How is the Fed going to cut rates with inflation over 3%?

[mattee2264]

Lower interest rates must also be a factor in higher margins. And we haven't really seen the full impact of reversion of interest rates to more normal (if still quite low) levels because most companies were smart enough to pile on low cost long term debt during the pandemic before the rate hiking cycle began. 

 

Financial engineering has also been a factor in stock returns exceeding earnings returns as companies were able to borrow cheaply to fund stock buybacks and a shrinking share count supports higher prices and provides a constant bid for the underlying shares. 

 

And something else that has been helping margins is that companies have been able to use inflation as an excuse to increase prices by 50% from pre-pandemic levels and even though their input costs have now come down and they've been able to make cost savings by cutting staff numbers and limiting wage increases to well below the rate of inflation these haven't been passed on to consumers. A reflection of how concentrated most markets are these days. 

 

And of course there are composition changes. You'd expect S&P margins to be higher when tech has gone from 10-15% to 30-35% of the index and in this cycle there has also been a shift in investor preferences away from low margin value stocks and cyclicals and towards high margin if low growth consumer defensives. 

 

[Cigarbutt]

On 4/5/2024 at 9:42 AM, gfp said:

It probably obvious but of course the corporate income tax has been materially reduced as well.

Relating to the recent rise in profit margins (since 1999 when Mr. Buffett voiced his 6% 'normal profits' assumption), the material reduction in corporate taxes plays a role but there are other specific material variables, 

including maybe a common denominator?

-----

Relevance for our day-to-day search for alpha?

Since 1999, where i've 'looked', most (by far) of the improvement in net margins at relevant investment opportunities have come from lower debt service costs and lower corporate taxes, not from higher margins related to what @Dinar describes ie companies that (apparently) have the intrinsic ability to obtain and maintain superior products versus simply the possibility that monopoly power has gone up because of etc etc

Maybe i'm not wired to 'look' where the real money is?

[Dinar]

@Cigarbutt, I would do the following: 

a) Look at the most profitable companies in say 1999 and what were their EBIT margins

b) Look at the most profitable companies in say 2023 and what were their EBIT margins?

 

the most profitable in 2023 were probably MSFT, Alphabet, Meta which are all essentially monopolies or close to it.  Also, Tech spend as a % of GDP probably doubled if not tripled since 1999, and tech companies have insane margins when well run - CRM, Intuit, etc...

[ValueArb]

On 4/5/2024 at 7:52 PM, Jaygo said:

An empire cannot really fall unless there is a suitable replacement. The UK gave way to a far stronger but allied USA, it was a smooth transition with somewhat similar beliefs. The USSR in Gorbachev had a really great opportunity as well all things considered. Their ego may have been bruised but their villages were not pillaged.

 

There is currently no viable replacement to the US so the US cannot move out of the way and fade gracefully like the UK with their pomp and dignity intact. 

 

That makes it more likely that the Empire remains in power longer and more likely that it becomes a bit ugly towards the end, whenever that may be. As far as I understand the roman empire went out like a blind sick dog. The people lost faith, the empire became scared and forceful against its own and that caused the people to revolt leading to centre of power shifting to the Byzantines. 

 

Empires fall whether a replacement is ready or not.

 

Specifically there was no suitable replacement for the Roman empire. It didn't fall because people lost faith, it did not "become scared", and romans as a whole didn't revolt per se, though Rome was certainly greatly weakened by civil wars.

 

The direct cause of the fall of Rome was because it lacked the economic strength to maintain a strong enough military to guard its borders. Ultimately they were overwhelmed by Goths and Huns and lost their key provinces of France, Spain, and North Africa to barbarian kings, and then Italy itself.

 

I think Gibbon traced the fall back to Julius Caesar, and I agree with that. Rome was never a democracy but it was a republic founded on democratic principles. Once Caesar and his nephew Octavian replaced the Roman Republic with an autocratic Roman Empire, it led to powerful generals and senators vying to become Emperor, leading to a succession of costly civil wars that slowly bled Rome of its troops and wealth.

 

The final blows were Christianity and pandemics. The co-opting of the Emperor into Christianity began even more infighting over religious doctrines. First, most Romans had been polytheistic pagans, that couldn't be allowed by devout Christians, and Theodosius I banned paganism, destroying pagan (and other religions such as Manichean) temples and sites, and even executing adherents. This also helped stoke more civil wars, where some usurpers gathered support from oppressed pagans. Finally pagans were forced to convert to christianity under pain of death or banishment.  During and after this there were also more conflict interpretation of Jesus's true nature, causing schisms in which Christian sects like Arianism and Monophysites were considered heretics and frequently purged, stripped of their properties and even executed. 

 

Finally the pandemics reduced the populations significantly, and seemed to which hit the heavily concentrated cities of the Roman civilization much harder than it did the more diffuse lands of barbarians. 

 

And there were never any Byzantines or a Byzantine empire. They always considered themselves Romans and Constantinople the legitimate capital of the Roman empire for another thousand years. 

 

My opinion is that the Roman empire shrunk to the easily defended Constantinople because the rich and powerful (and Christian) constantly set its people against each other. The romans were pretty good at incorporating other peoples into the empire for a long while, barbarian soldiers could rise to become Roman generals, or wealthy Senators, it was in many ways a capitalist system that rewarded mostly based on ability (after the Social Wars that is). If the Republic had continued and continued to be religiously tolerant, Rome would not have been sapped of its economic and military power by civil wars and religious persecutions, and probably would have lasted far longer.

 

Lessons for today would probably be for society to minimize sources of conflict such as religious extremism and class warfare, and strive to make our laws and society as inclusive and free as possible so we can be more unified against external threats. But the reality is that our great war is between MAGA and Progressivism, which the US can never win as which ever side wins will still deficit spend us into a fiscal disaster.

 

[Eldad]

Services 5.4% annualized. That’s high and becomes self-fulfilling. 

[blakehampton]

I have a couple of questions for anyone willing to answer:

1. Do you think that short-term treasury bills are a good inflation hedge?
2. What are some future implications of deficit spending and how would they coincide with higher long-term interest rates?

[Eldad]

5 minutes ago, blakehampton said:

I have a couple of questions for anyone willing to answer:

1. Do you think that short-term treasury bills are a good inflation hedge?
2. What are some future implications of deficit spending and how would they coincide with higher long-term interest rates?

1. They won’t go up in value if inflation goes up. They will go down less than long dated and you will get your money back quicker to redeploy. Not a hedge IMO. 
 

2. Too complicated for me. If the USA was Argentina, it would simple, but we are still very powerful and very rich. 

[HubbadaPow]

T Bills have retained their purchasing power over the past century, but not more than that.  One consideration is taxes, as I believe the chart below assumes reinvestment of the entire coupon, but generally TBills have kept pace with inflation.  I like them while I'm between deals

[TwoCitiesCapital]

33 minutes ago, blakehampton said:

I have a couple of questions for anyone willing to answer:

1. Do you think that short-term treasury bills are a good inflation hedge?
2. What are some future implications of deficit spending and how would they coincide with higher long-term interest rates?

 

Depends on how short, but in general are a better inflation hedge than most other assets. The best immediate inflation hedge is oil. But oil is also exposed to idiosyncratic risks like cratering demand if the economy is also weakening (and politics!). 

 

So a basket that is heavily skewed to oil, some to gold, and some short-term fixed income should be a reasonably good hedge against inflation. 

 

Oil is immune to interest rates, but not immune to the economy.  Gold/short term bonds are largely immune to the economy, but not real rates. As a basket, they should diversify the idiosyncratic risks of real rates, nominal rates, and the economy while hedging inflation. 

 

Future implications of deficit spending? More volatile inflation going forward. 

Edited April 10 by TwoCitiesCapital

[Gregmal]

IDK. In Q4 2021 I was told real estate was gonna crash when they raised rates. I bought a townhouse on the lake instead(in a blue state at that!). Today my neighbor, identical unit, closed on the sale of their unit at 37% premium. I haven't calculated what t-bills woulda done for me. No substitute for just using common sense. Real assets will do well in the current and future environment, regardless of what the little monkey boys bidding up and down stocks assure us. 

[Eldad]

1 hour ago, Gregmal said:

IDK. In Q4 2021 I was told real estate was gonna crash when they raised rates. I bought a townhouse on the lake instead(in a blue state at that!). Today my neighbor, identical unit, closed on the sale of their unit at 37% premium. I haven't calculated what t-bills woulda done for me. No substitute for just using common sense. Real assets will do well in the current and future environment, regardless of what the little monkey boys bidding up and down stocks assure us. 

Yeah. Unknowable and not really worth the time. 
 

Get good at microeconomics and leave macro alone. Paraphrasing Charlie M. 
 

Stocks probably do better in most every environment. Buy some good ones and hold them a long time. 

[Gregmal]

17 minutes ago, Eldad said:

Yeah. Unknowable and not really worth the time. 
 

Get good at microeconomics and leave macro alone. Paraphrasing Charlie M. 
 

Stocks probably do better in most every environment. Buy some good ones and hold them a long time. 

I mean it really just comes down to one’s ability to understand what they invest in. If the worst case is that you can buy more of things you like for the mid-longer term…then what’s there to be afraid of? People act like drawdowns and volatility are something to be feared, but I’ve always found them fun. 
 

If you’re under 50 and your livelihood is not going to be impaired by stock market volatility then just pig out when all these short term trading clowns freak out. You want to be ACCUMULATING durable and desirable asset for as much of your useful life as possible. I don’t consider cash to be one of those. Much rather own great businesses and real estate.

[TwoCitiesCapital]

16 hours ago, Gregmal said:

IDK. In Q4 2021 I was told real estate was gonna crash when they raised rates. I bought a townhouse on the lake instead(in a blue state at that!). Today my neighbor, identical unit, closed on the sale of their unit at 37% premium. I haven't calculated what t-bills woulda done for me. No substitute for just using common sense. Real assets will do well in the current and future environment, regardless of what the little monkey boys bidding up and down stocks assure us. 

 

That's great. I've owned a condo whose price has gone nowhere in 7-years judged by the asking prices of my current neighbors. Significantly negative inflation adjusted returns on the gross asset value. 

 

Oil/gold/Tbills are available to everyone - and accessible in brokerage accounts. Your neighbor's house isn't

 

Just a little to easy to cherry pick anecdotes in hindsight without considering the availability/luck involved with that. Really seems like the approach here is a rather flippant "it's easy to make money in real estate"  and "if it didn't go up, you shouldn't have bought it" while ignoring every example of people who've lost money holding/buying real estate in the last few years. My brother is also upside down on his mortgage from 2021 - and he lives in an entirely different state/city/environment. Real estate is NOT working out for everyone for the last few years. 

 

Would also put many oil producers/gold miners against that 37% return. I've made more than 37% on most of the ones I own just this year - let alone their returns since late 2020. 

Edited April 11 by TwoCitiesCapital

[blakehampton]

Thought some of you might find this great @wabuffo post interesting.

 

On 1/4/2021 at 7:53 AM, wabuffo said:

I think of of money supply this way:

Private sector assets = Public sector (i.e., Federal govt) liabilities. 

 

So money is basically a liability of the Federal government and an asset of the private sector.  As I've indicated in other posts, the Federal government offers the private sector three forms of "money":

a) currency in circulation

b) reserve balances with the Federal Reserve banks

c) US Treasury securities

 

In my view, the traditional measures of money supply - M1, M2, MZM are simply imperfect measures of private sector assets that can be more easily measured by looking at their mirror image of Federal government liabilities of "moneyness".

 

Here's a FRED chart that puts it together.  The formula is: (currency in circulation + reserve balances at the Fed + US Treasury debt held by the public - US Treasury debt held by the Fed).  As of this Dec. 30th, 2020 - the total money liabilities of the Federal government stood at $22t.  That liability has grown 18.9% since March 4, 2020.  While that sounds impressive - this measure has been growing at +10.8% per year since mid-2008.  [click on chart for full-screen viewing]

 

 

Ok - so what is the effect of all this?  My own theory is that it is already having an effect - just not in CPI measures, but in debasement of the currency which manifests itself in asset inflation.  The canary in the coal mine for me is gold which has been very sensitive to this "money" growth.  Here's two examples from this dataset - one when money "supply" fell significantly and one when money "supply" increased significantly.

 

The first is from 1997-2001 when the US actually ran a Federal surplus (taxes exceeded spending).  This caused "money supply" to fall for one of the few times in our recent history (-4% per year over this period).  Look what happened to gold - it fell too.  In addition, the stock market had a three-year funk (2000-2002) as it finally started to feel the cumulative deflationary effect at the beginning of 2000.

 

 

On 1/4/2021 at 7:53 AM, wabuffo said:

I think of of money supply this way:

Private sector assets = Public sector (i.e., Federal govt) liabilities. 

 

So money is basically a liability of the Federal government and an asset of the private sector.  As I've indicated in other posts, the Federal government offers the private sector three forms of "money":

a) currency in circulation

b) reserve balances with the Federal Reserve banks

c) US Treasury securities

 

In my view, the traditional measures of money supply - M1, M2, MZM are simply imperfect measures of private sector assets that can be more easily measured by looking at their mirror image of Federal government liabilities of "moneyness".

 

Here's a FRED chart that puts it together.  The formula is: (currency in circulation + reserve balances at the Fed + US Treasury debt held by the public - US Treasury debt held by the Fed).  As of this Dec. 30th, 2020 - the total money liabilities of the Federal government stood at $22t.  That liability has grown 18.9% since March 4, 2020.  While that sounds impressive - this measure has been growing at +10.8% per year since mid-2008.  [click on chart for full-screen viewing]

 

 

Ok - so what is the effect of all this?  My own theory is that it is already having an effect - just not in CPI measures, but in debasement of the currency which manifests itself in asset inflation.  The canary in the coal mine for me is gold which has been very sensitive to this "money" growth.  Here's two examples from this dataset - one when money "supply" fell significantly and one when money "supply" increased significantly.

 

The first is from 1997-2001 when the US actually ran a Federal surplus (taxes exceeded spending).  This caused "money supply" to fall for one of the few times in our recent history (-4% per year over this period).  Look what happened to gold - it fell too.  In addition, the stock market had a three-year funk (2000-2002) as it finally started to feel the cumulative deflationary effect at the beginning of 2000.

 

 

The next chart is after the GFC, when spending ramped up in response to the crisis, "money supply" increased 17% per year from mid-2008 to the end of 2012.  Gold responded to this as well.  Now the relationship between money supply growth and asset inflation (or gold) isn't linear or perfect so its not a perfect "hard and fast" rule.  But I think the general relationship makes sense to me as the supply of new gold mined every year is around 1.8% of the above-ground gold inventory.  Gold's monetary attribute is stability since it grows very slowly.  This is also what Bitcoin is trying to do - grow supply at 2% per year (like gold).

 

 

My guess is that the reason gold is jumping again since early December is because it is starting to "feel" the effect of this second round of stimulus that has begun this week and will start to appear in the US Treasury spending numbers in January.

 

FWIW,

wabuffo

 

 

The next chart is after the GFC, when spending ramped up in response to the crisis, "money supply" increased 17% per year from mid-2008 to the end of 2012.  Gold responded to this as well.  Now the relationship between money supply growth and asset inflation (or gold) isn't linear or perfect so its not a perfect "hard and fast" rule.  But I think the general relationship makes sense to me as the supply of new gold mined every year is around 1.8% of the above-ground gold inventory.  Gold's monetary attribute is stability since it grows very slowly.  This is also what Bitcoin is trying to do - grow supply at 2% per year (like gold).

 

 

My guess is that the reason gold is jumping again since early December is because it is starting to "feel" the effect of this second round of stimulus that has begun this week and will start to appear in the US Treasury spending numbers in January.

 

FWIW,

wabuffo

[Vish_ram]

Everyone is focused on inflation picture. The unemp side is slowly getting uglier. 

 

Af. Am. unemp is a canary in the coal mine. It is trending upwards

https://fred.stlouisfed.org/series/LNS14000006

 

The other indicator is "temp help". This is trending down solidly. 

 

Leading causes of inflation are housing & car insurance right now. These two are the most lagging ones too (As per Siegel). There's a good chance that politicians will ramp up pressure on Fed once unemp. goes higher. 

 

[TwoCitiesCapital]

18 minutes ago, Vish_ram said:

Everyone is focused on inflation picture. The unemp side is slowly getting uglier. 

 

Af. Am. unemp is a canary in the coal mine. It is trending upwards

https://fred.stlouisfed.org/series/LNS14000006

 

The other indicator is "temp help". This is trending down solidly. 

 

Leading causes of inflation are housing & car insurance right now. These two are the most lagging ones too (As per Siegel). There's a good chance that politicians will ramp up pressure on Fed once unemp. goes higher. 

 

 

+1

 

 

Have been conservatively positioned since 2021 and have been wrong thus far to be light on equities -  but the data is still there to support a fairly dramatic slowing IMO. 

 

Fixed I come hasn't been a terrible place to be over that period, but the last ~18 months or so have definitely closed the gap and "risk on" was the place to be. 

[blakehampton]

The FED posts these monetary policy updates for Congress twice a year.

 

https://www.federalreserve.gov/publications/files/20240301_mprfullreport.pdf

[james22]

 

 

[Cigarbutt]

On 4/7/2024 at 1:42 PM, Dinar said:

@Cigarbutt, I would do the following: 

a) Look at the most profitable companies in say 1999 and what were their EBIT margins

b) Look at the most profitable companies in say 2023 and what were their EBIT margins?

the most profitable in 2023 were probably MSFT, Alphabet, Meta which are all essentially monopolies or close to it.  Also, Tech spend as a % of GDP probably doubled if not tripled since 1999, and tech companies have insane margins when well run - CRM, Intuit, etc...

Thank you for the feedback. However, the companies mentioned are not within my circle of competence.

If others can benefit (seeing the present benefit as well as the discounted value of future benefits), that's great.

[mattee2264]

Fed have already said that a worsening unemployment situation could justify a cut even if inflation remains sticky. 

 

But it is hard to imagine unemployment rising significantly when the US government continues to run massive fiscal deficits at full employment. So I expect US GDP growth to remain strong and US inflation to remain sticky and with that being the case agree that it is difficult to imagine more than a few cuts this year and probably towards the end of the year rather than in the summer.

 

Something that does concern me a little is whether there is a "boiling frog" scenario. So far high interest rates haven't been a massive issue because a lot of companies and consumers are still benefiting from low-cost debt raised during ZIRP. But refinancing cannot be delayed forever and there is a lot of leverage in the system as companies and consumers and governments took advantage of ZIRP to pile on debt. 

[Eldad]

1 hour ago, james22 said:

 

 

Wow. You know they really wanted to cut in June for the Big Guy. Too bad. 

[Dinar]

@Cigarbutt, I think that there may be three other issues at play.  Companies have gotten better at price discrimination/yield management software, which allows them to squeeze more revenue at 100% margin at very low and perhaps zero volume loss (airlines, concert tickets are good examples.)  Companies may be more aggressive at raising pricing - look at historical price increases for aggregates for instance, and look at the last couple of years and 2024. 

 

IT investment has also probably allowed massive cost reductions.  Company like EQR are pretty explicit about it, and I am sure that banks/airlines, etc... have also cut out plenty of costs.

Edited April 12 by Dinar

[ValueArb]

3 hours ago, Eldad said:

Wow. You know they really wanted to cut in June for the Big Guy. Too bad. 

 

The real irony is that Trump was just as terrible at fiscal leadership as Biden. When Republicans controlled both houses while he was president, the spending spigots were wide open. The only difference was that spending was directed to a different set of friendly political supporters. 

 

Neither president has done anything to make the Feds job easier, they've both made it extremely difficult.

[Eldad]

2 hours ago, ValueArb said:

 

The real irony is that Trump was just as terrible at fiscal leadership as Biden. When Republicans controlled both houses while he was president, the spending spigots were wide open. The only difference was that spending was directed to a different set of friendly political supporters. 

 

Neither president has done anything to make the Feds job easier, they've both made it extremely difficult.

For sure. But one side has the whole government protecting and working to further its interests. RFK Jr. said it best, Biden and his team are the real threat to democracy. 
 

Trump is not fit to be President. But neither is Biden and the things the Dem machine is doing are actually harming our democracy. 

[Jaygo]

1 hour ago, Eldad said:

For sure. But one side has the whole government protecting and working to further its interests. RFK Jr. said it best, Biden and his team are the real threat to democracy. 
 

Trump is not fit to be President. But neither is Biden and the things the Dem machine is doing are actually harming our democracy. 

The very idea of a sitting president who is mentally degraded yet is being propped up in a weekend at Bernie’s like situation tells me democracy is in question with the current admin. 
 

Sure Biden has his fire and brimstone speeches on a good day but some times he has major mental issues front and centre that should be justification for him to step aside. His handlers do not want it and the American people are the victims of a sham.