Market thoughts on the Covid-19 Christmas lockdowns?

[LC]

What bothers me about the rates argument is, when does the equity yield become so low that it does not justify the risk you are taking?

 

Ok in a world of sub 2% bond yields,  sure I can understand why a 3.5% equity yield exists. But as an individual, why invest in that? Just to sell at a 2.5 or 3% yield? That strikes me as a bit of the “greater fool” angle. Prices just seem dangerously high to me.

[Viking]

What bothers me about the rates argument is, when does the equity yield become so low that it does not justify the risk you are taking?

 

Ok in a world of sub 2% bond yields,  sure I can understand why a 3.5% equity yield exists. But as an individual, why invest in that? Just to sell at a 2.5 or 3% yield? That strikes me as a bit of the “greater fool” angle. Prices just seem dangerously high to me.

 

LC, i agree with you. My post above is done partly tongue in cheek - sort of :-) to stimulate discussion and thinking.

 

I have been trying to wrap my head around what central banks have been doing (QE etc) for the past 8 years, watching governments everywhere take on crazy amounts of debt, watching real estate in Metropolitan Canada go through the roof etc. We seem to be on this borrowing binge and rates just keep going lower (which leads to more borrowing). Maybe it all does make sense. Low rates. Massive debt. Super high prices for financial assets. The new normal.

[Viking]

What bothers me about the rates argument is, when does the equity yield become so low that it does not justify the risk you are taking?

 

Ok in a world of sub 2% bond yields,  sure I can understand why a 3.5% equity yield exists. But as an individual, why invest in that? Just to sell at a 2.5 or 3% yield? That strikes me as a bit of the “greater fool” angle. Prices just seem dangerously high to me.

 

The simple answer is you will put your money where it will give you the best returns. Bond yields have cratered. Why will we not see yields from other asset classes follow suit?

 

As an example is this not what Flatt at Brookfield exxpects to happen with real estate (much higher prices and much lower yields)?

[rb]

The thing with monopoly money is that it's all monopoly money unless you're willing to exchange it for real money. So the bank pumps out monopoly money. Your house value goes up. Your house value is also monopoly money unless you're willing to sell it (convert to real money). I'd wager that you're not willing to do that.

 

What you're talking about is really about interest rate arbitrage. More about whether rates are priced or not in assets. I've made really good money on that bet when it was pretty clear that lower rates were not priced into assets earlier on in the decade. That was pretty standard economics stuff. You could measure it and figure it out without having to be a genius. Now I fear that a lot of what gregmal says is true. If it is, then the real risk is that rates move up. What that means for asset prices is a bit of a mixed bag. A rising tide lifts all boats but a lowering one is more tricky and its effects will depend on the type of boat you have. Stocks could do well but their valuations are already stretched so they're a crapshoot. Bonds are going to get murdered. Your house will definitely do badly.

 

This is definitely the point where I'm looking to get some swaps. The only question is how much to get and which part of the yield curve to target (likely the longer end).

[mattee2264]

Good point rb. If people tried to cash out the wealth they've enjoyed during QE or if wealth effects on consumption were a lot stronger we would be seeing a lot more consumer price inflation and rates would not be able to stay this low. And of course if everyone is trying to sell their highly priced stocks and real estate that will evaporate inflated asset values. Perhaps the broadening participation in the final stages of the bull market will change things especially when things open up and people want to spend.

 

LC, I think the short answer is you look at the equity risk premium. Historically that has been around 300 to 500 basis points. So if you are fairly optimistic about S&P 500 earnings then with interest rates around 1% an earnings yield of 4% (normalized P/E ratio of 25x) looks fairly reasonable. Within that risk premium is the risk that at some point in the future interest rates will be higher.

 

I think the reason Viking's thought experiment hasn't yet happened is that low interest rates tend to co-exist in a deflationary/low growth world. In that world you aren't getting much growth from the vast majority of equities. So multiples in say Europe are very modest despite even lower interest rates than the USA. The difference in the USA is you have a far greater concentration of growth stocks where you are seeing very rich multiples. If the market suddenly decides that the economy can grow very fast and interest rates can stay near zero then I'd expect multiples to explode. And that could make for a crazy 2021 as the market confused catch-up growth driven by pent-up demand and fiscal stimulus with sustainable long term growth.

 

Oh and the mutant strain has spooked European markets and oil markets today. Obviously every country is stopping flights from the UK. But the cat might already be out of the bag. And while scientists are confident the vaccine will still work against it there is still some uncertainty about this. Probably it is overhyped. But if it is a lot more contagious and scares governments into implementing even stricter lockdowns over the next few months of next year that could be enough to take markets down 10-20% especially as there is a lot of leverage and extreme positioning so a rush to the exits could be messy.

[SharperDingaan]

The problem with monopoly money is that you can sell your house at an inflated price, but then you've got to buy another one to live in at an inflated price. The only beneficiaries are the intermediaries charging a % fee.

 

Toronto's new condo market has long been driven by FR interest +ppty tax +locker fee +condo fee < rent. New condos sold well because the condo fee wasn't funding the reserve fund, and the owners expected to be long gone before the repair assessments arrived. Footage shrank to reduce the down payment, but interest savings were often offset by locker fees. Then, as now, you bought a new place because it was both available, and a lot better than the alternative run-down dive at the same rent -  but lose your job, stay too long, or interest rates rise, and you lose your home.

 

It is highly likely that a number of very high quality Alberta o/g firms will be partially restoring their dividends over 2021. At current prices, and a 75% restoration, most will have a cash yield of 7% ++. Even if you added 50% to the current 1.75% yield (1.5-2.0% avg) to get a yield of 2.625%, the value of these firms rise 2.67x plus. Point? In some sectors even if you see a 3.0-3.5x rise in price, the sector will still NOT be expensive!

 

How do you get OUT of the nuthouse? Quietly move a % of gains into BTC and precious metals.

There is a reason why BTC has become a lot more 'mainstream'  :)

 

SD

 

 

 

 

 

 

[mattee2264]

 

Naively I thought vaccines would allow us to vaccinate the most vulnerable reducing hospitalisations and deaths and the stress on the health system and therefore a faster return to normal. And actually re-opening would accelerate herd immunity if it allowed the virus to spread around the young and healthy who are probably the most likely to refuse vaccines.

 

But in many parts of Europe national lockdowns are on the cards with governments seemingly terrified about mutant strains and rising case numbers in spite of existing tight restrictions. The message is "the vaccine is our only hope". If I was being cynical I would wonder whether governments are trying to scare/bully us into submission presenting us with the choice between either getting vaccinated or enduring the hell of national lockdowns for most of the year.

 

No idea what direction USA will go under Biden. But if herd immunity via vaccinations is the aim then it will probably be seen as advantageous to keep things tight until enough people are vaccinated which could delay re-openings until the summer rather than the spring.

 

Of course the virus could just burn out in the spring like last time. But double dip recessions seem far more likely, at least in Europe. Interesting to see if there will be any kind of reaction.