.) all the stimulus spent governments during covid

Of course, there are also the covid ‘boomerang’ effects. Travel is going to boom. China is just coming out of covid and its economic growth is going to pop higher. 
 

What does all this mean? One possibility is higher interest rates. Like Fed funds of 6%? Not on anyones radar right now. Continued QT… that would be be significant tightening. And at some point i would expect basic economic theory to start to work again - slowing economy/mild recession.

 

What is an investor to do? As yields move higher, bonds are looking more attractive. Interesting times!

—————

So far, the economy (the deer) has escaped the increase in interest rates (the croc)… 

 

 

Edited February 15, 2023 by Viking

[Gregmal]

16 minutes ago, SHDL said:

Thanks to @fareastwarriors for the link.

 

The reasoning isn't so clear to me from the article but it sounds like the gist is that the yield curve inversion we're seeing now is largely driven by the "inversion" in inflation expectations (meaning short term inflation expectations are much higher than long term inflation expectations) and therefore it is not as strong an indicator of an upcoming recession as it normally is.

 

Anyhow I thought it was interesting that this was coming from the man who invented the indicator.

This is halfassedly how I look at it and think it makes sense. We have shorter term, "transitory"(I know, gasp!) issues related to the covid experience that need to work their way through the system. The short term rate...4-5%....shockingly, is pretty darn close to what the real inflation rate is right now, give or take a few basis point. Inflation is NOT what the inflationistas are pointing to... IE CPI or some >5% rate. It wasn't even high most of last year either. It just went bonkers over 18 months and now averages out, no different than when people quote you on a 3-5 year annual return rate but the returns are flat 3 years, negative one, and then like 40% for one year. The past 3 years of market activity have been beautiful for everyone; investors, speculators, fraudsters, etc because theres such an amalgamation of datapoints that literally allow one to weave whatever the F the want to and create a somewhat believable narrative using largely real data. 

[SHDL]

26 minutes ago, TwoCitiesCapital said:

What I would say is I do NOT believe 1.5% real yield on the 10-year is the right number. 

 

I'm pretty sure that 1.5% number is just taken from the TIPS yield curve. I do agree that 2.x% inflation is perhaps a bit too sanguine but it is what the bond market is currently pricing in.

[TwoCitiesCapital]

4 minutes ago, SHDL said:

 

I'm pretty sure that 1.5% number is just taken from the TIPS yield curve. I do agree that 2.x% inflation is perhaps a bit too sanguine but it is what the bond market is currently pricing in.

 

I agree that it was taken from breakevens. 

 

I just think

1) the Fed owns a significant portion of the TIPS market (~25%)

 

2) TIPS are quite a bit less liquid then treasuries so incremental buyers/sellers impact prices more

 

3) we just came off an inflation scare where people flocked to TIPS and we're then disappointed by the performance. 

 

I dunno what that means for TIPS over-estimating, under-estimating, or correctly predicting inflation, but I'd hazard a guess that they're less accurate at predicting go-forward inflation than the nominal yield curve has been at predicting recessions which makes me hesitant to use them as a signal to debunk it. 

Edited February 15, 2023 by TwoCitiesCapital

[dealraker]

So I bought the lake lot next door at retail asking price (my family developed this area) of $5,000 then the lot next to it that I live on for $7,500.  Pretty sure there have been times when I'd have trouble selling either lot for what I paid - inflation adjusted - we've had some bang up downturns being where 15,000 furniture jobs vanished (in a community then of 130,000).  Although I have no biological children I come from a big family, we simply said  long ago, "If we have things for sale, either in the stores or company property, everybody pays the same thing...the market determines it."  So I didn't get discounts on building materials either.

 

Today?  I could get $250,000 to $300,000 per lot if the house wasn't on one of them.  Kinda the same way I invest, try to get things that over time will go up at some rate.  But I never think in terms of beating the market or selling one day.

 

So we are probably born engrained to do this or that and it may really be impossible to chage it.

Edited February 15, 2023 by dealraker

[Spekulatius]

7 minutes ago, dealraker said:

So I bought the lake lot next door at retail asking price (my family developed this area) of $5,000 then the lot next to it that I live on for $7,500.  Pretty sure there have been times when I'd have trouble selling either lot for what I paid - inflation adjusted - we've had some bang up downturns being where 15,000 furniture jobs vanished (in a community then of 130,000).  We have a big family, we simply said  long ago, "If we have things for sale, either in the stores or company property, everybody pays the same thing...the market determines it.  So I didn't get discounts on building materials either.

 

Today?  I could get $250,000 to $300,000 per lot if the house wasn't on one of them.  Kinda the same way I invest, try to get things that over time will go up at some rate.  But I never think in terms of beating the market or selling one day.

 

So we are probably born engrained to do this or that and it may really be impossible to chage it.

$250K for a nice buildable lot on the lake doesn't sound that steep. I have seen lakeside  lots trading for more in the southern NH boonies and the climate is much more agreeable in NC. I don't think the bottom is in for those.

Edited February 15, 2023 by Spekulatius

[changegonnacome]

2 minutes ago, Spekulatius said:

$250K for a nice buildable lot on the lake doesn't sound that steep. I have seen lakeside  lots trading for more in the southern NH boonies and the climate is much more agreeable in NC. I don't think the bottom is in for those.

 

Lake side lots are what the crypto nuts think bitcoin is - until you can sit on the porch of your bitcoin, have a beer and create life long family memories........I'll take the lake side lots all day long! 

[SHDL]

2 hours ago, Viking said:

What the hell is going on?

 

I think part of it is that real rates are still kind of low. So for example you have a government with a lot of debt that now has to pay higher interest but, thanks to inflation, tax revenue has gone up automatically and so it has no difficulty paying. 

 

Another thing is that US households mostly have their home mortgage rates locked in at low rates and so their financial situations aren't affected too much by these rate increases - and if anything they may have benefitted some (e.g., if you took out a 30 year mortgage at 2.x% at the right time and put the cash you saved into long term bonds at say 3%+ you got "free money").

Edited February 15, 2023 by SHDL

[thepupil]

55 minutes ago, SHDL said:

 

I think part of it is that real rates are still kind of low. So for example you have a government with a lot of debt that now has to pay higher interest but, thanks to inflation, tax revenue has gone up automatically and so it has no difficulty paying. 

 

Another thing is that US households mostly have their home mortgage rates locked in at low rates and so their financial situations aren't affected too much by these rate increases - and if anything they may have benefitted some (e.g., if you took out a 30 year mortgage at 2.x% at the right time and put the cash you saved into long term bonds at say 3%+ you got "free money").

 

yes. @wabuffohas pointed this out a lot that in aggregate raising rates puts money in households pockets because they have more cash/bonds than debt. obviously that "in aggregate" is doing a lot of work. Someone with $2mm of 1 year treasuries is making $100K risk free that they weren't 2 years ago. anyone (people assets and corporations) with significant net floating rate debt is hurting. 

 

[Viking]

37 minutes ago, thepupil said:

 

yes. @wabuffohas pointed this out a lot that in aggregate raising rates puts money in households pockets because they have more cash/bonds than debt. obviously that "in aggregate" is doing a lot of work. Someone with $2mm of 1 year treasuries is making $100K risk free that they weren't 2 years ago. anyone (people assets and corporations) with significant net floating rate debt is hurting. 

Here in Canada, a reasonably large subset of the population carries lots of debt (mortgages and LOC) thanks to our housing bubble. Lots of people own multiple properties with big mortgages (that were already cash flow negative at historically low interest rates). Most of this debt is variable, especially if interest rates stay high for years (even 20% of those 5 year fixed mortgages come due every year).
 

The real estate bubble has also created a mental rental market: here in Vancouver it is not uncommon to pay C$1,500-$1,700/month for a one bedroom and $2,800-$3,000 for a two bedroom - if you can find one (crazy low vacancy rate). Landlords with mortgages are going to need big increases in rental rates given their mortgage costs are going through the roof.

 

The learning is you do not want to blow a housing bubble because it usually causes big problems for years when it corrects. The US learned its lesson in 2008-2010. China is in even worse shape than Canada.

 

The Bank of Canada is really boxed in. Their answer is to stop rate hikes. Even in the face of high inflation (Canada has lots of very large public sector unions) and a very tight labour market. Government spending looks like it is accelerating.
 

No idea how it plays out here. Super happy i have no debt. 

Edited February 15, 2023 by Viking

[Gregmal]

Student in the back row raises hand and asks question…..

 

Teacher, if earnings keep coming in better than expected and stocks respond favorably because of this, what is the proper refrain? Revert back to “it’s a bubble and people are euphoric so the market still needs to crash”? Or what? 

[Dinar]

29 minutes ago, Viking said:

Here in Canada, a reasonably large subset of the population carries lots of debt (mortgages and LOC) thanks to our housing bubble. Lots of people own multiple properties with big mortgages (that were already cash flow negative at historically low interest rates). Most of this debt is variable, especially if interest rates stay high for years (even 20% of those 5 year fixed mortgages come due every year).
 

The real estate bubble has also created a mental rental market: here in Vancouver it is not uncommon to pay C$1,500-$1,700/month for a one bedroom and $2,800-$3,000 for a two bedroom - if you can find one (crazy low vacancy rate). Landlords with mortgages are going to need big increases in rental rates given their mortgage costs are going through the roof.

 

The learning is you do not want to blow a housing bubble because it usually causes big problems for years when it corrects. The US learned its lesson in 2008-2010. China is in even worse shape than Canada.

 

The Bank of Canada is really boxed in. Their answer is to stop rate hikes. Even in the face of high inflation (Canada has lots of very large public sector unions) and a very tight labour market. Government spending looks like it is accelerating.
 

No idea how it plays out here. Super happy i have no debt. 

Man, that's low.  How can I move to Vancouver?  Nice two bedroom in NYC is at least USD 8K in Manhattan (10K+ CAD), and as much in nice neighborhoods in Brooklyn.

[SHDL]

30 minutes ago, Viking said:

Here in Canada, a reasonably large subset of the population carries lots of debt (mortgages and LOC) thanks to our housing bubble. Lots of people own multiple properties with big mortgages (that were already cash flow negative at historically low interest rates). Most of this debt is variable, especially if interest rates stay high for years (even 20% of those 5 year fixed mortgages come due every year).
 

The real estate bubble has also created a mental rental market: here in Vancouver it is not uncommon to pay C$1,500-$1,700/month for a one bedroom and $2,800-$3,000 for a two bedroom - if you can find one (crazy low vacancy rate). Landlords with mortgages are going to need big increases in rental rates given their mortgage costs are going through the roof.

 

The learning is you do not want to blow a housing bubble because it usually causes big problems for years when it corrects. The US learned its lesson in 2008-2010. China is in even worse shape than Canada.

 

The Bank of Canada is really boxed in. Their answer is to stop rate hikes. Even in the face of high inflation (Canada has lots of very large public sector unions) and a very tight labour market. Government spending looks like it is accelerating.
 

No idea how it plays out here. Super happy i have no debt. 

 

Ouch that sounds like a disaster in the making... And IIRC you have rent control laws in place right?

 

Gonna call back that guy from Deutsche who wanted to sell me CDS on Canadian mortgage bonds 

[thepupil]

 

some doom porn for y’all

[thepupil]

2 hours ago, Gregmal said:

Student in the back row raises hand and asks question…..

 

Teacher, if earnings keep coming in better than expected and stocks respond favorably because of this, what is the proper refrain? Revert back to “it’s a bubble and people are euphoric so the market still needs to crash”? Or what? 

 

 

What are you referring to?

 

Here are the 2023 earnings estimate trajectories of the S&P 500 and 4/5 top components (I skipped AMZN because EPS not relevant)

 

 

 

 

 

 

 

Edited February 16, 2023 by thepupil