Permanently low interest rates

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Kbg
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Re: Permanently low interest rates

Post by Kbg » Mon Apr 22, 2019 2:48 pm

Sounds good and really super scary...a perfect news story headline to sell news.

Dig a little deeper and you will find corporate debt is a big fat meh right now.

Hint: If I make $100K a year and my credit card balance goes up by an astounding factor of 10 do I have a problem? Answer: It depends...what is the starting point, what is the interest rate, how do I make my 100K a year.

Also, it goes without saying that high levels are eventually going to be “the peak.” When does 5-6 years of peaking get credit for being darn good? And how much longer are we going to “peak.”

Finally, is it really a “Fed problem” if people are stupid and take on too much debt? Would it be a Fed problem is there was no liquidity in the system. Of the two...which one do they actually directly control. As they say, invert, always invert.
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Re: Permanently low interest rates

Post by pmward » Mon Apr 22, 2019 5:08 pm

Kbg wrote:
Mon Apr 22, 2019 2:48 pm
Sounds good and really super scary...a perfect news story headline to sell news.

Dig a little deeper and you will find corporate debt is a big fat meh right now.

Hint: If I make $100K a year and my credit card balance goes up by an astounding factor of 10 do I have a problem? Answer: It depends...what is the starting point, what is the interest rate, how do I make my 100K a year.

Also, it goes without saying that high levels are eventually going to be “the peak.” When does 5-6 years of peaking get credit for being darn good? And how much longer are we going to “peak.”

Finally, is it really a “Fed problem” if people are stupid and take on too much debt? Would it be a Fed problem is there was no liquidity in the system. Of the two...which one do they actually directly control. As they say, invert, always invert.
Corporate debt rates are very far from "meh" they are the highest they've ever been at 46% of GDP... and if I recall correctly 60%+ is coming to maturity in the next few years, at a current higher interest rate than it was taken out at. Corporate debt is in a bubble right now, and it is not going to end well. Now when does the bubble burst? I have no idea. But it will burst and there will be another large scale deleveraging, with all the pain that comes along with it. At the moment corporate debt to profits level is still in a manageable (though elevated) state. All it will take is a slow down in profits to start triggering some downgrades and defaults, and then we have the start of another nasty deleveraging on our hands. All the kindling is there, all it will take is a spark to start the fire.

And yes it is a fed problem because they created it by keeping interest rates at 0 for a decade. Humans have always been stupid with debt, you can't assume humans will be responsible with debt if they've never proven capable of doing so. This is the whole reason we have the "business cycle". It's not a business cycle it's a debt cycle. Debt is assumed until it gets out of control, then eventually the bill comes due. After the crisis in 2008 households have not levered up again like they were, partly because they are afraid too and partly because of additional regulations and pickiness on banks part to lend to households again after the sub-prime mortgage crisis. But corporations have been a different story. They've been assuming all the debt they can get their hands on over the last 10 years. A lot of that has been malinvestment. They would not have levered up to such a degree if the Fed didn't enable them to by keeping rates low for as long as they did. The kicker is, when the deleveraging happens again, liquidity will once again be drained from the system, requiring the Fed to act in even more aggressive ways to keep liquidity in the system. It's a pretty shit situation we are currently in.
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Re: Permanently low interest rates

Post by Kbg » Mon Apr 22, 2019 9:22 pm

Hint #2: Gross vs. net corporate debt.

Credit card analogy #2: My credit card debt is up 10 fold again, darn it! Going from $100 to 1000 and I have 100K in STTs. Do I have a debt problem?

Have you examined a chart of corporate profits to GDP? Surprise...also at historical highs. Look away folks, no relationship here.

Ok, let’s make this as direct as we can...scroll on down to page 4.

https://www.yardeni.com/pub/fofnfdebt.pdf

You are not ever going to read the headline: “Corporate debt ratios somewhat below 50 year average.”

Finally, the Fed is causing zero interest rates or printing money like crazy which in theory is inflationary...if you are a Fed basher pick one or the other, you don’t get option Both.
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Re: Permanently low interest rates

Post by boglerdude » Mon Apr 22, 2019 11:29 pm

Everyone loves Dalio's video but im not sure yet. How does he come up with "typically 50 years" for a long term cycle. The world changes a lot over 50 year spans. We had a soft landing after the tech bubble. If it was even a "bubble", we didnt know how tech would pan out. Predicting the future is hard.

In addition to that, very basic research always loses money. People bash Tesla but it's not supposed to be a sure thing. The only sure thing in investing is the necessities (housing, food, car, clothes, education) and all those are driven by population growth.

Australia hasn't had a recession/cycle in 27 years. They've gotten rich selling dirt to China and they haven't done stupid smash n'grab policy like Bush+Greenspan. In 2005 I made $1k/month and had a mortgage of 1k, and Chase directed me to Indymac, who gave me 200k to buy another house in a slum. They knew it wouldn't be my primary residence and they knew I borrowed the down payment. It all went through, the tenants were deadbeats, and in 2013 I barely got it out of foreclosure.

The Fed can create cycles with their rate changes (they change rates by printing or burning cash). Companies shouldn't malinvest but on the other hand they know they'll get bailed out. I wonder if the buybacks are making PE ratios appear more attractive than they are. But people (Bogleheads) more educated than me aren't concerned.
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Re: Permanently low interest rates

Post by Kbg » Tue Apr 23, 2019 8:28 am

Buybacks are a form of corporate resource allocation. Companies can do three things with excess cash.

1. Invest
2. Buybacks
3. Dividends

Due to the US tax code, only stupid companies pay dividends. So most companies chose #1 or #2. It's also a reason why they finance with debt vs. equity now days.

Worth a read if you are interested...https://corporatefinanceinstitute.com/r ... epurchase/
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Re: Permanently low interest rates

Post by pmward » Tue Apr 23, 2019 8:46 am

boglerdude wrote:
Mon Apr 22, 2019 11:29 pm
Everyone loves Dalio's video but im not sure yet. How does he come up with "typically 50 years" for a long term cycle. The world changes a lot over 50 year spans. We had a soft landing after the tech bubble. If it was even a "bubble", we didnt know how tech would pan out. Predicting the future is hard.

In addition to that, very basic research always loses money. People bash Tesla but it's not supposed to be a sure thing. The only sure thing in investing is the necessities (housing, food, car, clothes, education) and all those are driven by population growth.

Australia hasn't had a recession/cycle in 27 years. They've gotten rich selling dirt to China and they haven't done stupid smash n'grab policy like Bush+Greenspan. In 2005 I made $1k/month and had a mortgage of 1k, and Chase directed me to Indymac, who gave me 200k to buy another house in a slum. They knew it wouldn't be my primary residence and they knew I borrowed the down payment. It all went through, the tenants were deadbeats, and in 2013 I barely got it out of foreclosure.

The Fed can create cycles with their rate changes (they change rates by printing or burning cash). Companies shouldn't malinvest but on the other hand they know they'll get bailed out. I wonder if the buybacks are making PE ratios appear more attractive than they are. But people (Bogleheads) more educated than me aren't concerned.
The keyword is "typically". It's basically just looking back at different countries and times and creating a best guess. It's not a hard rule, and could come sooner or later. What we are in now is still in ways an extension of 2008, so if we did hit another recession and went back to 0% interest rates and had more deleveraging on a corporate level, like I think it likely, I would personally consider it still a part of the bottoming process to the cycle that started to come to an end in 2008 just like the late 30's recession was an extension of the Great Depression.

Also, I wouldn't necessarily assume that "Bogleheads" as a whole are smarter than you. I facepalm about something damn near every time I browse that forum, haha. They do a good thing by at least getting people to invest long term in low cost index funds, but there is a lot of misinformation that is spread there as well (mostly in the form of opinion being spread as fact). Of course, with a long enough investing timeframe (like buy and hold) even misinformation tends to not really matter much as assets tend to go up over time.
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Re: Permanently low interest rates

Post by pmward » Tue Apr 23, 2019 9:01 am

Kbg wrote:
Mon Apr 22, 2019 9:22 pm
Hint #2: Gross vs. net corporate debt.

Credit card analogy #2: My credit card debt is up 10 fold again, darn it! Going from $100 to 1000 and I have 100K in STTs. Do I have a debt problem?

Have you examined a chart of corporate profits to GDP? Surprise...also at historical highs. Look away folks, no relationship here.

Ok, let’s make this as direct as we can...scroll on down to page 4.

https://www.yardeni.com/pub/fofnfdebt.pdf

You are not ever going to read the headline: “Corporate debt ratios somewhat below 50 year average.”
The charts on page 4 are interesting. But that's nothing different than what I stated above, that current debt ratios are manageable... but if 60%+ of that debt rolls over in the next few years at higher interest rates, and if we hit an earnings recession, that can cause a squeeze that can take us from manageable to unmanageable in a hurry!
Kbg wrote:
Mon Apr 22, 2019 9:22 pm

Finally, the Fed is causing zero interest rates or printing money like crazy which in theory is inflationary...if you are a Fed basher pick one or the other, you don’t get option Both.
I don't think it's a binary choice, I think it's a spectrum and interest rates can effect different economic climates differently. In the short term low interest rates are inflationary, but on a long term scale they are deflationary. We needed to go to 0% in 2008, we were in a deflation and it did help reflate the economy. The problem is once interest rates are at 0 and you're doing QE, it's very hard to stop. And after enough years of it, it does influence debt levels to rise at an unhealthy rate. And while those debt levels are still serviceable when times are good, when the tides shift they become unmanageable. Case in point, in 2008/2009 even people that had good credit and were quality borrowers were foreclosing on their homes, because the economy turned and their expenditures, while steady in a nominal sense, became unmanageable because their incomes dropped. If their incomes had remained steady then they would have been fine. My parents were in that boat. Everything was great until my father got laid off unexpectedly. Then boom.

If the economy stays at its current levels for another decade with no recession and corporate debt levels also stay steady, sure it won't become a crisis. But is that realistic? If we go through a growth and inflation boom, it won't become a problem. But are there any signs pointing to this growth and inflation boom happening? Both have been quite anemic on the whole. Meanwhile, there is a lot of kindling in place, and more being placed down by the day.
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Re: Permanently low interest rates

Post by boglerdude » Tue Apr 23, 2019 11:44 pm

Companies know rates can go up, they'd deserve to go under. I might agree that BOJ and ECB are keeping bad companies afloat with free money. Unemployed/bored people commit crime tho, another reason to get rid of min wage.

https://seekingalpha.com/article/425075 ... ok-cheaper

^ wrong?
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Re: Permanently low interest rates

Post by pmward » Wed Apr 24, 2019 8:47 am

If the only metric someone looks at is P/E, then yes it does make the market look cheaper than it is. I think an argument could be made that over the last 10 years buybacks alone are the main reason for the U.S. outperformance. I'm not opposed to letting a company buy back their own stock if they have no better ways to allocate their cashflows, but I do think that it is not normal a normal condition when companies are taking on debt to do so.
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Re: Permanently low interest rates

Post by pmward » Wed Apr 24, 2019 3:36 pm

Jesse Felder released a blog post today that in a lot of ways touches on some of the things we've been discussing here: https://thefelderreport.com/2019/04/24/ ... ded4b883a5

"Live by the bubble, die by the bubble"
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Re: Permanently low interest rates

Post by Tortoise » Wed Apr 24, 2019 5:44 pm

pmward wrote:
Wed Apr 24, 2019 8:47 am
I think an argument could be made that over the last 10 years buybacks alone are the main reason for the U.S. outperformance. I'm not opposed to letting a company buy back their own stock if they have no better ways to allocate their cashflows, but I do think that it is not normal a normal condition when companies are taking on debt to do so.
I don't yet quite understand why corporate debt has been on the rise in recent years, and I'm hoping someone here can help to explain.

My understanding is that when companies need more capital, there are a few main ways in which they can raise it:
  • Issue new stock (equity financing)
  • Issue bonds (debt financing)
  • Borrow from banks (?)
And my understanding is that when companies have surplus capital, there are a few different things they can do with it:
  • Invest in the company (R&D, new facilities, higher salaries/bonuses, etc.)
  • Return it to shareholders directly as dividends
  • Return it to shareholders indirectly as share buybacks
Presumably, at any given time, a company either needs more capital or has a surplus of capital, but not both. But unless I'm mistaken, what seems to be happening currently is that corporate debt levels and corporate share buybacks are both rising simultaneously. That seems to suggest that on average, corporations currently both need more capital and have a surplus of it -- an apparent contradiction.

Seems like I may be missing something here?
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Re: Permanently low interest rates

Post by drumminj » Wed Apr 24, 2019 6:20 pm

Tortoise wrote:
Wed Apr 24, 2019 5:44 pm
Seems like I may be missing something here?
They're borrowing money to buy back stock?
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Re: Permanently low interest rates

Post by Tortoise » Wed Apr 24, 2019 7:00 pm

drumminj wrote:
Wed Apr 24, 2019 6:20 pm
They're borrowing money to buy back stock?
In other words, my assumption that companies only do share buybacks when they have surplus capital was apparently incorrect. Interesting.

Follow-up question: What is the likely thought process of a corporate executive who borrows money to buy back shares? Is the idea that unless the shareholders see a return in the form of dividends or increased earnings per share from a buyback, they might start losing faith in the company's profitability (i.e., they'll actually start to see the truth)?
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Re: Permanently low interest rates

Post by pmward » Wed Apr 24, 2019 9:21 pm

Tortoise wrote:
Wed Apr 24, 2019 7:00 pm

In other words, my assumption that companies only do share buybacks when they have surplus capital was apparently incorrect. Interesting.

Follow-up question: What is the likely thought process of a corporate executive who borrows money to buy back shares? Is the idea that unless the shareholders see a return in the form of dividends or increased earnings per share from a buyback, they might start losing faith in the company's profitability (i.e., they'll actually start to see the truth)?
In a general sense. You also have to think about the motivations of executives, most executives are paid the majority of their wages in company stock. So by buying back shares, they are in essence propping the stock price up until they vest. If they announce a buy-back, they then can buy the stock back up any time it starts to dip. So there are some personal benefit they get from it, aside from appeasing the shareholders. This is why it's been so controversial recently. I'm not an executive, but I get a substantial amount of my yearly pay in the form of company equity that vests over time. It does help me feel a bit safer when my company announces a buyback, especially since I work for a high growth tech company with a triple digit P/E valuation. The high valuation does make me nervous in general.

I don't think that in a normal interest rate environment this is an issue, but when a company can borrow money dirt cheap it enables them to borrow to buy back shares, and generally enables wasteful spending practices.
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Re: Permanently low interest rates

Post by drumminj » Wed Apr 24, 2019 9:38 pm

It's also worth noting that stock buybacks were illegal prior to 1982.
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Re: Permanently low interest rates

Post by pmward » Wed Apr 24, 2019 9:40 pm

drumminj wrote:
Wed Apr 24, 2019 9:38 pm
It's also worth noting that stock buybacks were illegal prior to 1982.
Yeah, I actually just learned that a few weeks ago. I wasn't aware it was ever banned. But yeah, some politicians are moving to ban it again because they think it's unethical to allow executives to raid their companies balance sheets for their own personal benefit. Of course, the real question is, is that fixing the real problem or just treating the symptom of the problem?
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Re: Permanently low interest rates

Post by Tortoise » Wed Apr 24, 2019 10:29 pm

It seems like stock buybacks should be allowed as long as they’re done with excess capital, i.e., not with borrowed funds.

In a sense, stock buybacks are the opposite of issuing new stock. Companies issue new stock to raise capital, so the opposite activity (buying back shares) should be done to drain excess capital.
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Re: Permanently low interest rates

Post by Kriegsspiel » Thu Apr 25, 2019 6:55 am

I remember reading an interesting idea in Korten's When Corporations Rule The World where he proposed (IIRC) requiring companies to distribute x% of profits as dividends. I wonder if that's a better scenario for corporations than one where they have the option to buy back shares.
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Re: Permanently low interest rates

Post by pmward » Thu Apr 25, 2019 8:19 am

Tortoise wrote:
Wed Apr 24, 2019 10:29 pm
It seems like stock buybacks should be allowed as long as they’re done with excess capital, i.e., not with borrowed funds.

In a sense, stock buybacks are the opposite of issuing new stock. Companies issue new stock to raise capital, so the opposite activity (buying back shares) should be done to drain excess capital.
It would be very difficult to enforce that. There would wind up being loopholes that they would exploit one way or another. Plus, at the moment it's already too late. The bubble has already been filled. Companies have already assumed massive amounts of non-productive debt in the forms of leveraged buybacks and malinvestment. The more responsible companies with good balance sheets will do fine in the next down turn. But the companies that have been taking out massive amounts of debt that has not generated a return, companies that are either not investment grade (junk bonds) or borderline investment grade (that will get downgraded to junk), companies that have been following the trend of using collateralized loan obligations (CLO's) that are highly leveraged with variable rates, etc... well what happens to those companies is not going to be pretty.
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Re: Permanently low interest rates

Post by pmward » Sun Apr 28, 2019 9:44 am

A pair of articles written this week by Kevin Muir on MMT, analyzing it and trying to separate the wheat from the chaff, and looking at how we as investors should look at and prepare for MMT. It is very unbiased and is not political in any way (though he does mention that under Trump we actually are already in the most MMT regime we have ever had):

https://www.themacrotourist.com/posts/2019/04/23/mmt1/
https://www.themacrotourist.com/posts/2019/04/24/mmt2/
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Re: Permanently low interest rates

Post by boglerdude » Mon Apr 29, 2019 2:07 am

Is inflation low? Trillion dollar deficits for 10 years, thats 10 trillion of inflationary pressure. And they say banks create 90% of new money? How much are they lending compared with how much gets payed back (destroyed)

Food is cheap, but also subsidized. What if the subsidies ended. Whats the point of putting deflationary things in the CPI. You'd think the point of talking about inflation would be to figure out exactly how much the inflation tax is. I was thinking the 30 year rate might tell you market expectations of inflation, but if the Fed steps in to buy they'll lower the rate. "financial repression." Maybe things in fixed supply can give you an idea, like gold or college tuition
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Re: Permanently low interest rates

Post by pmward » Mon Apr 29, 2019 9:12 am

boglerdude wrote:
Mon Apr 29, 2019 2:07 am
Is inflation low? Trillion dollar deficits for 10 years, thats 10 trillion of inflationary pressure. And they say banks create 90% of new money? How much are they lending compared with how much gets payed back (destroyed)

Food is cheap, but also subsidized. What if the subsidies ended. Whats the point of putting deflationary things in the CPI. You'd think the point of talking about inflation would be to figure out exactly how much the inflation tax is. I was thinking the 30 year rate might tell you market expectations of inflation, but if the Fed steps in to buy they'll lower the rate. "financial repression." Maybe things in fixed supply can give you an idea, like gold or college tuition
Yes inflation is low; problematically so. It's the sole reason the Fed can't get interest rates off the floor. Also, do keep in mind that inflation and growth are correlated, we have low inflation because we have had low growth. An increase in growth would lead to an increase in inflation, which would allow the Fed to raise rates to a more normal level, which in turn would provide us protection in a downturn. Also, higher interest rates would help eliminate the deflationary pressures we currently are still experiencing, as low interest rates over a long period of time are inherently deflationary.
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