Another Such Victory and I am Undone
Investors and commentators have long bemoaned the catastrophic effects of a zero-interest-rate environment: a disincentive to save, distorted wanted allocations, excessive risk-taking, and inflated probity prices.
Theory vs. Practice: Following the path to today’s portfolio.
While a student at Yale in 1882, Benjamin Brewster unwittingly entered a debate with an early well-wisher of efficient markets. His interlocutor claimed, “theory and practice cannot be at variance,” and that Brewster’s disagreement counted as “a vulgar error.” Brewster then propounds a famous aphorism:
The thoughtful Benjamin went on to a distinguished career as a cleric and bishop of the Episcopalian Church.
This quirky phrase applies to investing very well. By now, most informed investors know what wonk theory says, and in practice, we have wilt very good at ignoring much of it. It doesn’t matter what’s right; it only matters what we wits to be right.
In theory, non-professional, long-only investors, are supposed to diversify wideness all windfall classes and within each windfall class. In practice, most investors have decided that US Stocks are good unbearable for their probity investments. Global diversification, etc., is not working. However, within the US, investors have wilt pretty good at diversification by investing in fund portfolios (passive or active) over picking individual stocks.
In theory, we know that money is made by ownership low and selling high. Therefore, when resources that form the thrump-cap of our portfolios go lanugo (think EM, bonds, International, REITS), we know we are supposed to buy into that weakness and rebalance our portfolio. Firms like GMO and Vanguard publish 7-year forecasts projecting and comparing resources that are likely to return the most and the least.
In practice, we spend exactly 7-seconds looking at these charts and wringer to personize our biases and ignore what we don’t like. We have decided that, in practice, these long-term analysts know nothing increasingly than we do.
We might unclose in the passing that some emerging markets might do well, some international stocks are very cheap, that value should write-up growth over time, and that small cap should write-up large cap over time, but a large number of investors have said bye-bye to all that. Unbearable money has been lost in very dollars and in opportunity forfeit pursuing all these theoretical learnings and analysis. Most investors have voted with their wallet and don’t wish to add to the wallet of the service providers selling those products. This is not a judgment undeniability on either the investors or the service providers, just that people have, in practice, moved on.
In theory, all investors require the safety of principal. We would love for our principal to grow rapidly, but most of us don’t do well with volatility. Given a nomination between an 8% return with lower volatility and a 12% return with 1.5x that volatility, investors may say they want the latter, but they really want the former. We divine from a combination of past volatility and current portfolio construction to make conclusions well-nigh the future and hope we are approximately right well-nigh our assessment. There are no good models that predict with any verism the future volatility of the market. Investors have learnt that windfall typecasting of the right percentage holding between stocks and unscratched Treasury bills might help mute that volatility and have moved in that direction.
Short-term risk-free resources is the one place where theory and practice have come together today without scrutinizingly 15-16 years. We unchangingly knew it would be nice to be rewarded as savers with income, but it took the market a while to get there.
U.S. Treasury snout (aka “cash”) yields, 9/29/2023
| Annualized yield | |
| One-month T bill | 5.395% |
| Two-month T bill | 5.459 |
| Three-month T bill | 5.471 |
| Four-month T bill | 5.527 |
| Six-month T bill | 5.552 |
5.5% short-term US Government Treasury bills with no volatility is right in academia and right in practice for those who know how to save. Overnight interest rates in the United States of America, mind you, this isn’t in pesos or liras; we are talking US Dollars here, baby, are providing that return, and it’s both a heaven and hell.
After going through “How do I ditch my wall who’s screwing me with low interest rates on my deposit,” “How do I buy the non-callable CDs,” “What’s the right way to buy T-Bills,” and “How do I know which Money Market fund to buy,” investors have figured out how to get to the 5.5% heaven. Here’s a orchestration from Goldman Sachs that shows the fund flows this year and makes the point. Year-to-date Money Market ETFs and bilateral funds have received over $ 1 trillion in inflows.
These short-term interest rates, while a oasis for savers have wilt (or are becoming) a very big problem for all other assets. It’s an unsurmountable wrestle to prove that one needs to take risks in anything else.
The State of the Long Yoke Market
With “cash” offering upper rates and zero volatility, investors are fleeing longer-dated bonds. Longer-dated Treasury Notes and Immuration are in self-ruling fall. Squint at the two charts below. The first orchestration is the price drawdown from the peak of the Total Yoke Market ETF (BND) and Vanguard Inflation-Protected Securities (VIPSX). These track wholesale yoke indexes. Then, the second orchestration is the price drawdown specifically of the longer-dated yoke fund, iShares 20 Year Treasury Yoke ETF (TLT), and the long-dated inflation fund, PIMCO 15 Year US TIPS ETF (LTPZ).
The broad-based Total Yoke Market ETF is lanugo 22% in price terms since 2021. It’s one of the worst drawdowns since the 1970s (although this orchestration or the fund doesn’t go out that far).
The real horror story is below: in the longest-dated immuration with the highest duration. These are lanugo between 45% and 49% in price since 2020. This year alone, the TLT is lanugo increasingly than 10%, and so instead of providing “fixed income,” these long-term immuration have wilt “fixed problems” in portfolios for all kinds of investment players.
Why has the yoke market, and long immuration in particular, washed-up so poorly?
The astronomer Carl Sagan, staring at the night sky, famously observed that there were “billions and billions” of stars. If he’d looked at the US yoke market, he might well have discerned “billions and billions” of moving parts. The yoke market is gigantic, with a total value of $53 trillion, larger by $7 trillion than the huge US stock market. When the windfall matriculation is so big and so deep, no one knows all of the moving parts. There is the story of the six blindfolded men who were asked to touch an elephant and guess what they were touching. A tree, a pillar, a French horn, and a broom, came the answers.
Similarly, the answers spritz in for the yoke market meltdown:
- the economy is no longer going to see a recession this year,
- the Japanese Central Wall has walked yonder from the Yield Lines Control,
- Fitch USA credit rating downgrade,
- Government shutdown,
- dysfunctional politics in the US,
- high debt to GDP ratios,
- weaponization of the US Dollar serving as a wake-up undeniability to China’s Treasury holdings,
- reshoring and union strikes, making US inflation stickier,
and on and on. There are uncounted answers to the Whys of the yoke market meltdown. The answers are not important considering they do not help us wordplay the question, what would we do plane if we knew exactly what was driving things? Nothing. Immuration have been used as a diversification tool, an income tool, a hedge in a recession or market crash, and they have been none of those things in the last 2-3 years.
What are the implications of a yoke market meltdown?
What happens when investors with combined trillions of dollars in immuration find their value is suddenly 10 or 20% lower than before? Maybe people planned for it, maybe they didn’t.
US Government immuration act as collateral for the vast merchantry of over-the-counter derivatives and futures and options mart margins. What happens when the pipes get clogged considering the value of collateral declines this much? Maybe the systems are much largest than in the past, and no one will be surprised. Maybe they will. Do people lose faith in the collateral and ask for more?
What happens when the market wants to revisit the financial slipperiness from older in the year when the yoke losses on banks’ wastefulness sheets in the Hold to Maturity finance wilt too large for the eye to ignore? A recent Barrons article, Bank of America’s Huge Yoke Losses Likely Widened in Third Quarter (9/28/2023) estimates the losses on the wastefulness sheet might be in the range of $115-$120 billion. Does it matter in the context of a Federal Reserve program where banks can infringe money versus their immuration with the Federal Reserve and never have to sell the immuration until they mature? It doesn’t until it does.
One outcome is that the Private Credit market is expanding profoundly in size considering banks can no longer make loans as the immuration with losses protract to sit on Wastefulness sheets.
What happens when the higher volatility in immuration flows through to Wall Street’s Value at Risk models? Usually, the lower the price of an windfall and the higher the volatility, the less risk managers want that windfall on the Wastefulness Sheet. But hey, this is THE Risk-Free Yoke we are talking about. Not some Argentine or Lebanese bond.
None of these individually seem to be a small problem. When combined, these are a very big headache. Or maybe they won’t be. The implications are various, but it’s up to the market when and how big of a problem to make it. It’s up to us to decide what we want out of our portfolio experience. Investors know when they are wrong-footed and need to assess all possibilities.
What would make the yoke market less of a problem?
It would help very much if the yoke market went up in price or at least if it stopped selling off. My biggest snooping is if people don’t want to buy long-dated US bonds, why will they want to go remoter withal the risk lines and buy anything else? When the price of a security, whatever that security might be, keeps going lower day without day, new buyers tend to hold off. Why incur price risk? This can wilt a buyer’s strike and enforce a vicious trundling until the value players come in.
But didn’t we have 5% long-bond interest rates or higher in the 90s and the aughts? And didn’t the stock market do just fine?
Yes, we did. But in those decades, we were coming in from higher inflation and higher yoke yields. A 5% long yoke coming from a 7% long yoke is a much variegated story than when we get there from 3.5% in the long bonds. In the former periods, inflation was subsiding, and until recently, inflation in the US was rising. At best, the level of inflation is questionable.
The Chicago Federal Reserve President and Fed Vice Chair, Austin Goolsbee, said on September 28th: Once inflation is when to the 2% target, or on a well-spoken path to it, then it would be “perfectly appropriate” to discuss the target itself.
I wrote in the June MFO issue well-nigh how Warren Buffett is looking at debt and inflation here. I still believe in that structural view. Ultimately, it feels like the only way is to let inflation run hotter than 2%, and yoke investors are voting with their feet. Ultimately, this is positive for the nominal earnings of unrepealable companies with long-life assets. But tactically, this yoke mayhem is an issue that investors can do without.
When the price of long-dated risk goes up, it affects everything. Take a squint at some of the major windfall classes and see for yourself how much of a drawdown from the peak the passive ETFs of these cadre resources have suffered:
International Equities (VTIAX): 21% lanugo from the highs
Emerging Markets (VEMAX): 33% lanugo from their (2008!) highs
Equity REITS (VGSLX): 35% lanugo from the highs
The only windfall matriculation that is impervious thus far is the US stock market, lanugo only a gentle 13% from the highs in comparison.
Isn’t this a nice outcome?
In theory, it would be nice if we could protract this American dream forever. Money markets provide investors with a 5.5%-dollar income, and US stocks behave beautifully and don’t correct like the other windfall classes. This music can go on forever. The US probity market is now a standout and in a matriculation of its own. It’s nice, for sure. Will it last?
What could go wrong? Meet Murray Stahl
Enter Murray Stahl, who is the co-founder and co-portfolio manager of various funds and finance managed by Horizon Kinetics Windfall Management. Now, I must shoehorn that we wrote critically well-nigh Horizon Kinetics funds and their ginormous 60% positions in one stock – Texas Pacific Land. We were right, too (perhaps increasingly lucky than right). The stock and the fund corrected sharply thereafter. But sometimes, the greatest education comes from finding out why rational people like Stahl would do seemingly irrational things. Was he irrational, or was my understanding too parochial? I couldn’t wait to learn more.That’s taken me lanugo a Murray Stahl rabbit hole. Recently, I paid $200 for a used reprinting of his typesetting and read the whole thing in a few days. In 26 chapters, Stahl boils lanugo how unconfined investors survived bad times and compounded wealth in good times.
I went through all his written material and videos on the fund website, which helped me understand why the fund was this big in TPL. Stahl has terminated that passive indexing is a good idea gone too far, inflation is here to stay, that real resources will benefit, and that royalty and streaming companies will outperform most other resources in the world as thingamabob prices increase, but the forfeit for these companies does not. He notes that true wealth comes from truly long-term compounding (we are talking decades) and the benefits of what happens when a stock that has compounded beautifully for decades becomes a very large % of the portfolio (like TPL), then grows the next 10% and the 10% after. The impact of that growth is enormous for wealth megacosm at the portfolio level.
We see that same illustration in Buffett’s holding of GEICO (now increasingly Apple) or Ron Baron’s holding of Tesla. Just to point out, when a stock becomes this big in the portfolio, it is pretty much destiny for that investor. It’s okay for Stahl, Buffett, or Baron to do this. Shah should be increasingly shielding in their portfolio as that last name does not match with any of those three above!!
Murray’s Q2 2023 Commentary and the Technology Bubble.
Readers would enrich themselves tremendously by spending time and sustentation on the Horizon Kinetics Q2 2023 commentary, where Stahl lays out the specimen for how to identify frothing and where he claims the US stock market is in the midst of one of those right now. There are three charts from that commentary that I’d like to highlight.
The first orchestration shows that the % of IT stock Market Value is virtually 28% in the S&P 500 as of Q2’23.
“But wait, is this calculated correctly?”, Stahl asks. For example, Google, Meta, Amazon, Tesla, and Netflix are NOT in the whilom chart. The ETF provider iShares reclassified those companies and other companies as Communications or Consumer from the IT sector.
He included those reclassified companies when into the IT sector, and the IT sector would really be 41% of the S&P 500, which is plane higher than the dot com era rainbow market share of the IT sector in the S&P 500.
His commentary and other commentaries are worth a serious read for the questioning investor. His volitional is not to spray and pray on all resources worldwide. Rather, he has a nuanced view of a basket of streaming and royalty stocks (and digital currencies, I know!!) that will goody going forth.
The caveat: Stahl has been railing versus passive indices and benchmarks since at least 2015. The indices have washed-up just fine in the last eight years, maybe too fine, equal to Stahl’s beliefs. Yet, we must read his work. Growth for investors comes not from confirmation bias, but by reading opposing views and testing your own hypothesis. Stahl gives plenty of that.
If he is correct, and if the US stock market is in a rainbow led by IT stocks, and the rainbow breaks, (perhaps considering of the yoke market’s relentless selloff), then the practical portfolio most investors have piled today will be in trouble.
In Conclusion
Should we use the yoke market watchtower wedding and Murray Stahl’s works to justify selling everything and going home? I wouldn’t do that, but I would be watching like a hawk, and I’d be paying very shielding sustentation to the portfolio I hold. Ultimately, I like going when to the Buffett perspective on markets right now, which I wrote well-nigh in June.
The Investor’s dilemma now and unchangingly is what and whom to listen to. Here’s what I do know: if the yoke market keeps on cracking, that’s the ONE windfall we need to listen to. When the forfeit of borrowing structurally increases for the US Government for the next 30 years, so does the forfeit for EVERYONE ELSE.
It does not matter if you are Apple or NVIDIA or the Indian stock market. Everyone everywhere will finger it. Watch the yoke market thoughtfully and pray to your personal God that the yoke market settles lanugo and soon.