Photo Credit: atramos || Inflation isn’t the most organized phenomenon, and investors often all want to be on the same side of the boat…
I have a very irregular series called, “Problems with Constant Compound Interest.” Part of the idea of that series is that it is difficult to assure growth in capital in any sort of constant way. The simple models of the CFPs, and even actuaries that assume constant or near constant growth are ultimately doomed to fail if they try to exceed growth in nominal GDP by more than 2%/year.
Because of the oddities in the current market environment, current interest rates and inflation have decoupled. They are separate processes. We all want to build value in real (inflation-adjusted) terms, but how do you do that in an environment where price to free cash flow multiples are sky high, nominal interest rates are low, and the prices of most commodities are high as well (leaving aside gold as an oddity). Mindless stock bulls talk of TINA [There Is No Alternative (to buying stocks)], as if there is no limit to how high stock prices can go when interest rates are low. I want to tell you about TIN. There Is Nothing (worth buying). This is the nature of financial repression.
If you invest in short bonds, you get gouged by current inflation. If you buy long bonds, you run the risk that the Fed might start monetizing Treasury debt directly, and inflation really runs. With stocks you run the risk of any hiccup in the global economy (when is the omega variant coming so that we can move on to Hebrew letters?) can derail the market, particularly if it leads to higher interest rates.
The Fed has gotten its wish and is forcing an asset bubble on the US to aid growth, however fitfully. All of the relationships of the present to the future are out of whack, because interest rates are too low. But if intermediate interest rates rose to the level of nominal GDP growth, we would see deficits grow even more rapidly as the US government would refinance at higher rates. The Fed is stuck in a doom loop of its own design ever since Alan Greenspan got the great idea to cut short recessions too soon. That has led us into a liquidity trap designed by the Fed.
As I said to one of my clients this week (a bright man), “If you are not bewildered, you are not thinking.” About the only idea I can think of for investing at present is the intersection of high quality and low-ish valuations. As it says in Ecclesiastes 11:2 “Give a serving to seven, and also to eight, For you do not know what evil will be on the earth.” Diversify among safe-ish investments, with a few cyclicals that will do well if things run hot, and stable businesses, if things do not.
That’s all.
I think there’s a small bargain to be had in Series I savings bonds. On Nov 1, they reset to 7.12% annual rate. I say small bargain because one can only buy $10k worth per calendar year. But one can buy now and again in early January 2022 at this rate.
The other caveat is a one year minimum holding period, and if you sell within five years, 3 months interest is forfeited. At worst, I’d consider this like a 12-15 month CD, but at much better rates, as I believe inflation will still be high at the next reset in May. Double bonus that the interest is state income tax exempt.
Not bad for AAA rated debt (or AA, if you ask S&P).
This might be an opportune time to venture out into Crypto currencies. Right now, interest rates on staking ‘stablecoins’ (coins based on USD such as Tether: 1 coin is always $1) are around 10% or more. These are for 3 month terms that can be renewed, like a short term CD. I think this is a more accurate reflection of true interest rates of the dollar.
Cardano (or ADA for short) is looking to bring banking services to the ‘unbanked’ in places like Africa- by allowing people in a low trust society to participate in a trustless currency without the necessity of centralized banks. There’s some noble visions behind some of these currencies and decentralized finance.
Yes, I know the government could, with the stroke of a pen, obliterate crypto (in the US at least) by taxing it into oblivion… so I wouldn’t put all your bread in a single basket- but perhaps a single ‘piece of bread’ might find a home here.
Long bonds (using TLT here, but pick your favorite) have been a wonderful investment, returning 7.0% annualized for the 5 years through yesterday.
Whenever the everyone is on the same side of the boat (calling for inflation and lower bond returns), the market does an amazing job of proving the overwhelming consensus wrong.
There is no reason why long bonds cannot continue to have great returns for the next five years on a total return basis (capital gains + income). At least I have not seen any compelling arguments to that effect.
“High quality and low-ish valuations” – are there any sectors / names that stand out to you here?
I have been going through who I would expect to have pricing power in a continued inflation that aren’t trading at high levels / have lots of debt, it’s not that easy to find
Another good option that I have chosen is a good long/short mutual fund. Currently i am invested in BIVIX which is run by the people that formerly managed the Boston Partners long/short fund which did excellent during the last market downturn. They are long companies with low valuations based on P/E and BV and they are short on overvalued companies based on the same metrics. This way I don’t have to guess which asset class will outperform or provide less risk. Mainly it is a directional bet on a return to sanity of market valuations.