Guess what stock this is?

Sep 16, 2019 | About Bonds, Current Investments, Economic Commentary, Investment Philosophy, Investment Soapbox

Our belief resides in the fact that economies grow through productive means – not monetary stimulus.

Imagine if you had this in your portfolio one year ago – you would be up 100%!

Wish you had bought it back in 2018, right?  Well, it isn’t a stock – it is a bond.  And it illustrates what is wrong with our global financial system.  I would have used ‘capital markets’ but didn’t want to affiliate the word ‘capital’ aka true capitalism with today’s market place that determines the price of money since the system of setting the price for money today is the furthest thing from a free market.  Today’s marketplace unfortunately is controlled and manipulated by a handful of central banks around the world.  Within the walls of these institutions likely are bright people but it might be that when separated from a text book or classroom, they struggle with common sense.

Maybe we are missing something – but to us the reality today is that our monetary system is out of control.  If monetary policy of forcing rates to 1 or 2% didn’t create the growth they were looking for, what makes them think that zero (or negative) will.  Our belief resides in the fact that economies grow through productive means – not monetary stimulus.  Maybe stimulus encourages investment in productive assets – supporting future economic growth – but it seems that today’s central planners believe monetary stimulus equals growth – which isn’t true.  In fact – unintended consequence are bubbles and the misallocation of capital.

What has the past 10 years of extreme monetary policy (cheap money) generated? 

First and foremost – it generated $16 TRILLION of ‘assets’ (we would call liabilities) that no one who values their capital should touch in a million years…

Here is a chart showing the market value of negative yielding debt around the world.   Five years ago – it was about zero.  Today – $16 TRILLION.  And global GDP has grown by $10 trillion over that time frame.    Not a good return in our opinion and creates a larger problem of how to get out of this addiction.  Our thoughts were summed up well in this Forbes article.

Second – Unicorns (private companies valued over $1 billion).

When money in your pocket costs you to hold it – then you are incented to put it ‘to work’.  Unfortunately, cheap money has no value and results in malinvestment.  Similar to the late 90s – when companies focused on ‘clicks’ – it seems today it is more important to focus on revenue growth than profit growth – which to us is illogical.  However, GS (Bloomberg article) tells its clients as much – focus on revenue growth and not profits – now – their incentive is about 4.4% in fees per IPO – with having done close to $6B in IPOs – they have earned close to $262 million selling new IPOs just this year alone.  So – they made $262mm selling companies they are telling their clients to buy – maybe they should roll that $262mm of fees into all those money losing companies for 10 years – since it is such a good deal. (Bloomberg League Table – 9/4/2019)

WeWork – IPO announced.  The last valuation of WeWork was done at a $50 billion valuation by SoftBank.  Today IPO price talk of WeWork is $10-15 billion.  How does the value of an asset decline by $35 or $40 billion in such a short time frame?  Well some examples that come to mind are Enron and WorldCom in early 2000s – but these were both frauds.  Others would be CSCO, MSFT and many other Tech companies in FY00 – but these are all in a bubble.  Well – today you can include WeWork, UBER, WORK, LYFT and many other multi-billion companies that don’t make money, may never make money, but the reason to buy it was growth at any cost.  Well, once the market wants a return on its capital, the downside is treacherous (remember when people paid for ‘eyeballs’ and ‘clicks’ in late 90s).  But how should one determine a return on capital or how to assess what their returns should be?  It comes back to our philosophy of knowing what you own.  This philosophy leads us to our final symptom of crazy monetary policy – the rapid growth of passive investing.

Third – Passive Investing –  Talk about being as far away from knowing what you own. 

If you want a market return – that is fine but just don’t pay anyone for it. Go do it yourself and pay about 5 bps in low cost ETFs.  However, if you actually want to know what you own – like where you put your money, how much is it earning and what is the thesis around why the value of the asset you own is supposed to grow over time – then passive investing is one of the worst ideas ever.  It reminds us of all the water cooler conversations in the late 90s where the topic was someone’s great stocking picking abilities – don’t confuse a bull market with investment skills – the results can be devastating to your capital.

Go capture Beta (passive investing) just don’t pay for it. If you want a portfolio constructed from the bottom up – then pay for it.  But in doing so – know what you are paying for and if you look at your statement and it consists of 8-12 funds or a hodgepodge of stocks, then you might want to think long and hard about what you are paying for – you may have just paid for something that could have been free.

 

 

 

 

 

Math and The Capital Markets

Apr 15, 2019 | Current Investments, Economic Commentary

You may not realize it, but because of how index investing works, you may have some negative yielding bonds in funds you own.

Despite soundbites from Washington DC and the Fed about how great things are – this blog entry attempts to frame the capital markets with a different perspective. Let’s look at some facts and figures that support our view –  under the surface, the capital markets are not what they appear to be.

To start, we provide this definition: Capital markets is defined as the intersection where those with capital (buy side) and those seeking capital (sell side) intersect.  On the surface of that intersection things appear good.

Our thesis: Things are good in large part because the Fed (and other central banks) have artificially kept the price of money low – which makes the job of those with capital treacherous.

Recently the Fed changed their stance on monetary policy, reminding us of an old adage – when it comes to other people making recommendations about your money –  do as they do, not as they say. Despite calming words from the Fed, their actions speak louder than words. The past 10 years of global central bank experimentation indicates under the surface all is not well.  Artificially suppressing the price of money results in unintended consequences and an illusion of prosperity.

Prosperity is easily seen in some graphs – such as unemployment at decade lows – back to where it was in 2006 and 2000:

Stocks at all time highs (more good news):

Inflation tame (and not deflating):

Looking at these pictures and it seems things are rosy and prosperity if widespread. Why not invest for the long term – put all your eggs in equity and just don’t worry?

How about this chart (above) – which we believe is the elephant in the room.  This is the total amount of negative yielding global debt outstanding– the 9.142M stands for $9.142 TRILLION dollars of securities around the world that have negative yields.  You might ask – why do we not show the years 2000 and 2006 for this chart? Well, it didn’t exist in 2000 and 2006. Not until global central banks started their mad monetary experiment did negative yields come into existence – it was actually over $13 Trillion at one point during this recovery.

(You may not realize it, but because of how index investing works, you may have some of these negative yielding bonds in funds you own. Funds managed by Blackrock, PIMCO, and Vanguard, for example, own billions of these negative yielding bonds.)

Prosperity shouldn’t be dependent on suppressing the price on 9 Trillion dollars of capital. The artificial price on that $9 trillion trickles down to impact the price on all assets – whether it is Investment Grade, High Yield, Equity or Real Estate.  

When the price of borrowing money is negligible – the cost of taking on debt or investing capital  is minimal. Furthermore, being paid to hold someone’s money is a great situation for borrowers (governments) – but not so much for savers and people trying to invest capital.  US Government has $22 Trillion of debt outstanding and investment grade US denominated debt totals $5 Trillion.

Although that is a lot of debt, the cost to service that debt (interest coverage) is healthy.  The example is Uncle Sam – The US Government had $10 trillion of debt in 2008 and paid $451mm of interest – for an implied coupon of 4.50%.  Today, the US Government has $22 trillion of debt but paid $458mm in 2017 for an approximate average coupon of 2.25%. So debt service cost looks good – we pay $450 billion of debt service – and receipts are higher – so the US Treasury is in good shape.  However, if rates were 200bps higher – back to where they were in 2006/07 – debt service would be $1.02 Trillion. Imagine the budget cuts of government programs should rates go back to where they were in 2006. Don’t even ask about rates in 2000.

Bottom line – we can’t afford higher rates.  So despite Fed speak about ‘getting back to a neutral rate’ – they know and we know – Uncle Sam nor our economy can afford that.

In conclusion – our economy can’t afford higher rates – even though it seems prosperity is all around us and the monetary experiment of global central banks have painted us into a corner of unicorns and negative rates.  If rates go higher – things slow down (dramatically) and the Fed will resort to additional measures of monetary stimulus.

Tariffs… More or War?

Apr 2, 2018 | Economic Commentary

The Trump administration has ordered tariffs on steel & aluminum imports and continues to discuss other, similar actions. What Ballast will say is that tariffs raise prices, and this can be good and bad. What could be very bad is a trade war. The rhetoric is simmering, and we think if it reaches a boil, capital markets will react harshly. So far, investor sentiment seems to be that the risks can be brushed off.

If you read or listen to the “expert” commentary around this topic it ranges from “this is a great thing for our country and our economy” to “this is going to be a disaster.”  This is a perfect example of why we shy away from taking equity risk – unless we are very well educated about the value and the risks for the price we are paying.  Risking hard earned money and savings in an equity market that has influencers, such as a tariff war hanging over it’s head (influencers that “experts” disagree on the effect they could have), seems like maybe it might not be a good idea.

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