I have a saying, ?Don?t buy what someone wants to sell you. Buy what you have researched.?
And so I would tell everyone: don?t give brokers discretion over you accounts, and don?t let them convince you to buy unusual bonds, or obscure securities of any sort.? By unusual bonds, I mean structured notes, and eminent men like Joshua Brown and Larry Swedroe encourage the same thing: Don?t buy them.
Understand yourself, understand the advisor, understand the counsel that is offered, and finally, we wary of what you here through the media, including me.
When I started blogging in February 2007, I did not know that I would be able to write on new topics for so long.? But I committed to writing two short posts a night initially, which became one long post per night, excluding the Sabbath.
I have admiration for many of the long-term bloggers who churn out content regularly.? It takes effort.? It’s not easy to come up with fresh content on a regular basis.? My well is not dry, but sometimes I wonder.? Still, I have the following when things seem dull:
Much as I have non-consensus views on many matters, it is not my goal to write about those views all of the time.? I want to teach people about investing, and get them to avoid many of the traps that are common in the markets.
I try to write about a wide number of issues in the markets, both hot and cold, private and public.? My goals is to create skeptical investors that invest in valuable investments after doing sufficient research.
Much as I have become a better writer through blogging, that was not my goal in writing here or at RealMoney.? It is my goal to educate.? I want people to make better decisions, and avoid the scammers who push illiquid investments.? If an investment is illiquid, it deserves three times the scrutiny as to its value.
Avoid investments that lock up your funds.? I have two of them, one an incredible success, and one a horrible loss. On net, I have won, but I wish I had not invested in the loser.? Hindsight is 20/20 — could I have seen it in advance?? No.? Nor could I have seen the incredible turnaround in the other investment, which is now distributing 30%/year.
I like writing for my audience.? And thanks for reading me.? I am open to allowing a simpler commenting system.? If that is something you would like, please let me know.? In the past, I have been reluctant to do that because many comments on the internet are low value.? But if you want me to loosen up comments, let me know.
Missed signals: behind Trafigura’s $577mn loss on non-existent nickel https://t.co/fJNQSmKbgl Fascinating that they never did physical checks of what was delivered. Also that they didn’t do a background check on TMT. Feb 16, 2023
Podcast Companies, Once Walking on Air, Feel the Strain of Gravity https://t.co/RaNTop40uS My kids ask me to do a podcast. I tell them it’s too much work for too little gain. I would rather read than listen, unless I am driving or cutting the yard. Feb 15, 2023
One of the world’s richest families was thrust into the spotlight by a surprising share sale from one of its own members https://t.co/Gk6Xzr2OcU You need a liquidity plan, akin to what a private real estate fund does. You can’t assume that no family member needs liquidity Feb 15, 2023
How Ben & Jerry’s ended up at war with itself https://t.co/x2W5knUvR7 The revolution eats it own children, even as they eat ice cream Feb 15, 2023
As tech companies shed thousands of jobs, more employees want a say in their severance https://t.co/WHDVvdwRCO Hiring a lawyer at your severance can be valuable. Feb 15, 2023
On the latest episode of the Zero podcast, @AkshatRathi speaks to the founder of Imprint Energy, which developed a printable battery for internet-connected devices. https://t.co/uIdNoxfPlz Looks promising Feb 15, 2023
FICO scores are flawed. These lenders say they’ve found a better way to judge your credit https://t.co/jklyVW53r3 Sowing the seeds of new consumer bankruptcies on the low end of the income scale. Avoid debt for consumption purposes. Feb 14, 2023
A $4B accounting shortfall typically raises alarm bells for an auditor. Somehow a PwC affiliate missed it at Americanas https://t.co/Vr72rqV6c7 PwC may have cultural problems. If you can miss something that large & not be culpable, it calls into question the value of audits Feb 14, 2023
As tech giants look to slim down, middle managers are feeling the pressure https://t.co/4I5JhO6ez8 Not sure if this is good or bad Feb 13, 2023
Odds & Ends
New Car Prices Are So High Only Rich Americans Can Afford Them https://t.co/yrGEmDSIVS This will eventually have political impacts, as regulations affect poor people more than the rich Feb 18, 2023
Wanting to go big with AI in search, Microsoft could end up causing the kinds of harm it will come to regret, writes @parmy https://t.co/e9g3Mlom6D They are not sentient. They are easily tricked. They are code. Feb 18, 2023
The buildout of so-called dark warehouses has begun, but the high-tech facilities are far from common due to their high price tags and the limitations of robotic technology https://t.co/i1xgwi8BKY Not quite ready for prime time Feb 17, 2023
A ‘Crucial Bridge’ to History, the Codex Sassoon Could Fetch $50 Million https://t.co/z9xQGClGoF Really, you can’t put a price on this. I bet there are Hebrew scholars worried about who will buy this, & future access. Feb 16, 2023
3 amateur codebreakers set out to decrypt old letters. They uncovered royal history https://t.co/kNGYZx6YT7 But nothing significant, really… Feb 16, 2023
This Company Uses Machine Learning to Track Your Antibodies https://t.co/c0r5Bk1Tn4 Promising technology Feb 15, 2023
Two of the most-talked-about Super Bowl ads on Sunday focused on an unlikely topic: Jesus https://t.co/lDOsgH3cjM The gospels were written for a Roman audience as eyewitness accounts of who Jesus was & what he did. Read them & ask, was Jesus a legend, liar, lunatic or Lord? Feb 13, 2023
@codywillard Wow, Cody. Glad you’re alive. The Lord had mercy on you and your family. Feb 12, 2023
Culture
Yes, Single People Can Be Happy and Healthy https://t.co/6mrXtdv6ai It is better to be single & wish you were married, than to be married & wish you were single. That said, this article is wrong, at least for men. Married men live longer & are happier than single men, on average Feb 18, 2023
The adults celebrating child-free lives https://t.co/hkiZK3zrpn Those not having or adopting children should be excluded from government pensions and healthcare benefits Feb 18, 2023
Some school districts are doing away with honors classes, which has made some parents unhappy https://t.co/rPHDXEx68L All teaching only reaches a fraction of IQs. This is why there needs to be many levels of teaching: high, middle, low, if you want to have all children improve. Feb 17, 2023
Education should not be a social experiment. It needs to be based off of what works, not wishful theories. What gets taught to prospective teachers in college is positively harmful to pedagogy. We need to end that. https://t.co/uHyxOznUxl Feb 17, 2023
Miriam Adelson, along with her late-husband, poured tens of millions of dollars into former President Trump’s reelection campaign. Now she’s leading a push to legalize gambling in Texas https://t.co/jMmlxpVWq7 Legal gambling leaves society as a whole worse off Feb 16, 2023
As the country emerges from a pandemic that left children zoning out over Zoom, parents are turning to the turbocharged “Russian math” method to give their kids an academic edge. https://t.co/zsdtgrNnel The examples given are not impressive Feb 16, 2023
Disney has tightly controlled Winnie-the-Pooh’s image. With the copyright expired, ‘Winnie-the-Pooh: Blood and Honey’ breaks the wholesome mold https://t.co/2H3IxjRtOc This is not good, but it is notable. Perhaps $DIS will find a way to sue. Feb 15, 2023
Real Estate
America’s Priciest Neighborhoods Are Changing as the Ultra-Rich Move to Florida https://t.co/GOIJ61QsPD The wealthy seek lower taxes and warmer places. There should be no surprise here. Feb 15, 2023
Turning offices into condos: New York after the pandemic https://t.co/z8zoyRUTyy Popular concept. Tough but not impossible to execute Feb 15, 2023
Brookfield Defaults on Two Los Angeles Office Towers. The properties include the Gas Company Tower and the 777 Tower https://t.co/KmTLc9r9OZ Losses go to Brookfield DTLA Fund holders, & their lenders Feb 15, 2023
When It’s Easy to Be a Landlord, No One Wants to Sell https://t.co/brqym7aoJS With help from firms like Mynd that do property managment, you can keep your home w/a low rate mortgage, and rent it out Feb 13, 2023
Why mortgage rates spiked from 6% to 6.5% early-February 2023 & what’s next https://t.co/y6sKncYEBs Complex way of saying “We don’t know.” Hint: the long end of the curve does not move much in response to short-term inflation. FOMC, take note Feb 13, 2023
The high costs of housing are influencing romantic decisions https://t.co/opJ5P2Abjw Moving in reveals who each of you really are. Selfishness, laziness, bad communicating, substance abuse, lying… break relationships Feb 13, 2023
Adani Group
Adani Group tells investors that they will address deadlines to repay debt with options including private placement notes and cash from operations https://t.co/FUEWh43C3I But will they be profitable after refinancing near-term debt at higher rates? What covenants will they make? Feb 17, 2023
Adani halts $847mn acquisition of coal-fired power plant in India https://t.co/hJQDR61XfB Financing is less available. Not a good sign. Feb 16, 2023
That would functionally subordinate some of their public debts, making them even less valuable. I remember looking at the final private placement Enron issued. Complexity was over the top; we did not participate. I would love to see the PP memorandum leaked. https://t.co/sDRoh7P6qc Feb 16, 2023
Indian conglomerate Adani Group is in talks with potential investors as it considers offering privately placed bonds for at least three of its group companies, people familiar with the matter say https://t.co/YF98mIE4Vb Maybe they do secured debt, or add protective covenants Feb 16, 2023
Adani Group sees no material refinancing risk for its listed companies and has no significant near-term liquidity requirements https://t.co/frK2aP7nZq Complex holding company structures make liquidity management difficult. I’ve lost money on a few of those. Feb 15, 2023
Adani Group sees no material refinancing risk for its listed companies and has no significant near-term liquidity requirements https://t.co/frK2aP7nZq If so, keep paying down your debts, and feed losses to the shorts. Feb 15, 2023
The Markets
The rise of short-dated options is creating event risk on the scale of the stock market’s early-2018 volatility implosion, JPMorgan’s Marko Kolanovic says https://t.co/IRIg7SYOb8 Possibility of self-reinforcing move if 0DTE options go into the money, forcing option deals to hedge Feb 16, 2023
A once arcane corner of Wall Street is now in demand as borrowing costs soar and $6 trillion of bond maturities loom https://t.co/XZsM1nDN43 The corporate bond market is not arcane, & though there will be bankruptcies, this is not a crisis. Feb 16, 2023
The shares have surged so much that it’s creating a dilemma for investment giant Nuveen — and posing a little-known risk to its investors https://t.co/jmcR1WpDbH Why not do an “in kind” distribution as a dividend, or a discounted buyback, or just “ride the ask” $ENGH Feb 16, 2023
Credit Suisse is offering investors a hefty incentive to buy its new euro bonds just days after announcing a bigger-than-expected quarterly loss https://t.co/OeuM8J31NO Seems desperate Feb 15, 2023
The mood is starting to shift in global credit markets after a three-month rally https://t.co/VRjlamNJ0W Credit rally overdone & difficult to get away from LIBOR #liborwasbetter Feb 13, 2023
Non-US
Nigeria is trying to gain more control over its vast cash economy by compelling citizens to swap their old money for newly designed naira bills. But the plan is running into serious trouble https://t.co/63mjaLLbBQ Difficult to outlaw cash when financial systems are underdeveloped Feb 16, 2023
It’s undermining Beijing’s attempt to engineer an economic recovery tied to consumption https://t.co/GrjowTdfdT Efforts to get Chinese to consume more creates financial speculation via low rates on personal loans. Feb 15, 2023
More than 200 construction bosses face arrest in Gaziantep and cities across Turkey’s earthquake zone. https://t.co/sCgMpMdLup Corruption leading to deaths Feb 15, 2023
Japan is quietly experiencing its biggest outbreak of the pandemic https://t.co/rbwea15TwH Elderly population is more likely to die. Medical resources are stretched. Feb 15, 2023
Moldova’s pro-European president accused Russia of trying to overthrow its democratic system and open a fresh front in Moscow’s war on Ukraine https://t.co/2koKvf0DbJ Putin wants the USSR back. Feb 13, 2023
Central Banking
Richmond Fed President Tom Barkin says he supported the central bank’s plans to continue raising interest rates in quarter-point increments https://t.co/R9w8bhtw3l Driving through the rear-view mirror. My three questions he didn’t answer at the 3/22 @CFASBaltimore all came true Feb 17, 2023
President Christine Lagarde reiterates that the European Central Bank intends to raise borrowing costs by another half-point next month https://t.co/zGOtVri6ka Unless you want to discover hidden weaknesses in EU financial systems, you shouldn’t invert the yield curve further Feb 15, 2023
Liquidity, leverage and interconnectedness? https://t.co/abqrRH6lsZ Good interview w/@fmnatalucci. He understands financial risk and liquidity. A lot of what he said sounds like me. Where I see risk is not open-end high yield funds, but EU banks & pseudo-banks. Feb 15, 2023
The White House is considering nominating Austan Goolsbee, who became president of the Chicago Fed last month, to serve as vice chair of the Federal Reserve’s board of governors https://t.co/QwxJJD5Gph We could do worse, but why not Lacy Hunt? Feb 15, 2023
The end of distressingly high inflation is coming into view, but the cost of goods, housing and other services is complicating path for easing consumer prices https://t.co/laCY0cZDdn Focus on median inflation than all of the measures that drop out whole spending categories Feb 13, 2023
Economic Policy
How three major bills could change the American economy. https://t.co/ufiiuufFTw Nothing useful, lots of additional debt Feb 17, 2023
The US Supreme Court could rewrite the rules of the internet with a challenge to the liability shield cherished by online companies https://t.co/sQfeDhzmJO I lean in favor of allowing lawsuits against social media companies for inadequate moderation, but limiting damage claims Feb 17, 2023
Odd Lots Transcript: This Is What Happens If the US Actually Hits the Debt Ceiling –What if it doesn’t get lifted? https://t.co/AkPZE6hxoy No one knows. Maybe the 14th amendment section 4 can be invoked to invalidate the debt ceiling Feb 16, 2023
New York City is pausing a small business loan program less than a month after it launched after an unanticipated influx of over 10,000 applications https://t.co/i9uRS9Ml2o Why governments should not subsidize: they are either too generous or cheapskates Feb 15, 2023
China
China’s sweeping policy support for the property sector has been no quick fix for developers’ liquidity struggles, leaving some investors waiting until the last minute for cash https://t.co/EB7wDHkaJH The Chinese Communist Party learns reflating a bubble is surprisingly difficult Feb 17, 2023
Heard on the Street: China’s fiscal position—and ability to fund other priorities—will increasingly be threatened by threatened by rising healthcare costs https://t.co/0sX2iyoBoE Social welfare systems only work well when populations are young. Feb 17, 2023
Investors are buying Chinese stock funds, betting that the reopening of China’s economy will help push markets higher https://t.co/hISEKrfwbN ‘“There’s opportunity, to be sure, but I think those are trades, not investments,” said Nancy Tengler.’ Feb 15, 2023
In China, single mothers are facing fewer hurdles as Beijing tries to boost its fertility rate https://t.co/BNIeVRlIs2 Reduces abortion Feb 15, 2023
Crypto
Binance is considering ending relationships with US business partners as regulators turn up the heat on crypto https://t.co/8f7dIWson0 Pushing crypto out of the US is good policy Feb 17, 2023
Crypto platforms could soon face a new set of hurdles to hold digital assets owned by clients of hedge funds and private equity firms in the US https://t.co/m9bZLCxokL Makes sense if you want custodial accounts. Feb 15, 2023
Sam Bankman-Fried was blocked from using virtual private networks while on bail, with the judge overseeing his fraud case expressing concern that VPNs present similar risks as encrypted messaging apps https://t.co/7zpiWHoMjE From crypto-king to peasant disallowed encryption Feb 15, 2023
US regulatory crackdown on crypto aids Tether’s USDT, a stablecoin that’s located offshore, even as the transparency of its reserves faces scrutiny https://t.co/didoPeEO6t US holders of Tether will appreciate the foreign domicile when Tether fails & recovering value is hard Feb 15, 2023
War
Hundreds of fuel vessels are taking steps to hide where they’re going https://t.co/wK67gNEjV2 Evading sanctions — there is a profit to be made, and Russia needs money for the war Feb 18, 2023
Many countries are reassessing their military might — and it’s not just limited to Ukraine’s neighbors https://t.co/C0QpA7rXOj War takes resources, & budgets are stretched… what will be given up? Feb 18, 2023
The world’s war machine is running low on ammunition https://t.co/VAMcJLwxbp Together with stretched government budgets and relatively tight money globally — is this why the long end is selling off? Feb 16, 2023
Pensions
Time Bomb of Public Pension Funding Ticks Louder https://t.co/QO6mS07lwI One way the article could have been improved would be to add in the effects of falling interest rates, not just the long stock rally Feb 13, 2023
The aggregate funding level for state and local pension plans is below 50%, inviting a disaster that would outstrip the occasional municipal bankruptcy https://t.co/QO6mS07lwI Well written. Will it take the failure of a US State to get serious about this? Feb 13, 2023
Photo Credit: Gene Han || This picture was taken four years after the attack.
I am going to reprint here the beginning of the article The Education of a Corporate Bond Manager, Part VI. I am doing this because it describes how our investment department dealt with 9-11. Here it is:
After 9/11, and and before the merger was complete on 9/30/2001, our investment team got together and came to an unusual conclusion ? 9/11 would have little independent impact on the credit markets, so be willing to take credit risk where it is not well-understood by the market.? We bought bonds in hotels, airplane EETCs (A-tranches), anything having to do with confidence in the system at that time.? I consciously downgraded our portfolio two full notches from September to November.
I went to a Chief Investment Officers’ conference for insurance investors in October 2001.? What I remember most is that we were the only company being so aggressive.? In a closed-door meeting, the representative from Conseco told me I was irresponsible.? To hear that from a company near bankruptcy rang the bell.? I was convinced we were on the right track.
By mid-November, we had almost completed our purchases of yieldy assets, when I received a phone call from the chief actuary of our client expressing concern over the credit risks we were taking; the rating agencies were threatening a downgrade.
Well, what do you know?!? The company that did not understand the meaning of the word risk finally gets it , and happily, at the right time.? We were done with our trade.
We looked like doofuses for three months before the market began to turn, and I began a humongous ?up in credit? trade as we began to make a lot of money.? By the time I was done in early June, I had upgraded the whole portfolio three full notches.? A great trade?? You bet, and more.? What?s worse, it was what the client wanted, but not what it should have wanted.
9-11 was a shock to the system, but one where our investment team concluded that everything would return to normal, and relatively soon. We thought that the terrorists had gotten lucky, and that there was no persistent threat. Thus, prosperity would return, well, as long as the economy would hold up, which was in question at that time. The second-order effects of the deflation of the dot-com bubble were more severe than 9-11 would ever be.
From October 2001 through October 2002, our department bravely soldiered on, and during that time I played the speculation cycle relatively well, as noted in other episodes of “Education of a Corporate Bond Manager.”
The main challenge was trying to separate the transitory from the medium-term from the permanent. 9-11 was transitory. Deflation of the dot-com bubble was medium-term, and general prosperity was the long term — and definitely so at the valuations experienced in October 2002.
The same is true today. The coronavirus, no matter how ugly it will be, is transitory, as are the effects on the supply chain, travel, etc. But if you can believe it, valuations are still absolutely high (5.5%/year over the next 10 years), though not high relative compared to bonds and cash.
So, if you have courage, buy the damaged industries. People will still travel, and not a lot of people will die. Buy the strongest companies that you know will survive.
My main point to you is this: the coronavirus is transitory. Act as if it is so, and think about what the economy will be like 3-5 years from now. Do that, and you will likely prosper, unless the effects of too much debt finally comes to bear on the market. We can’t tell when the day of reckoning will come on that topic.
I published another article at The Balance:?Considering Event-Driven Investing.? This is one place where writing in the third person leaves a lot out.? I’ve done a lot with some types of event-driven investing.
Speculating on hurricanes — I did that successfully at the hedge fund 2004, 2005 and 2006.? 2006 because I thought the risk of another strong hurricane year was overplayed.? 2004 and 2005 because I had a good idea of who was underreporting claims after disasters.? That was the only time in my life that I went from long a company to short without stopping, and I covered on the day the CEO resigned, and caught the bottom tick.
From the prior article, speculating on Lula’s non-impact on Brazil qualifies as event-driven.
Stock arbitrage — did a lot with it when I was younger.? Didn’t do so well.
Index arbitrage — did a neutral trade where we shorted one company out of the Russell 2000, and bought another one in.? Made no money on the trade.? We had a good fundamental justification for the trade, but it just goes to show you that this isn’t as easy as it looks.
I buy a decent number of spinoffs.? Most succeeded as investments for me.
Now, all that said, most areas where there are simple arbitrages typically boil down to a simple credit risk: will the deal get completed? Will the company not take an action that changes its capital structure in a way that hurts me?
Since these are relatively simple trades, the returns are relatively low like that on a short-term junk bond — at present, like the yield on T-bills plus 2-3%.? It’s not very compelling given the risks involved.? Most of the mutual funds that do that type of arbitrage have not done so well.
Thus, aside from spinoffs, at present, I don’t do that much with event-driven investing.? Many of the forms of it are too crowded, and I prefer simplicity in investing.
This article is another experiment. Please bear with me.
Q: What is an asset worth?
A: An asset is worth whatever the highest bidder will pay for it at the time you offer it for sale.
Q: Come on, the value of an asset must be more enduring than that. ?You look at the balance sheets of corporations, and they don’t list their assets at sales prices.
A: That’s for a different purpose. ?We can’t get the prices of all assets to trade frequently. ?The economic world isn’t only about trading, it is about building objects, offering services… and really, it is about making people happier through service. ?Because the assets don’t trade regularly, they are entered onto the balance sheet at:
Cost, which is sometimes adjusted for cost and other things that are time-related, and subject to writedowns.
The value of the asset at its most recent sale date before the date of the statement
An estimated value calculated from sales of assets like it, meant to reflect the likely markets at the time of the statement — what might the price be in a deal between and un-coerced buyer and seller?
Anyway, values in financial statements are only indicative of aspects of value. ?Few investors use them in detail. ?Even value investors who use the detailed balance sheet values in their investment decisions make extensive adjustments to them to try to make them more realistic. ?Other value investors look at where the prices of similar companies that went private to try to estimate the value of public equities.
Certainly the same thing goes on with real estate. ?Realtors and appraisers come up with values of comparable properties, and make adjustments to try to estimate the value of the property in question. ?Much as realtors don’t like Zillow, it does the same thing just with a huge econometric model that factors in as much information as they have regarding the likely prices of residential real estate given the prices of the sparse number of sales that they have to work from.
Q: What if it’s a bad day when I offer my asset for sale? ?Is my asset worth less simply because of transitory conditions?
A: Do you have to sell your asset that day or not?
Q: Why does that matter?
A: If you don’t need the money immediately, you could wait. ?You also don’t have to auction the asset if you think that hiring an expert come in and talk with a variety of motivated buyers could result in a better price after commissions. ?There are no guarantees of a better result there though.
The same problem exists on the stock market. ?If you want the the money now, issue a market order to sell the security, and you will get something close to the best price at that moment. ?That said, I never use market orders.
Q: Why don’t you use market orders?
A: I don’t want to be left at the mercy of those trading rapidly in the markets. ?I would rather set out a price that I think someone will transact at, and adjust it if need be. ?Nothing is guaranteed — a trade might not get done. ?But I won’t get caught in a “flash crash” type of scenario, or most other types of minor market manipulation.
Patience is a virtue in buying and selling, as is the option of walking away. ?If you seem to be a forced seller, buyers will lower their bids if you seem to be desperate. ?You may not notice this in liquid stocks, but in illiquid stocks and other illiquid assets, this is definitely a factor.
-==-=-=–=-==-=-=–=–=-==–=-=-=-=-=-=-=-=
That’s all for now. ?If anyone has any ideas on if, where, or how I should continue this piece, let me know in the comments, or send me an e-mail. ?Thanks for reading.
Above is the chart, and here is the data for tonight’s piece:
Date
T1
T3
T5
T7
T10
T20
T30
AAA
BAA
Spd
Note
3/1/71
3.69
4.50
5.00
5.42
5.70
5.94
6.01*
7.21
8.46
1.25
High
4/1/77
5.44
6.31
6.79
7.11
7.37
7.67
7.73
8.04
9.07
1.03
Med
12/1/91
4.38
5.39
6.19
6.69
7.09
7.66
7.70
8.31
9.26
0.95
Med
8/1/93
3.44
4.36
5.03
5.35
5.68
6.27
6.32
6.85
7.60
0.75
Med
10/1/01
2.33
3.14
3.91
4.31
4.57
5.34
5.32
7.03
7.91
0.88
Med
7/1/04
2.10
3.05
3.69
4.11
4.50
5.24
5.23
5.82
6.62
0.80
Med
6/1/10
0.32
1.17
2.00
2.66
3.20
3.95
4.13
4.88
6.23
1.35
High
8/1/14
0.13
0.94
1.67
2.16
2.52
3.03
3.29
4.18
4.75
0.57
Low
Source: FRED ? ||| ? ? * = Simulated data value ?||| ?Note: T1 means the yield on a one-year Treasury Note, T30, 30-year Treasury Bond, etc.
Above you see the seven yield curves most like the current yield curve, since 1953. ?The table also shows yields for Aaa and Baa bonds (25-30 years in length), and the spread between them.
Tonight’s exercise is to describe the historical environments for these time periods, throw in some color from other markets,?describe what happened afterward, and see if there might be any lessons for us today. ?Let’s go!
March 1971
Fed funds hits a local low point as the FOMC loosens policy under Burns to boost the economy, to fight rising unemployment, so that Richard Nixon could be reassured re-election. ?The S&P 500 was near an all-time high. ?Corporate yield spreads ?were high; maybe the corporate bond market was skeptical.
1971?was a tough year, with the Vietnam War being unpopular.?Inflation was rising, Nixon severed the final link that the US Dollar had to Gold, an Imposed wage and price controls. ?There were two moon landings in 1971 — the US Government was in some ways trying to do too much with too little.
Monetary policy remained loose for most of 1972, tightening late in the years, with the result coming in 1973-4: a severe recession accompanied by high inflation, and a severe bear market. ?I remember the economic news of that era, even though I was a teenager watching Louis Rukeyser on Friday nights with my Mom.
April 1977
Once again, Fed funds is very near its local low point for that cycle, and inflation is rising. ?After the 1975-6 recovery, the stock market is muddling along. ?The post-election period is the only period of time in the Carter presidency where the economy feels decent. ?The corporate bond market is getting close to finishing its spread narrowing after the 1973-4?recession.
The “energy crisis” and the Cold War were in full swing in April 1977. ?Economically, there was no malaise at the time, but in 3 short years, the Fed funds rate would rise from 4.73% to 17.61% in April 1980, as Paul Volcker slammed on the brakes in an effort to contain rising inflation. ?A lotta things weren’t secured and flew through the metaphorical windshield, including the bond market, real GDP,?unemployment, and Carter’s re-election chances. ?Oddly, the stock market did not fall but muddled, with a lot of short-term volatility.
December 1991
This yield curve is the second most like today’s yield curve. ?It comes very near the end of the loosening that the FOMC was doing in order to rescue the banks from all of the bad commercial real estate lending they had done in the late 1980s. ?A wide yield curve would give surviving banks the ability to make profits and heal themselves (sound familiar?). ?Supposedly at the beginning of that process in late 1990, Alan Greenspan said something to the effect of “We’re going to give the banks a lay-up!” ?Thus Fed funds went from 7.3% to 4.4%?in the 12 months prior to December 1991, before settling out at 3% 12 months later. ?Inflation and unemployment were relatively flat.
1991 was a triumphant year in the US, with the Soviet Union falling, Gulf War I ending in a victory (though with an uncertain future), 30-year bond yields hitting new lows, and the stock market hitting new all time highs. ?Corporate bonds were doing well also, with tightening spreads.
What would the future bring? ?The next section will tell you.
August 1993
This yield curve is the most like today’s yield curve. ?Fed funds are in the 13th month out of 19 where they have been held there amid a strengthening economy. ?The housing market is?doing well, and mortgage refinancing has been high for the last three years, creating a situation where those investing in mortgages securities have a limited set of coupon rates that they can buy if they want to put money to work in size.
An aside before I go on — 1989 through 1993 was the era of clever mortgage bond managers, as CMOs sliced and diced bundles of mortgage payments so that managers could make exotic bets on moves in interest and prepayment rates. ?Prior to 1994, it seemed the more risk you took, the better returns were. ?The models that most used were crude, but they thought they had sophisticated models. ?The 1990s were an era where prepayment occurred at lower and lower thresholds of interest rate savings.
As short rates stayed low, long bonds rallied for two reasons: mortgage bond managers would hedge their portfolios by buying Treasuries as prepayments occurred. ?They did that to try to maintain a constant degree of interest rate sensitivity to overall moves in interest rates. ?Second, when you hold down short rates long enough, and you give the impression that they will stay there (extended period language was used — though no FOMC Statements were made prior to 1994), bond managers start to speculate by buying longer securities in an effort to clip extra income. ?(This is the era that this story (number 2 in this article) took place in, which is part of how the era affected me.)
At the time, nothing felt too unusual. ?The economy was growing, inflation was tame, unemployment was flat. ?But six months later came the comeuppance in the bond market, which had some knock-on effects to the economy, but primarily was just a bond market issue. ? The FOMC hiked the Fed funds rate in February 1994 by one?quarter percent, together with a novel statement issued by Chairman Greenspan. ?The bond market was caught by surprise, and as rates rose, prepayments fell. ?To maintain a neutral market posture, mortgage bond managers sold long Treasury and mortgage bonds, forcing long rates still higher. ?In the midst of this the FOMC began raising the fed funds rate higher and higher as they feared economic growth would lead to inflation, with rising long rates a possible sign of higher expected inflation. ?The FOMC raises Fed fund by 1/2%.
In April, thinking they see continued rises in inflation expectation, they do an inter-meeting surprise 1/4% raise of Fed funds, followed by another 1/2% in May. ?It is at this pint that Vice Chairman McDonough tentatively realizes?[page 27] that the mortgage market has?now tightly coupled the response of the long end of the bond market to the short end the bond market, and thus, Fed policy. ?This was never mentioned again in the FOMC Transcripts, though it was the dominant factor moving the bond markets. ?The Fed was so focused on the real economy, that they did not realize their actions were mostly affecting the financial economy.
FOMC policy continued: Nothing in July, 1/2% rise in August, nothing in September, 3/4% rise in November, nothing in December, and 1/2% rise in February 1995, ending the tightening. In late December 1994 and January of 1995, the US Treasury and the Fed participated in a rescue of the Mexican peso, which was mostly caused by bad Mexican economic policy, but higher rates in the US diminished demand for the cetes, short-term US Dollar-denominated Mexican government?notes.
The stock market muddled during this period, and the real economy kept growing, inflation in check, and unemployment unaffected. ?Corporate spreads tightened; I remember that it was difficult to get good yields for my Guaranteed Investment Contract [GIC] business back then.
But the bond markets left their own impacts: many seemingly clever mortgage bond managers blew up, as did the finances of Orange County, whose Treasurer was a mortgage bond speculator. ?Certain interest rate derivatives blew up, such as the ones at Procter & Gamble. ?Several life insurers lost a bundle in the floating rate GIC market; the company I served was not one of them. ?We even made extra money that year.
The main point of August 1993 is this: holding short rates low for an extended period builds up imbalances in some part of the financial sector — in this case, it was residential mortgages. ?There are costs to providing too much liquidity, but the FOMC is not an institution with foresight, and I don’t think they learn, either.
This has already gotten too long, so I will close up here, and do part II tomorrow. ?Thanks for reading.
As time has gone along, I realize that my blog is different. ?I do things that most bloggers don’t do, e.g. book reviews, answer e-mails publicly, and a few other things. ?Also, my audience is far more international than most, with a large contingent from India. ?Well, here is another e-mail from a reader in India:
Hi David,
I am a big fan or your articles and read regularly when I get time. I respect you for what you are trying to do with your blog – it is a free education for people like us. I also write a blog but it is mostly a commentary sorts than educating blog like yours.
I am writing to you today because I want to seek out your advice on my portfolio (and my ongoing investment education).?
Screening technique
I normally use Reverse DCF with 15% discount rate, 3% terminal growth rate and future growth assumption of a quarter of historical (5 or 10 years) FCF growth rate. For eg. if historical FCF growth rate of a company is 40%, and reverse DCF suggest market is factoring 10%, that company gets shortlisted.
I also try to invest in companies with 5 years avg ROCE of more than 25% – assumption being management being prudent and high quality will generate good returns on capital available to them.
When I am done screening the stocks, I read their previous 2-3 annual reports to get the feel of the business, how do they money and what are the underlying risks etc. I also read their commentaries on the business prospects and any extraordinary or hidden/ contingent charges they might have. I try to find out what makes the business earn so consistent results.
The screen I use normally allow me to avoid the folly of forecasting. I avoid making an elaborate model and try to forecast future earnings and cash flows. I just try to buy the security at a good discount to what my Reverse DCF model suggests.
Selling strategy
Now, lot of my stocks (8/13) have doubled in 1-3 years duration. I, as a rule, take out my capital when my stock doubles i.e sell half of my holdings. I assume that whatever I have thought about the future prospects of the business could be wrong. Some of my stocks are trading below the level I took out my capital and some of them have turn out to be multi-baggers. What are your thoughts on this selling strategy.
I also have issues with a stock if it has been on my watchlist and has run up a bit. I think this is anchor bias everyone talks about. But I still want to know your thoughts. Do you buy in a single trade or do you build your position slowly.
One more thing, I know you write a lot about portfolio structure, what do you suggest to do if the business you have made the highest allocation to is generating lower returns and vice-versa.
I know I am bothering you a lot, but knowing your thoughts will help me a lot.
I also tried my hands on liquidation analysis that Peter Cundill speaks about in his book – There’s always something to do.
I bought a stock, which was trading way below its liquidation value ( if you buy the entire market cap, sell all the assets at half the prices, and pay off all the liabilities, you still will be left with some cash). I have read their ARs and have found nothing wrong with management, of course their business is not generating lot of profits. I have put a google alert on company’s name if there is some news report or some analysis on the company that may alert me if they’re fraud. So my question is how do you (or a retail investor like me) make sure that management is not fraud or accounts are not cooked.
I know these are lot of questions – that too from a stranger sitting in India but I’ll be happy if you give me some sense of direction – whether I am doing things right or what should I change.
Keep writing and educating, Thanks,
I don’t use DCF or reverse DCF because of the many assumptions employed in DCF. ?I am happier using simpler techniques like P/E, P/B, P/S, and then trying to critique them considering what I know about the company and industry in question.
As for you insistence on a high ROCE — that can work in India, but is less likely to work in the developed world, because few companies can beat the 25% threshold, that have reasonable valuations.
I take out assets from companies as they rise. ?I do it more regularly and slowly than you do — it is a risk control mechanism. ?On the downside, it is a way to make more money, by buying quality companies when they are down.
For more thoughts on selling, look at my portfolio rules seven and eight.
Regarding watchlist assets that have risen in value, I follow portfolio rule eight, and only buy assets that would be a net improvement to the portfolio. ?Timing will almost never be right, but if you have a favorable?valuation for the asset in question, and a sound balance sheet, you will do well.
Regarding portfolio construction,?I only look at the likely future. ?I will hold onto a company that has done badly, but still offers an opportunity of doing well in the future. ?The objective is to be forward-looking.
I buy positions all-at-once, or as close to it as I can, because a few positions are illiquid. ?There is no reason to delay in investing if your thesis is a good one.
Regarding crooked managements — the first question to ask is how are you going to grow revenues. ?If the answer is at all unbelievable, run away. ?There are other tests:
1) look at their results over many years, and compare it to their commentary. ?Don’t give any credit for one-time (negative) events because over the long run, managements that have too many one time events are bad managements.
2) use statistics like normalized operating accruals to see if the accounting is conservative or liberal.
3) Analyze growth in book value plus dividends versus earnings. ?Growth in book value plus dividends is a better measure of value than earnings is.
4) look at management incentives — the best managers are idealists. ?They love what they do, and would do it for free. if they could. ?You want a management team that is hungry; you son’t want a management team that feels full.
Thanks for writing me, and I hope you prosper in your investing in India.
Every hundred or so posts, I take a step back, and try to think about broader issues about blogging about finance. ?Tonight, I want to explain to new readers what the Aleph Blog is about.
There have been many new followers added to my blog recently, ?through e-mail, RSS, and natively. ?This is because of this great article at Marketwatch, which builds off of this great article at Michael Kitces’ blog.
I am humbled to be included among Barry Ritholtz, Josh Brown, and Cullen Roche, and am genuinely surprised to be at number 4 among RIAs in social media influence. ?Soli Deo Gloria.
What Does the Aleph Blog Care About?
I’m writing this primarily for new readers, because I’ve written a lot, and over a lot of areas. ?I write about a broader range of topics than almost all finance bloggers do because:
I’m both a quantitative analyst and a qualitative analyst.
I’m an economist that is skeptical about the current received wisdom.
I like reading books, so I write a lot of book reviews.
I’m also a skeptic regarding Modern Portfolio Theory, and would like to see it discarded from the CFA and SOA syllabuses.
I believe in value investing, in both the quantitative and qualitative varieties.
I believe that risk control is a core concept for making money — you make more money by not losing it.
I believe that good government policy focuses on ethics, not results. ?The bailouts were not fair to average Americans. ?What would have been fair would have been to let the bank/financial holding companies fail, while protecting the interests of depositors. ?The taxpayers would have been spared, and there would have been no systematic crisis had that been done.
I care about people not getting cheated. ?That includes penny stocks, structured notes, private REITs, and many other financial innovations. ?No one on Wall Street wants to do you a favor, so do your own research and buy what you want to own, not what someone wants to sell you.
Again, I don’t want to see people cheated, so I write about ?insurance. ?As a former actuary, and insurance buy-side analyst, I know a lot about insurance. ?I don’t know this for sure, but I think this is the blog that writes the most about insurance on the web for free. ?I write as one that invests in insurance stocks, and generally, I buy the stocks because I like the management teams. ?Ethical, hard working insurance management teams do the best.
Oddly, this is regarded to be a good accounting blog, because as a user of accounting statements, I write about accounting issues.
I am a skeptic on monetary and fiscal policy, and believe both of them tend to sacrifice the future to benefit the present. ?Our grandchildren will hate us. ? That brings up another issue: I write about the effects of demographics on the markets. ?In a world where populations are shrinking in developed nations, and will be shrinking globally by 2040, there are significant economic impacts. ?Economies don’t do well when workers are shrinking in proportion to those who are not working. ?(Note: include stay-at-home moms and dads in those who work. ?They are valuable.)
I care about the bond market. ?There aren’t that many good bond market blogs. ?I won’t write about it every day, but I will write about i when it is important.
I care about pensions. ?Most of the financial media knows things are screwed up there, but they do not grasp how bad the eventual outcome will likely be. ?This is scary stuff — choose the state you live in with care.
My blog is not for everyone. ?I write about what I feel most strongly about each evening. ?Since I have a wide array of interests, that makes for uneven reading, because not everyone cares about all the things that I do. ?If that makes my readership smaller, so be it. ?My blog expresses my point of view; it is not meant to be the largest website on finance. ?I want to be special, even if that means small, expressing my point ?of view to those who will listen.
I thank all of my readers for reading me. ?I appreciate all of you, and thank you for taking the time to read me.
As one final comment, I need to say this. ?I note people unfollowing my blog at certain times, and I say to myself, “Oh, I haven’t been writing about his pet issue for a while.” ?Lo, and behold, after these people leave, I start writing about it again. ?That is not intentional, but it is very similar to how the market works. ? People buy and sell investments at the wrong times.
To all my readers, thank you for reading me. ?I value all of you, and though I can’t answer all e-mails, I read all e-mails.
In summary: the Aleph Blog is about ethics and competence. ?I want to do what is right, and do what gives the best investment performance, in that order.
It almost never makes sense to play for the last 5% of something; it costs too much. Getting 90-95% is relatively easy; grasping for the last 5-10% usually results in losing some of the 90-95%.
Even Buffett didn’t get super-rich by only investing his own money. ?He had to invest the money of others as well. ?The super-rich form corporations and grow them; they build institutions bigger than themselves.
On the Variable Annuity product that would simply be a tax scam. ?Later I would learn that product exists now, just not in the form I proposed 8 years earlier when it didn’t exist.
