Is The Bottom Almost Here?

[Spekulatius]

2 minutes ago, Minseok said:

 

That day is already here. Banks are increasing payment on variable rate mortgages without the consent of home owners when the trigger rate is hit. I voluntarily increased my payment at every rate hike for a total of $1250/month but one of my colleagues has had his bank forcebly increase payment by a total of $800/month through the hiking period. This is from a tier 1 bank. 

I am in the US and have a fixed mortgage, but my cost of homeownership still goes up by 4-5%. The reason is power (up ~25%) and NG is getting more expensive as well as real estate taxes keep creeping up.

 

The inflation looks like whack a mole to me. OK, fuel is down, used cars are down yoY, but now used car prices seem to rise again. Energy (except fuel) is getting way more expensive.  So you have these rolling inflation waves hitting you at different times but overall it looks like there is some persistency there. Or does anyone really thinks that rents for example will start to shrink? Rents tend to be sticky.

 

I see this at work too - the company I work for still tries to push down price increases - roughly 5-7% now. There is more pushback than last year. Some of the crazy input cost spikes for some materials are gone, but there is just a wave of overall input price increases as far as I can tell.

 

All those price increases used to be 0-2% ballpark until about 2020 when hell broke loose.

[thepupil]

 

yea same.

 

we use nuclear and natty for power/heating/etc so energy costs haven't been bad at all. but other stuff...a

 

since i bought in 2019:

 

property taxes:      +20% 

insurance:              +50% (but it was stupid low before)

other maint            +30-50%+ (annual mulch, gutter cleaning, that type of stuff

 

as a real estate investor if rents did ever go down because of s/d but the inflated opex stayed the same...NOI would get hurt a lot more obviously. 

Edited February 17, 2023 by thepupil

[Gregmal]

A lot of the real estate stuff and underpinning inflation is all complicated by the fact that there’s varying degree of correlation and it’s not all good or bad but a mixture that largely bets itself out. You aren’t poorer because property taxes went up; your property taxes went up because most likely, your home value went up. Costs of new water heaters and copper pipes goes up, but again, the cost to build did, if you own the build, it’s more negligible than you thought. Insurance goes up, because your home would cost more to replace, etc. That’s what I think gets missed a lot when people only look at say, an NOI or a fluctuating stock price. You aren’t getting as poor/rich as you think; it’s largely, by it’s very nature, just a robustly decent inflation hedge. 

[mattee2264]

Buffett always hedges his opinions on market levels by saying it depends on interest rates and interest rates are like gravity on financial assets. But we don't really seem to be seeing that to a large degree.

 

30 year US treasuries have increased from 2% at the end of 2021 to almost 4% today and could well head higher than 5% as most of the so-called disinflation just reflects energy prices coming down because the US are draining their SPR. 

 

The SPY peak was around 4800. That represents around 23x TTM earnings of $210 a share. To justify that you'd have to believe that those earnings were sustainable and interest rates would stay low and the 2% equity risk premium while below the historical average could be justified because of future growth potential or continued faith in the Fed put. 

 

Currently the SPY has fallen only 15% to 4100. Even if you use 2021 earnings that is still almost 20x earnings. This seems consistent with the idea that markets are pricing in an immaculate disinflation which will allow a Fed pivot so that interest rates fall to a 2% level which can be used to justify 20+ PE ratios AND that there will be a V shaped recovery of earnings to 2021 levels or higher within the next year or two. 

 

[thepupil]

Just now, mattee2264 said:

Buffett always hedges his opinions on market levels by saying it depends on interest rates and interest rates are like gravity on financial assets. But we don't really seem to be seeing that to a large degree.

 

30 year US treasuries have increased from 2% at the end of 2021 to almost 4% today and could well head higher than 5% as most of the so-called disinflation just reflects energy prices coming down because the US are draining their SPR. 

 

The SPY peak was around 4800. That represents around 23x TTM earnings of $210 a share. To justify that you'd have to believe that those earnings were sustainable and interest rates would stay low and the 2% equity risk premium while below the historical average could be justified because of future growth potential or continued faith in the Fed put. 

 

Currently the SPY has fallen only 15% to 4100. Even if you use 2021 earnings that is still almost 20x earnings. This seems consistent with the idea that markets are pricing in an immaculate disinflation which will allow a Fed pivot so that interest rates fall to a 2% level which can be used to justify 20+ PE ratios AND that there will be a V shaped recovery of earnings to 2021 levels or higher within the next year or two. 

 

 

 I'll put my bull hat on here. I don't think markets ever really fully priced in 2% rates / negative real rates, so It's not entirely surprising that they haven't come down more than an academic duration measure might suggest given the move in the 10-30 year treasuries.

 

I'm guilty of this too, but a gentle reminder that the equity risk premium is Total Expected Return on Stock - Expected Return on Bond, though some folks (includng me) will define as earnings yield - bond yield. Both of these remain positive, but assuming LT growth in earnings, the one with total return is obviously much more positive (as there's little differential b/w earnings yields and bond yields at this time). 

 

 

 

 

 

[TwoCitiesCapital]

46 minutes ago, thepupil said:

 

 I'll put my bull hat on here. I don't think markets ever really fully priced in 2% rates / negative real rates, so It's not entirely surprising that they haven't come down more than an academic duration measure might suggest given the move in the 10-30 year treasuries.

 

 

 

While I understand the theory of WHY interest rates matter, and how they play through the discounting mechanism, historically the correlation between interest rates and movements in equities or multiples in equities has been spurious. 

 

Even directionally there have been extended periods of time where bonds were positively correlated (consistent with the academic theory) and extended periods of time where they were negatively correlated (inconsistent with the academic theory). 

 

What has WAY more explanatory power is the inflation rate. When inflation is stable at ~0-4%, you get high equity multiples. As inflation gets above, or below, that threshold you get dramatic contractions on those multiples.

 

This is consistent with what we've witnessed in 2022. The contraction started because inflation was 6% and heading to 9%. It's paused/reversed some as inflation came back done from 9 to 6% and markets are hopeful the Fed can thread the needle and get it back to 0-4%. 

 

It's more probable, IMO, that the multiple contraction continues as I expect inflation to be unstable and bounce around quite a bit as opposed to the nice, consistent 1-2% we saw most years from 2009-2019. 

 

 

[Gregmal]

13 minutes ago, TwoCitiesCapital said:

It's more probable, IMO, that the multiple contraction continues as I expect inflation to be unstable and bounce around quite a bit as opposed to the nice, consistent 1-2% we saw most years from 2009-2019. 

 

 

I dont think we see 1-2% sustained barring some sort of massive and unlikely reset. But if the range of outcomes is 0-4%, 4-6%, and 6%+....I certainly think that overall we're treading in the middle right now, and that we are probably closer(hence valuations) to pricing into the 0-4% inflation range, but at the same time, going all out on an aggressive short or cash hoard approach seems to be banking on a hard swing into the 6%+ range. So in a roundabout way, summing it all up, I think you need to be picking single stocks wisely and with a longer term fundamental based approach, because "the indexes" or whatever just seem like they dont have a predictable catalyst to go up/down in a way that makes wagering on that worthwhile. Kuppys blog again on "I just dont know" seems spot on. The clear bubble stuff is gone. Theres some stuff thats cheap but not nearly as much as a couple Qs ago. So otherwise, its like what are we playing for? 

[SHDL]

1 hour ago, mattee2264 said:

Buffett always hedges his opinions on market levels by saying it depends on interest rates and interest rates are like gravity on financial assets. But we don't really seem to be seeing that to a large degree.

 

30 year US treasuries have increased from 2% at the end of 2021 to almost 4% today and could well head higher than 5% as most of the so-called disinflation just reflects energy prices coming down because the US are draining their SPR. 

 

The SPY peak was around 4800. That represents around 23x TTM earnings of $210 a share. To justify that you'd have to believe that those earnings were sustainable and interest rates would stay low and the 2% equity risk premium while below the historical average could be justified because of future growth potential or continued faith in the Fed put. 

 

Currently the SPY has fallen only 15% to 4100. Even if you use 2021 earnings that is still almost 20x earnings. This seems consistent with the idea that markets are pricing in an immaculate disinflation which will allow a Fed pivot so that interest rates fall to a 2% level which can be used to justify 20+ PE ratios AND that there will be a V shaped recovery of earnings to 2021 levels or higher within the next year or two. 

 

 

My own take is that stocks aren't down that much because real rates haven't really gone up that much. Nominal rates are up, yes, but inflation is up too so it is not clear if bonds are all that attractive vs equities. At least personally I look at these ~4% long term bond yields and say to myself okay great but I think inflation is going to be just about has high so my real return is going to be really low and so I just hold on to my stocks.

 

So I think for the market as a whole to go down meaningfully valuation alone won't do it - we need either the economy to deteriorate meaningfully or have the Fed jack up rates much much higher. Those things could happen of course but at the moment I'm not quite feeling it.

[mattee2264]

Agree if you are picking your spots it matters less. Value stocks for example often do quite well during inflationary periods. But of course the big winners this bull market that still dominate the indices are the growth stocks which are quite sensitive to interest rates and inflation and have seen a pretty big rebound because markets seem to be quite confident about an immaculate disinflation and a Fed pivot.

 

And as a lot of the long bull market has been driven by multiple expansion based on low interest rates and the idea that TINA to equities then a moderation of market multiples and a re-allocation towards bonds doesn't feel like a supportive environment for equities especially if earnings fail to hold up.

 

And interestingly it is a similar dynamic. At first people were reluctant to price up equities even though interest rates were near zero post GFC because they thought zero interest rates were temporary. Then they got comfortable with the idea that interest rates would stay low and the Fed would cut at the first sign of trouble and multiples drifted above 20. Now even though interest rates are a lot higher people assume it is just transitory and they will fall back down once inflation is tamed and are still pricing based on a low interest rate environment. Perhaps again it will take time before people start to believe that higher (but still quite moderate by historical standards) interest rates are here to stay and adjust multiples accordingly. 

 

 

[TwoCitiesCapital]

2 hours ago, SHDL said:

 

My own take is that stocks aren't down that much because real rates haven't really gone up that much. Nominal rates are up, yes, but inflation is up too so it is not clear if bonds are all that attractive vs equities. At least personally I look at these ~4% long term bond yields and say to myself okay great but I think inflation is going to be just about has high so my real return is going to be really low and so I just hold on to my stocks.

 

So I think for the market as a whole to go down meaningfully valuation alone won't do it - we need either the economy to deteriorate meaningfully or have the Fed jack up rates much much higher. Those things could happen of course but at the moment I'm not quite feeling it.

 

Our of curiosity, how are you measuring meaningful deterioration? 

[SHDL]

55 minutes ago, TwoCitiesCapital said:

 

Our of curiosity, how are you measuring meaningful deterioration? 

 

By "meaningful deterioration" I just meant a "big drop" in things like cash flows and income and employment. 

 

Speaking of which, there are signs/leading indicators of weakness for sure as you and others have already discussed but personally I'm just having a hard time seeing how far that trend goes - or put differently I can't really tell if we are just cooling down a little coming out of this strange boom period or if things are about to get much worse. 

[Gregmal]

29 minutes ago, SHDL said:

I can't really tell if we are just cooling down a little coming out of this strange boom period or if things are about to get much worse. 

This is a thing that over time Ive desensitized myself to. For the past decade plus, every single year in memory we've had "signs" of impending doom or downright disaster and plenty of folks claiming theyre just around the corner. Every single one of them. Same goes with the "valuation" argument. In hind site everyone knows just how obvious this fed and liquidity driven, decade long boom was. At the time? LOL Not so much. So my default answer is to just invest wisely and buy things that are durable and desirable. 

Edited February 17, 2023 by Gregmal

[mattee2264]

For the past decade the Fed has been bailing investors out at the first sign of trouble and interest rates have been persistently low and a low growth low inflation environment has been very favourable to secular growth companies who've been able to juice returns by buying back lots of shares. And they even admitted that they were deliberately suppressing interest rates to encourage investors to chase returns and bid up risk assets such as equities to generate positive wealth effects. We had a soft landing in 2015 and 2018. In 2020 unprecedented monetary and fiscal stimulus saved the day. And somehow even with successive rounds of QE and persistently low interest rates inflation remained low. Until it didn't. 

 

 So ignoring the noise and buying the dips was the winning strategy and the higher your equity allocation the better the results. So understandable that markets are somewhat complacent and assuming there will be an immaculate disinflation with a soft landing and even if something does break the Fed will go back to QE and all will be well. 

 

But who knows perhaps a decade from now it will seem obvious that the Fed withdrawing liquidity through QT and taking interest rates from zero to 5% or higher and keeping them there longer than the market initially expected would result in a lost decade with negative real returns. 

 

 

[SHDL]

24 minutes ago, Gregmal said:

So my default answer is to just invest wisely and buy things that are durable and desirable. 

 

Yeah that's the game plan for me as well. I might look to hedge at some point but not until I have more conviction.

 

To be fair though I was more negative in late 2019 or so looking at similar signals - but back then things were clearer (at least in my head) as we were not coming out of such a bizarre macro environment. My suspicion is that Mr Market is similarly confused and hence the extended period of go-nowhere index price action.

[thepupil]

 

 

some more credit bear porn. Looks like about 30% of B- rates leveraged loan borrowers are at <1.1x and something like 10% at <0.5x

 

reiterate that “the market” (broad cap weighted indices) has very high credit quality, low leverage, and is very well termed out and that 10+ years of regulations have pushed off this risk off bank b/s’s.
 

Private equity/private credit is where the bodies are buried / will be. 

[changegonnacome]

https://www.marketwatch.com/story/investors-have-pushed-stocks-into-the-death-zone-warns-morgan-stanleys-mike-wilson-dcef3c63

Quote

Back to Wilson, who says the P-to-E ratio is now 18.6, and equity risk premium at 155 basis points, meaning “we are in the thinest air of the entire liquidity-driven secular bull market that began back in 2009.” He says the bear market rally that begin in October from reasonable prices has turned into a speculative frenzy based on a Fed pause/pivot that isnt coming.

 

 

Pretty much my thoughts about where we are right now - when the pause/pivot delusion unwinds it’s gonna be interesting to watch.

Edited February 20, 2023 by changegonnacome

[Gregmal]

Looks like he literally just made up the chart and created “zones”. Also, IIRC, isn’t this the guy who in Q4 had this major “call” for a 20% decline in H1 followed by a huge rally to end the year around 4000? I really can’t believe any of this shit gets taken seriously anymore.

[changegonnacome]

What should be taken seriously is falling nominal earnings (worse in real terms).......can we start admitting that E getting whacked thesis is playing out? We are pretty much done now with Q4 earnings....in aggregate they weren't good.

 

https://www.wsj.com/livecoverage/stock-market-news-today-02-17-2023/card/earnings-check-in-q4-reporting-season-nearly-complete-evZim9wC9NMm7CtxSvv8 

 

From above - "Profits are set to decline 4.7% in the fourth quarter from the year prior"

 

As I've mentioned however 4.7% nominal decline is for kindergartners & the deluded......that nominal decline in earnings happened in a 6% inflationary environment......in REAL terms earnings YoY declined 10%.

 

 

 

 

[Dinar]

48 minutes ago, changegonnacome said:

https://www.marketwatch.com/story/investors-have-pushed-stocks-into-the-death-zone-warns-morgan-stanleys-mike-wilson-dcef3c63

 

 

Pretty much my thoughts about where we are right now - when the pause/pivot delusion unwinds it’s gonna be interesting to watch.

If this guy computes equity risk premium as earnings yield - bond yield, he is incompetent and is not fit to come close to the stock market.  Any equity risk premium that does not take into account future growth and capital that is required to provide is not worth the paper it is printed on.

[John Hjorth]

Quote

... He says the bear rally that begin in October from reasonable prices has turned into a speculative frenzy based on a  FED pause/pivot that isnt coming. ...

 

@Xerxes,

 

Honestly, why is is it even relevant to quote something like this here on CoBF, where you can take as a given assumption that the individual members actually know what sh1te [<- @SharperDingaan phrasing!] they own.

 

Mentioned here ref. @Gregmals post above. Bring it here only if it's also your personal position on the topic at hand , and you're willing to defend it under discussion.

[Gregmal]

16 minutes ago, changegonnacome said:

What should be taken seriously is falling nominal earnings (worse in real terms).......can we start admitting that E getting whacked thesis is playing out? We are pretty much done now with Q4 earnings....in aggregate they weren't good.

In terms of just in a vacuum, sure? In terms of a thesis where this would cause 2800-3200 SPY? Not yet and so far that thesis is quite wrong.

[mattee2264]

Agree that it is ridiculous to try to be so precise with the timing. 

 

But I don't think any of the fundamentals have changed and if anything they have deteriorated. What has changed is that markets seem a lot more confident there will be a soft landing and a lot more confident that we are near the end of the rate tightening cycle and the Fed will soon pivot. And forgetting that a soft landing isn't going to help bring inflation down and will probably necessitate further rate increases. 

 

In other words it seems likely it is a sentiment driven bear market rally. 

 

[mattee2264]

To add another point to the equity risk premium discussion: the bond yield is the bird in the hand while the birds in the bush are uncertain. Even the current earnings may well disappoint. So if you think you are getting a 5% earnings yield and earnings fall as they are prone to do during a recession you may well be disappointed and part of the reason for demanding a risk premium is to insure against such possibilities. 

[changegonnacome]

6 minutes ago, Gregmal said:

Not yet and so far that thesis is quite wrong.

 

& thats the opportunity......the underlying components of the thesis are playing out.....yet 'the market' has ignored the poor performance of E to date.....by actually paying a higher & higher multiple for those earnings just to standstill in this ~4000 area......so where do we go........

 

(1) I guess earnings could improve, in the next 12-24 months, such that they grow into the current multiple (very unlikely IMO) 

(2) I guess the Fed could get back to 0% fed funds as per the pivot/zirp delusion....such that the current multiple is justified relative to FUTURE investment alternatives (unlikely IMO)

 

We are left I think with two reasonable outcomes both with good positioning opportunities if one wants to take them. The two outcomes are (1) SPY declines significantly from here reflecting the new post ZIRP & earnings reality (2) SPY stays flat in nominal terms for many many years to come and what actually occurs is that in the REAL terms SPY's return is abysmal, even negative.

 

2010's - dont fight Fed.......stocks go up....earnings expand and multiples expand

 

Early 2020's - dont fight the Fed......stocks struggle to go up, they struggle to stay up........earnings are being eroded as consumer weakens, margins get squeezed & multiples have nowhere to expand too, in fact alternative asset classes that aren't equities are competing aggressively for flows (fixed income/checking/savings accounts).

 

Basic trading strategy:

 

In the 2010's you buy OTM calls on SPY/QQQ

Today you sell OTM calls on SPY/QQQ

 

[Dinar]

28 minutes ago, mattee2264 said:

To add another point to the equity risk premium discussion: the bond yield is the bird in the hand while the birds in the bush are uncertain. Even the current earnings may well disappoint. So if you think you are getting a 5% earnings yield and earnings fall as they are prone to do during a recession you may well be disappointed and part of the reason for demanding a risk premium is to insure against such possibilities. 

That's why risk premium exists, the point is that it should be calculated properly rather than omitting most of the return that comes from owning equities - earnings growth over time.