A weekly thread to discuss financial matters - from personal all the way up to global.
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Notes -
AI and government spending: teaming up to shiv the regular economy 🤝.
One bad thing about excessive government spending is that it increases the price of debt. Sure, I could loan you money for your new startup. But why do that when I can loan money to the government who will literally confiscate assets to pay me back?
The rapid AI buildout is having a similar effect. Hyperscalers like Amazon and Meta are borrowing hundreds of billions of dollars to build data centers. These are incredibly good credit risks with durable cash flows. Loan money to them and you will almost certainly get paid back.
So federal, state, and local governments are all increasing their borrowing at the same time that the largest corporations are doing the same. It's actually kind of surprising that the 30 year yield is only 5%.
Something has to break. There's just not enough liquidity in the system to finance everything that needs to be financed. And since AI productivity gains have thus far been elusive, we seem to be on a track to either austerity or inflation in the next couple years. Here's hoping it's inflation.
I honestly love US 30’s now. I’ve been seeing 2 possible medium term outcomes proposed: (1). AI is real and is a huge productivity boom causing mass unemployment. Deflationary. Likely causing rates to fall (2) it does not do that. Or something in between. Capex buildup for AI falls. Lower demand because that’s removed and is deflationary. Rates fall.
I also think big tech or some of the names after a recent dip are reasonable. And a friend asked me what would I want to hold thinking 9 months out. If I had to be long or short big tech I would choose long. But also the same with 30’s. And if rates fall you actually get very good appreciation in long term bonds too. 100 bps fall in yields will get you 15-20% price appreciation plus the yield
Back to big tech. If I couldn’t trade for a year I would own it. My current portfolio is approximately is about 25% long 30s, 40% cash, 35% equities. A lot of trading in between but overall those ratios I’ve been maintaining the last month. If I couldn’t trade for 9 months I would deploy a lot to Amazon and Google since I like their price better now. And a few random names I follow. And probably increase the 30 year exposure from 25 to 35%. I would have zero cash on a 9 month hold. That’s there to hopefully find better opportunities next few months.
Yeah, that's a good argument for 30 year treasuries.
Here's another one. Rates aren't going to 8%. They're just not. Because the government will go bankrupt in short order. So the Treasury and the Fed will find a way to fix it just like they "fixed" Covid by printing $10 trillion in helicopter money.
So, we might be in a similar situation to 2020, just opposite.
Back then, only a moron would buy treasuries because rates were near zero. It was impossible for them to go lower.
Today, it may be impossible for rates to get much higher. Gilts will be one to watch since British debt is already trading higher than US debt (their 30 year is approaching 6%) and the UK has a bad economy, bad politics, and horror show demographics. Will be interesting to see when they crack and what happens.
Here's a TIP for you. Take a look at TIPS (Treasury Inflation Protected Securities). You can lock in a yield of 3% + inflation for 30 years. So when the government prints you'll be protected, modulo how much you trust the CPI to be accurate.
Despite all this, I own almost no bonds because the stock market is a better opportunity, IMO.
High TIPs spread is one reason I’m recommending owning bonds is ok.
Fundamentally I’m a mean reversion guy. I’ve always traded that way. The trick with having that trading personality is I guess having a fundamental understanding and being right more times than wrong that it’s value. And my gut is rates are value here and not fucked. And duration can offer significant upside.
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This is actually why I was asking about the commodity futures fund in the other thread. There are an increasing number of things occuring these days that seem similar to the runup to the stagflation era. Commodities did well during that era, compared to the alternatives.
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I can merely suggest that any cognitive dissonance you're experiencing with real world outcomes could also be solved a different way, with an acknowledgement that your understanding/intuitions were mistaken.
It sounds like your model is one where 'finance' is quantity-constrained with floating price. That could be a hypothetically-used system, and the gold-standard-era sort of tried to mimic that at one level of the money hierarchy. But our current system, from the top to the bottom, is one where finance is infinitely-elastic, floating quantity, based on set prices. If you're credit-worthy, you can always borrow money into existence at a rate that gives the bank a margin. If the government has their own currency and their own central bank, they choose their own interest rates to pay as a matter of policy, setting the base rate for everyone else. If anything breaks in the near-future, it would be due to a similar inept policy choice, rather than any fundamental economic gravitational pull. It would be like giving up on building a house because you ran out of inches.
I'm having a hard time reading this comment charitably. I think that you are arguing with an imagined person who thinks that there is a pile of money somewhere that we are all competing for. I get it. That's a common fallacy. But, no, I am not an idiot.
I'll try not to make the same mistake, but I think I want to correct some things implied or said by your post. You probably already understand this, but its worth pointing out that.
Yes its true that technically, the "government" can set its own base rate. But even modern monetary theorists understand that this rate is constrained by inflation. Otherwise we can just set the rate to zero, negative even, and all problems are solved.
Furthermore, banks cannot bring infinite money into existence. Yes, its true that when you get a loan from the bank money is created. But the banks cannot do that infinitely. They are highly constrained by their capital, deposits, and other complicated regulations.
Companies generally borrow money from the bond market not banks. This is the aspect I'd like to talk about here.
So let's take a real world example, Charter Communications. This is a highly-levered company which owns broadband assets. They are quite cheap, trading at roughly 3.5 times earnings. However, they are also highly indebted, with debt equalling about 4 times market cap.
Charter is quite easily able to service its debt with its massive cash flow. But this debt service is a huge part of their cost. Their profit would be roughly double if their debt disappeared. Here's the problem. When it comes time to refinance their debt, as they must do from time to time, they are COMPETING with Google and the US government for the same debt. And the US government and Google are much better risks. Charter is going to have to pay a HIGHER interest rate.
Until recently, Google didn't need to borrow money at all. And the US government's needs were much smaller. There are more debtors chasing the same amount of creditors, which is why the 30 year treasury yield as increased from 4.1% in two years ago to 5.2% today. That is massive.
Going back to Charter, they are currently paying about 5% on their loans. But their most recent issues have ranged from 6%-7.85%. If this keeps happening, it could sent Charter into a doom loop and bankruptcy. Loan cost goes up -> less cash flow -> more credit risk -> loan cost goes up -> bankruptcy.
And this is why Charter trades at a PE of 3.5 despite having difficult to replace assets and stable cash flows. The real economy is getting whacked because FAANG needs money for AI buildout, the government needs money for welfare, and they are both competing for bond buyers with old economy companies like Charter.
Like I said, just an offered suggestion. If you don't actually feel any cognitive dissonance with any outcomes or past predictions, then fully ignorable, my mistake. I can then instead just offer my own prediction for the next few years, of no austerity, no demand-pull inflation (could get cost-push from oil prices, certainly up in the air right now), and no loss of control of interest rates (indeed at some point the Fed will likely do their job and exercise more yield curve control instead of having the treasury attempting to do it alone).
Well the chosen interest rate isn't constrained. What's constrained by inflation is the stimulative effect of increased deficit spending, but note that raising the interest rate directly increases government deficit spending. So as an economic tool, whether you're moving the rate up or down with monetary policy, you're pressing both the gas & brake pedal at the same time, and just hoping to correctly predict which channels will have a stronger effect. Currently most central bankers still use a rough reaction function where they hope the net effect of raising rates cools the economy on balance, fighting inflation, and lowering rates stimulates the economy / causes inflation, but the evidence is just getting murkier for that hope (so they're thankfully getting away from anything close to a rigid taylor-rule style). There's no evidence that leaving the rate at 0% causes inflation, and a mountain of evidence to the contrary. So personally I do think they should set it to 0-1% and leave it alone. As for solving all problems, surely not, but maybe a lot of the problems you were bringing up.
They could, via the core accounting and economic logic, as well as having access to the reserve banking system with a permanently available lender of last resort. But indeed you noted the real restraint, government regulation, with current rules requiring those commercial bank members to stay profitable and thus well capitalized, or else face reprimand & closure. So sure, Charter can't walk up and get another $90B tomorrow. But if we accidentally just 'shiv' a super productive & profitable economy by having over-tight regulation that prevents lending to credit-worthy borrowers, that would be a failure of policy & imagination, not any kind of inevitable 'crowded out by tech' story.
Fair, I don't know enough about the appetite of retail & institutional investors for corporate bonds. I would have guessed it was effectively limitless at the right price, with the market being tens of trillions in size, where a company's finances & fundamentals would dwarf any effect from competition between issuers.
Either way, the federal government is definitely not playing in that same game as a competitor that could crowd anyone out. Their 'borrowing' consists of mopping up the exact reserves that they just injected into the system with the prior deficit spending. As for the chosen monetary policy risk-free rate being the starting point for all other interest rates, which get priced at some spread above it, I wouldn't find it very illuminating to use 'competition' terminology for that. That's just always how it works, regardless of the level of government spending. It's more aptly seen as a subsidy: the government chooses to give out money to those who have money, which obviously sets a base opportunity cost. As for long-term treasury price floating, that's still a choice of monetary policy to allow some market participation in setting the price, based on predictions about future inflation and rate-changes. I don't know how valuable they really find that information gathering from the market, and they could definitely choose to control the yield curve with any durations having any prices they want.
Looking into it briefly, it seems like a pretty interesting and extraordinary case study, rather than some joe schmoe typical avatar of the non-AI 'regular economy'. I'm paying them every month myself, but never knew about their prior bankruptcy & recent debt shenanigans with the mergers.
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