Negative Real Interest Rates Harms Savers but Rewards Extreme Speculation

By the Curmudgeon with Victor Sperandeo



We hope readers enjoy our irreverent year end look at what the financial mainstream media won’t address. Wishing you all the best for 2022 (please read our End Note).

Financial Repression (Victor):

When the government keeps interest rates below the inflation rate savers receive a negative real rate of return on fixed term income investments (like T-bills, T-notes, CDs, money market funds, etc.).  That policy enables the government (e.g., U.S. Treasury) to borrow at extremely low interest rates, obtaining low-cost funding for government expenditures and easier financing for budget deficits (especially when the Fed buys over 50% of newly issued U.S. debt in its latest round of QE).  

Such “financial repression” has been ongoing for the past 13 years:

From 1/2009 to 11/2021 T-Bills earned 0.56% compounded before taxes, while the (understated) CPI compounded at 2.31%.

→Thereby, $1000 in U.S. savings became $739.39 in constant dollar terms.  That’s a negative (government theft) return of -26.1% in 12.92 years.  Meanwhile, the U.S. equity markets compounded at ~15% annually over the same period. 

→Savers were lured to higher risk investments, like stocks, options, junk bonds, etc. in hopes of a positive real return.  Market risk appeared to vanish with the Fed and U.S. Treasury adding more liquidity on any serious dip in the markets.

Curmudgeon: We think market risk may re-assert itself if the Fed and other central banks start raising rates quicker than now anticipated.  With sky high valuations (see charts below), there will be no shock absorber to cushion a steep market decline, as value players will likely sit on the sidelines.

U.S. Equity Valuations Have Never Been Higher:

The U.S. equity market has never been so expensive relative to underlying fundamentals as per the following two metrics.                                                                                                                                          


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Crescat Capital’s 15-factor valuation model is at record levels with 11 out of 15 fundamental metrics in the 100th percentile historically.  Meanwhile, the Shiller P/E for the S&P 500 is at 39.65 as per this chart:


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Biggest Tail-Risks for the Markets in 2022:

The biggest risks for markets in 2022 are inflation, the coronavirus, and geopolitical tensions, according to some 700 respondents to a Bloomberg Markets Live Global Survey.


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Curmudgeon Comment: 

How could inflation be the biggest tail risk in 2022 when it has been so widely publicized and likely discounted in 2021?

Vice - ‘To the Moon’ Crash Is Coming:

A longtime venture capitalist sees the religious dedication to Elon Musk, hype, and YOLO investing as almost a dot com-style pyramid scheme in the making.

Just over two decades ago, Josh Wolfe co-founded Lux Capital, a New York City-based venture capital firm dedicated to investing in science and technology firms developing ideas with the potential to change the world. The year was 2000, and the dramatic growth of the internet over the previous decade had created a bubble that was beginning to burst. Over the next few years, the NASDAQ would drop by more than 75% as a slew of heavily hyped tech startups plunged into failure, humbling the recently overconfident industry.

The market today reminds Wolfe in many ways of the same forces that were so prominent at the height of the dot com boom, and perhaps no single person better encapsulates the moment than the world’s richest man, Elon Musk.

Inflation has already been here for a very long time, not in the classic economic GDP numbers, but in asset prices. It matters not just that asset prices are inflated, but because I think we'll see a scenario where the poorest will be hit the hardest, as few fuel and food and basic consumer staples see rising prices, when consumers’ incomes or portfolios are hit the hardest. You're going to have this almost bifurcation of lower declining prices at the high end of stuff that nobody really needs, and rising prices of the stuff that people do need. It's going to be a potentially painful situation when Wall Street is potentially seeing the bubble deflated and people clinging to hope that their portfolios will come back. 

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The only thing the stock price measures is what other people believe. It doesn't measure fundamental value or intrinsic value, which is something you can look at by analyzing a balance sheet or an income statement and seeing what the actual performance of a business is. You have companies that are losing more money with every sale they make. Meaning they have negative gross margins, and the more they sell, the more money they lose. They must raise more money. You could show that you're growing sales 50 percent or 100 percent, and you could be losing 75% or 125%. So, price is only a measure of belief and expectations. Fundamentals are a measure of value. That discrepancy between fundamentals and expectation is where great investors are made.

Historically, when you had active investors in the market, you could short overly excessive expectations—which were either typically affiliated with fads or frauds or things that might face technological obsolescence—and you could be long the things that were ignored and unsexy but were great businesses, because they had good fundamental value and low expectations. And a lot of great investors over time just made that pairs trade. They would go long great companies, and short the crowd favorites that eventually would come back to reality.

Curmudgeon:  Sadly, the Fed, global central banks, and (to a lesser extent) the U.S. Treasury have nurtured a speculative mentality that has turned fundamental stock investing upside down.  Please see: Know-Nothings are the New Wizards of Wall Street.

T Rowe Price Warns of ‘free-form risk-taking’ in Buoyant Markets:

Bill Stromberg, the chief executive of T Rowe Price, warned that investors should “step away from risk” to avoid being burnt in an increasingly speculative market. He told the Financial Times, “Even if they are a year too early. Because when the market unwinds, it will be areas of risk that unwind the most.”

“Over last two years there has been a way above-average amount of speculation.  We’ve been in a cycle where there has been very free-form risk-taking.”  Widely tracked indices are being propped up by a small handful of extremely large, overvalued companies, Stromberg said, while much of the rest of the market is “picked over.”

“Investors should remain disciplined,” he said. “I can’t tell you when that period of speculation will end, but it won’t be sustained.”  Investors need to seek out active managers who “are willing to step away from risk” to avoid being scalded, he added.

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Fidelity: Could Technology’s Leadership Be Over?

Inflation had been exceptionally low for more than a decade before jumping recently. This change may have important ramifications for sector performance, and technology looks particularly vulnerable.

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Curmudgeon: Victor and I don’t think fossil fuels will be phased out for decades. That’s despite the UN Secretary General saying that OECD countries should stop generating electricity from coal by 2030 and the rest of the world by 2040.

Victor’s Conclusion:

Since 2008, the U.S. has not experienced a recession except for the two-month (March to April 2020) coronavirus induced decline in GDP.  Unless the business cycle has been repealed (?), a recession will come – perhaps sooner than most think. 

The U.S. equity market is held up by five stocks (Apple, Google/ Alphabet, Facebook, Microsoft, Tesla and Nvidia). Since the beginning of 2021, they collectively accounted for more than a third of the rise in the S&P 500.

When the long overdue recession arrives, Google, Facebook, and other companies which get significant revenue from advertising will be sold hard. The three other big tech high fliers will also decline. The S&P 500 and NDX 100 (NASDAQ 100) could be in a crash mode.

That scenario might happen if the Fed raises rates faster than the markets expect.  Or any negative event that the Fed can't control (e.g., China invading Taiwan) could trigger a stock market crash.

End Quotes:


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“When the time comes to ask, ‘What triggered the crash?’, the better question will actually be ‘What drove the bubble?’: Fed-induced speculation. That’s where the lesson will be…. A crash is just risk-aversion meeting a market that's priced for zero risk.”

John Hussman, PhD and Manager of the Hussman funds.


End Note:

We hope all readers are having a joyous, peaceful holiday (despite Coronavirus anxiety).  Wishing all a happy, healthy, and prosperous new year.  Let’s hope for a better 2022!

Stay healthy, enjoy life, success, good luck and till next time….

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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