Photo credit: Dickson Phua || A heavy use of derivatives is like being stuck in traffic… in the short run, you are going where everyone else is going… I’ve written about this topic a few times before: Don’t Become the MarketOn a Concentrated Bond Marketand, Two Questions on Fixed Income from the Mailbag (the first question only) What happens when a party or parties take on an investment position that is large relative to the amount they can afford to lose? The above articles handled questions on that for the following crises and mini-crises: The London WhaleWas PIMCO getting too large for the derivatives market?The 1993 blowup of the floating rate guaranteed investment contract marketThe demise of The Equitable in 1991.Long-term Capital ManagementThe Correlation … [Read More...]
Don’t Presume on History
Photo Credit: Sean MacEntee || Yes, victors write history, and so we are unprepared for the war that does not resemble the past. Dear Friends, this post is in some ways a hybrid between the posts This Has Never Happened Before and The Rules, Part LXIV “Weird begets weird.” What I am writing stems from what I have been hearing on Bloomberg Radio and other media outlets where they have bought into the idea that buying growth stocks at any price is the prudent thing to do. Why do they promote this idea? It stems from the idea that you can’t earn much in bonds, so you must buy stocks. It also stems from the idea that stocks outperform all asset classes over time. … [Read More...]
This Has Never Happened Before
Photo Credit: Boston Public Library || Should end the saying “Slower than molasses in January“ Life is somewhat predictable in the short run. That said, there are always surprises that make us say, “This has never happened before.” Here are a few examples: The policy response to the current C19 crisis. (Note: the C19 crisis itself is not new — we have had the Spanish Flu and the Black Death, which were far worse.)For those in the US, 9-11-2001 was a huge surprise.Few expected that the financial crisis in 2008 would be so large.No one expected the interest rates would rise so high 1979-82.The high inflation era of the ’70s was a total surprise. In one sense, what is more amazing is … [Read More...]
Only a Trickle
Photo Credit: Sarah Burget || Future returns of the S&P 500 will only be a trickle Dear friends, after some time away, this will be a short post, though I hope to write more soon. The S&P 500 model is forecasting returns of 2.23%/year over the next 10 years. Even if you compare that to the 10-year Treasury Note yielding 0.66%, that’s not enough of a risk premium. We are in the 97th percentile of valuations. Now, I know that the Fed is encouraging this. Somewhere, maybe from Bernanke, they picked up the bad meme that the Fed should care about the stock market. Let me tell you that that way lies madness. The Fed is banging hard on the “voting machine” aspect of the … [Read More...]
Wake Me When It’s Over
Photo Credit: premasagar || What a cute kid. The stock market is acting like a bunch of bored teenagers. At present, we have a number of “Adults in the Room” who are arguing that a crisis will come upon us soon from the effects of C19. My view is that the more the market is exposed to a concept, the less it reacts to it. Yes, in the initial phase, that is not true — briefly, the more we hear about new concepts, the more impact they have. But that dies out, and as some Millennials might say : NEXT! I am surprised at the resilience of equity and corporate bond markets amid the panic surrounding C19. That said, this is similar to how I think the … [Read More...]
Estimating Future Stock Returns, June 2020 Update
Image Credit: Aleph Blog || Really, do you want to earn 3 1/2% for the next 10 years? At present, the S&P 500 is priced to return 3.51%/year over the next ten years. Now if you were buying some ten-year investment grade corporate bonds, you might expect something around 2%. Is that 1.5% over corporates worth it? Truly, I don’t know. That said, you have choices. The most overpriced segment of the market now is the large cap growth FANGMAN stocks, which accounts for around 25% of the S&P 500. You can choose safer areas: Small cap stocksValue stocksCyclical stocksForeign stocks, including emerging marketsFinancial stocks, and maybe if you dare, energy stocks Now I know that what I said here embeds an idea that GDP will … [Read More...]
Persistent High Volatility
Photo Credit: picme1983 || Imagine a hurricane that never stops entirely This should be a short post. When valuations are high, volatility is typically high as well. When interest rates are low, volatility also is high. Why? A situation has been set up by the functional equivalent of the “Wizard of Oz” where small changes to interest rates or economic activity will have big impact on stock prices. And so I am telling you, be ready for whippy markets. The sorcerer’s apprentices at the Fed, gamely trying to cover for their bosses (Congress) who have no coherent idea of what to do, will keep short-term, high-quality interest rates low. And that’s fine, not, as even the slightest variation in wording will make … [Read More...]
Hertz Donut
Photo Credits: Michael Gray & Brian Turner || And thanks to Pine Tools for concatenating the images When I was in Eighth Grade, I wasn’t very popular, and in World History class, I sat behind a guy who was even less popular than me, and he was usually quite shy. Still it was my policy not to look down on anyone because I knew what it was like to be lonely, so occasionally I tried to be friendly to him. Well, one day he came up to me and said: “Have you heard of Hertz Rent-a-Car?” DM: “Of course.” Guy: “Have you ever heard of a Hertz Donut?” DM: “What’s a Hertz Donut?” He gives … [Read More...]
The Federal Holiday Polls via Twitter
Photo Credit: GPA Photo Archive || FIreworks over New York City — beautiful, huh? Though my adopted children were all black to some degree, I had not heard of Juneteenth until yesterday. When I read a little more about it, and the efforts of some to make it a Federal Holiday, I thought, “Okay, if Juneteenth became a Federal Holiday, which other Federal Holiday would likely disappear?” Now some might ask, “Why not just add another Holiday?” I don’t think there’s a free lunch there — if there is less labor, people would get paid less, and that would affect poor people more than those better off. Anyway, that made me think of doing a Twitter poll to see what holiday … [Read More...]