Changing Direction Slightly

Photo Credit: mark m || Every now and then, a change in tactics is justified

In 1994, there did come a limit where valuations of long debt undershot and started to come back. After more thought, the short-term yield effect of convexity hedging probably peaks out around 2.5-3.0% on 30-year mortgages. Unless the Fed becomes an aggressive seller of the their long bonds, and now-long MBS, I don’t see long rates going past their recent highs.

As such, I am likely to begin buying a little bit of long Treasuries as a hedge against market weakness induced by the likely Fed overshoot. Recently the short-term correlation between stocks and 30-year Treasuries has seemed to go back to stocks down, bonds up, and vice-versa.

That’s all for now.

14 thoughts on “Changing Direction Slightly

  1. David,

    A while back in a post on concentrated positions, you wrote “…the guys at Enron thought they were working for a cutting-edge company like Tesla. But any analyst worth his salt would have seen that free cash flow at Enron was deeply negative.” That was the first example I found quickly, but you have said similar things in other posts.

    In this post you talk about US Treasuries. The US government has spent more than it took in for more than 50 years. A group of octogenarians (both parties) are running things, and lets be charitable and say they are unlikely to be around long enough to see balanced spending much less repay anything. According to spending projections from both political parties, there is no chance for balanced spending in the next ten years. The octogenarian in the Oval Office is trying really hard to start two major wars against peer adversaries. Entitlement spending is a political promise, not a financial obligation, but practically speaking it is a promise that if broken would leave a staggering number of elderly in poverty. The federal government would not be stable if they renigged on their political promises, even if those promises are not legally binding.

    You say ” Unless the Fed becomes an aggressive seller of the their long bonds, and now-long MBS, I don’t see long rates going past their recent highs.” OK, but the Fed isn’t the only large holder of Treasuries. What if entities around the world look at the political seizure of Russian assets and reserves. If the politicians can seize assets on a political whim, who is to say they won’t turn on other creditors? For just one example, here is an op-ed suggesting that China (the US’s largest external creditor) should divest US Treasuries:
    https://asiatimes.com/2022/05/china-should-move-reserves-out-of-us-treasuries/

    There are lots of other US creditors who have run afoul of US cancel culture and/or US political winds. Their assets might be seized too, and they are also talking about this risk. The safe haven status of US Treasuries went up in flames when Biden got all self righteous about Putin.

    The US, like Enron, must borrow more and more and more for many years to come. It has no choice. US Treasuries have become PIK bonds, their interest being “paid” via selling even more debt. The spending spree is led by politicians who are never going to repay.

    Sure, the US government could print like Argentina or Zimbabwe. Sorry, but Ben Bernanke did not invent the currency printing press, and there is plenty of evidence that this trick won’t work.

    So why are you investing in a bigger ponzi scheme than Enron?

  2. @R Woods — buying a bond that pays 2-3% when inflation is running 8%+ (and will continue to do so for at least another year if not longer) doesn’t seem like an investment. Its a guaranteed 5%+ loss the first year, and perhaps for a while after that. As you say, the federal government has a huge incentive to whittle away at its massive debts by running inflation — although maybe not as blatantly as they are now.

    Something that locks in a loss over the long term is by definition NOT an investment. Its speculation, or more bluntly it is gambling.

    David is gambling that a near term drop in yields (and a corresponding increase in price) will compensate him for that 5% loss. y definition, anything short term is gambling. He might be wrong, he might be right — but its a gamble no matter the outcome. If the country is headed into a recession, the recent past suggests interest rates might fall — and that is the gamble David is making.

    David talked about his 6 month gamble in the stock of St Paul in that same “Concentrated positions” post. It wasn’t long term, and the short term trade may have had some fundamentals behind it. But it was a gamble.

    There is nothing wrong with gambling per se, provided one is honest and admit to yourself that gambling is what you are doing. The United States was built on people taking “smart” risks (smart wagers, smart gambles) and getting them right more often than wrong.

    But you are right that the debt of a perpetual spendthrift is by definition not an investment, no matter how many Wall Street salesman claim otherwise.

    I do wonder when voters in both parties will understand that there is no free lunch. We will pay for Washington’s spendthrift ways one way or another. Exorbitant taxes or exorbitant inflation (or a combination of both). There is always a price to pay for a bloated bureaucracy.

    1. You’re right — this is a short-term trade, but I think the greater risk is deflation because of the large debt overhang. Raising rates will have a strong effect on slowing the economy. The curve should flatten, and long rates will fall.

      When the economy was less indebted, inflation had stronger impacts on bond yields. But with so much of the financial sector playing spread games, and so little playing for absolute return, you don’t have much in the way of bond vigilantes vis-a-vis consumer price inflation.

  3. David lives in the shadow of NIH, home of Fauci, who funded the creation of Covid… David’s clients include many NIH employees

    Is it any wonder someone who lives off the federal government is pushing federal government priorities?

    1. And, I funded 4 of the 8 NIH buildings through credit Tenant Leases. Excellent creditworthiness. I had the promise of the government (not subject to appropriation), guarantees from an equity sponsor, and the buildings as collateral — getting paid T30 + 2%, because our dear government cannot borrow directly for capital projects — they have to fund them off-balance sheet.

      Maryland has Hopkins, UMD, and NIH — it is why we have a large pharma/biotech industry here. It’s also a reason why Maryland has had better health outcomes through C19. And I have no clients at NIH, though one retired from the FDA; most are in the private sector.

      You might recall that the easiest way to get banned here is to question my integrity. Question my wisdom? Fine. Facts? Great. Integrity? No.

      1. “When you tear out a man’s tongue, you are not proving him a liar, you’re only telling the world that you fear what he might say.”

        When Twitter banned Trump, it only proved they were afraid of what he had to say. When you get all defensive about the war crimes committed by NIH…

  4. I loved reading your blog post on how to invest better and it was really thought-provoking. I think it would be helpful if you discussed how to trade options and futures on margin. I use options and futures as a way to hedge my portfolio and I think that people would be interested in learning more about the strategy.

    1. I use options limitedly for clients for hedging purposes — long puts only, rolling 2.5 month hedge on average. I don’t use futures or margin. Too risky. Opens the door to “too smart for your own good risk.” Good investing is humble and risk averse.

  5. ” Entitlement spending is a political promise, not a financial obligation, but practically speaking it is a promise that if broken would leave a staggering number of elderly in poverty. ”
    vs.
    “There is always a price to pay for a bloated bureaucracy.”

    Basically, the bureaucracy, by way of budget, has been shrinking for years at the federal level. (state and local govt spending has been ballooning). About 55% of the budget is for SocSec and Medicare, and about 20% is military-related. Those dwarf everything else. The only way to significantly impact the federal budget is to reduce SocSec/Medicare and/or military spending.

    On Covid medical outcomes. The two “simplest” variables related to death rates (which are themselves correlated), are obesity and age. The state by state death rates are also confounded by lots of other complexities, e.g. how early did the virus arrive (what really impacted places like NY and LA- among other variables). I don’t think anybody knows (or is at least brave enough to publicly say) what the real impact of any of the health care interventions were. It’s actually ridiculous- some infectious disease statisticians probably know, but if they work for the NIH or CDC, they have to be careful about what they say or risk their employment.

    My guess/opinion- if they had opened the public schools (as almost all private schools did…), there would have been a big population of immunity created prior to the vaccine, and it would have shortened the pandemic, making it have much lower fatality rates. That is probably the single biggest (public health) policy mistake made during the whole episode. (Read- NIH/CDC bureaucrats doing CYA.)

    1. Oh boy, you federal employees need some new scams.

      First, you highlighted BUDGET, which is trillions of dollars less than actual spending. I’m sure federal bureaucrats have a legal loophole to squirm through, but it is a critical slip of the tongue. What you did is called FRAUD when common cititzens or Enron does the same thing.

      Even if we use your fraudulent stats, you focused on percent of total budget — conveniently omitting the fact that the total budget has been skyrocketing — albeit not as fast as total spending. By your fraudulent accounting, the bureaucracy is 25% of total budget, so its still trillions of dollars.

      Unfortunately for you, even the government’s own auditors have exposed how fraudulent these numbers are. Social Security Trustees, in their own internal study, found that it costs $1.50 to send grandma and grandpa $1,00. That is, 60% of the Soc Sec budget goes to administrative overhead — according to the Social Security Admin itself. Northrop Grumman (supposedly a weapons manufacturer?) is the largest contractor for Social Security Admin.

      Billing fraud in Medicare/Medicaid is legendary. Doctors over bill to cover all the no-pays. The bureaucrats at Medicare are in a rush to eat donuts and don’t check anything. When they do pay, its usually on a 14 month delay, so doctors pad their bills to cover the 14 months (or more) delay — nurses and medical suppliers expect to be paid the same month, not 14 months later when lazy federal bureaucrats get around to paying.

      Then you mentioned the 20% of budget spent on military. $200 million for a single airplane. Billions in spending renovating bases all over the world. Purchasing fraud is rampant. There is a reason all the big consulting firms have divisions dedicated to exploiting federal spending. Its incredibly lucrative.

      David admitted to getting money from NIH (even if he was joking). Johns Hopkins is just a scam to collect research grants, tax exempt bond funds and of course student loans… Yes, the other side of the student loan crisis is all the university administrators and social justice warriors that get funded by federal loans to students.

      Use your head man. Electors don’t spend $1 billion on presidential elections so the president can get $400K per year. They spend a billion to get their paws into $4.5 trilllion spending — at least 60% of which is administrative overhead if we accept internal audits. Its probably a LOT higher.

      Please stop lying to us. Please stop lying to yourselves. Northern VA, DC and most of Maryland are nothing but an organized crime syndicate sucking the life out of the rest of the country.

      1. I was not joking about NIH. I funded half of their buildings, and the credit tenant leases are still on the books of F&G Life. NIH is as honorable of an organization as exists in the US Government, and along with JHU and UMD creates the ecology that allows pharma and biotech to thrive in Maryland.

  6. It doesn’t matter if its Jim Baker preaching about Jesus, or a Muslim extremist killing people in the name of Allah, or a public prosecutor screaming on TV to set himself up for lucrative elected office.

    Whenever there is a self righteous prick high up on their pedestal casting scorn on the sinners below…. they are over compensating for their own sins

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Theme: Overlay by Kaira