jankythoughts2

Growth vs Dividends

by jankythoughts2September 8, 2023Leave a comment

Foreword

How should we evaluate a $100 company that pays $10 in dividends a year, every year, vs another $100 company that pays $5 in dividends this year, $5.25 next year, $5.51 the year after, and so on, increasing its dividends by 5% a year?

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Perfect world

Let’s say we have a business that scales infinitely at 10% returns — for every $100 you invest in it, it will return $10 every year in perpetuity. Further, let’s say we live in a perfect world, where there are no taxes to worry about and other transactional costs.

This business is, then, the first example from above — the $100 company that pays $10 in dividends every year.

Transmogrify

Now, imagine if at the end of year 1, instead of pocketing the $10 in dividends, you pocket $5, and invest $5 into the company. Now you have $105 invested in the company, so your next dividend will be $10.5. Again, you do the same thing, pocket half, and put the rest back into the company — in year 2, you’ll then pocket $5.25, and reinvest $5.25 for a total of $110.25 invested. In year 3, you’ll get $11.02 in dividends, of which you’ll pocket $5.51, and reinvest $5.51, and so on.

If you look at the numbers closely, you’ll realize that we’ve transformed our 10% dividend paying company, into a 5% dividend paying company, but with a 5% increase in dividends every year.

In general, absent frictional costs (like taxes, transaction costs, etc.), an asset that yields X% a year every year, is equivalent to an asset that yields Y% a year, but which grows the dividends at (X-Y)% a year — The difference (X-Y)% in yearly yield can be considered as being re-invested to grow the next year’s yield at an additional (X-Y)%.

Welcome to Earth

Of course, in real life, there are taxes and there are transactional costs — in the prior example, your $10 per year in dividends will be taxed, leaving you less than the desired amount to reinvest so that you cannot achieve the 5% increase in dividends for the next year — one way of thinking of it, is if the money was directly reinvested instead of first being passed to you as dividends, the taxes on that reinvested part will not be due yet, and so will compound for you instead of the government.

But even though so, in many cases, it is useful as a rule of thumb to think of the two companies as essentially equivalent. There are many ways around the frictional costs conundrum:

You could invest using a tax-advantaged account such as an IRA or a 401(k), in which case, there are no tax consequences right now either way.
If you didn’t intend to reinvest anyway, the tax drag is irrelevant.
When you pay taxes, and then reinvest in a smaller piece of the company with after tax money, your cost basis for that smaller piece of the company is higher, which reduces future taxes.
Reinvesting involves increasing your stake, which involves additional risks. The taxes paid now can be considered a counterbalancing force for not taking on those additional risks.

In practice, since tax rates can differ dramatically between different investors, many financial decisions are evaluated without taking taxes into consideration, with tax considerations being worked in later at the edges. So while a single person investing their own money may prefer one company or the other (depending on their personal tax situation), a fund manager (who services multiple clients with different tax situations) may actually treat the two companies as essentially the same.

Risks

One thing we only briefly touched on, is the idea of risk. If you take the $10 in dividends now, that’s a $10 profit there and then. But if you reinvest $5, then you are betting that the increased 5% of investment will result in 5% (or higher!) increase in yield going forward.

That may not be true!

Unlike our toy example, most businesses in practice do not scale forever. Whether you are selling cars, TVs, or services, at some point, you simply run out of customers to sell to. Also, as companies get bigger and bigger, bureaucratic overheads tend to grow and at some point, the marginal rate of return simply diminishes to 0 or even negative.

Which is to say, cash now is certain, while future growth is uncertain, and most investors will generally demand that an increase in investment of X% results in more than X% increase in yield going forward. Otherwise, it may not make sense from a risk/reward perspective.

Business returns

by jankythoughts2September 3, 2023September 4, 2023Leave a comment

Foreword

We’ve discuss the capital stack of a company before — basically how the company funds its initial creation and ongoing concerns. But why are there so many classes of funding? Why not just fund the entire company with equity? Or with debt?

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Perfect business

Let’s say we have found a magical business — it scales perfectly from $0 to infinity amount of money we invest in the business, and for every $1 invested, it will return 10c every single year. So, if we invest $100 into the business today, it’ll return $10 at the end of 1 year, another $10 at the end of the 2nd year, and so on.

A naïve view would say that this business returns 10%. But can we do better?

Terminologies

Before we go further, let’s get some terminologies out of the way:

Term	Definition
Returns on invested capital (ROIC)	A measure of the efficiency of a business, it is defined by NOPAT divided by invested capital: NOPAT / Invested capital
Cash returns on invested capital (CROIC)	A measure of the efficiency of a business, it is defined by free cash flow divided by invested capital: Free cash flow / Invested capital
Cash returns on capital invested (CROCI)	Not to be confused with CROIC, CROCI is another measure of the efficiency of a business and is more commonly used for enterprise purposes (i.e. when a company is trying to buy another company). It is defined by EBITDA divided by total equity: EBITDA / Equity
Invested capital	The total amount of capital invested into a business, generally defined as total equity + total debt: Equity + Debt
Net operating profit after tax (NOPAT)	A measure of how profitable a business is, it is defined by net operating profit – taxes: Net operating profits – taxes
Net operating profit	A measure of how profitable a business is, it is defined by free cash flow – depreciation – amortization: Free cash flow – depreciation – amortization (1)
Free cash flow	Another measure of how profitable a business is, it is defined by: Total sales – COGS – Operating expenses – Capex
Costs of goods sold (COGS)	The cost of making each unit of product sold by the business
Operating expenses	All costs related to a company’s primary business, other than COGS, such as sales and general administrative costs, etc.

For the purposes of this discussion, we’ll focus on ROIC.

ROIC

In our little toy example, the ROIC of the business is simply 10% — for every $1 invested, we get 10c back per year.

Does this mean that the owner of the company, i.e. the shareholders must settle for a 10% return on their money? Is there anything they can do to improve those returns?

Financial alchemy

Let’s say we want to invest $10,000 in the company, giving us a return of $1,000 per year.

We could put up that $10,000 ourselves and settle for a return of 10% a year, or we could borrow $5,000 at 5% interest rates, and only put up $5,000 of our own money:

Debt funding	Equity funding	Invested capital	Total return	Return to debt holders	Return to equity holders	% Return on equity
$0	$10,000	$10,000	$1,000	$0	$1,000	$1,000 / $10,000 = 10%
$5,000	$5,000	$10,000	$1,000	$5,000 x 5%= $250	$750	$750 / $5,000 = 15%

By funding half the business with debt at 5% interest rate, we’ve created an additional 5% of return for our equity holder!

In fact, if you think about it, as long as the interest rate paid for debt is below the ROIC, it always makes sense, in this example, to fund the business with debt — Since the debt holders demand a return less than the ROIC, the difference (ROIC – interest rate) effectively accrues to the equity holder.

ROIC vs CROIC

In our little toy example of a perfect business, ROIC = CROIC, as there are no taxes and the business is perfectly scalable with no drag (i.e. no depreciation nor amortization). In the real world, this is generally not true, and the difference between ROIC and CROIC is important!

ROIC measures how profitable a company is overall, while CROIC measures how good a company is at generating cash. Because debt interest payments are tax deductible, and because depreciation and amortization are tax deductible too, a company has some leeway to manipulate its funding sources (invested capital) to try and reduce its total taxes paid. For example, the more a company funds itself with debt, the higher ROIC it will generally be able to report, all else equal, as we’ve seen from above.

Furthermore, some businesses do not pay corporate taxes — REITs are a famous example, and instead, their shareholders pay taxes for profits directly on their own tax returns.

Finally, some businesses have depreciation and amortization costs that are far higher than what it actually costs the businesses — REITs again are a famous example, with proper maintenance, buildings tend to depreciate less than the accounting depreciation suggests.

For these reasons, generally speaking, most businesses should be valued on their ROIC, while real estate heavy businesses are generally better evaluated on their CROIC.

ROIC vs risk

In our perfect business example, because there is no risk, it is always preferable for the equity shareholders to fund the company with debt as long as the interest rate is below the ROIC. That is not always true in the real world — often, businesses tend to get less efficient after they reach a certain size, so infinite growth is impossible (edit: prior version had a typo saying infinite growth was possible — it’s not). Also, companies tend to get more risky as they take on more debt, as debt payments are mandatory, while equity dividends can generally be skipped without much financial repercussions — if a company falls on hard times, it can conserve cash by reducing or even skipping dividends, but it generally cannot reduce nor skip debt payments without an event of default.

Debt buyers understand that the more debt a business takes on, the more risky the debt becomes as there is less of an equity cushion if something goes wrong. As such, they’ll demand higher interest rates as the debt to equity ratio goes up.

Which is to say, the more debt a company takes on, the more levered it is, the more risky it tends to be. Though if everything works out, the more profitable for the equity shareholders it will be as well.

Footnotes

This isn’t exactly correct — certain non-cash expenditures such as stock based compensation, changes in inventory levels, etc. are taking out as well. For the purposes of this discussion, this is close enough.

August 8, 2023: Making moves

by jankythoughts2August 8, 20232 Comments

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

It’s early August, just one month away from the seasonally weakest month of the year for stocks, September. Time to make some moves?

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Weakest month

September is, traditionally speaking, the weakest month of the year, followed by August. There have been various theories put forth to explain this seeming affront to the Efficient Market Hypothesis, such as the end of summer where trader starts waking up from their vacation lull, the need to sell off assets to pay for a new school year, the selling of assets for tax lost harvesting, etc.

Whatever you may believe, it is undeniable that there is a fairly strong negative August/September effect for stocks:

SPY performance since 2019, monthly bars with Septembers annotated. Courtesy of Yahoo! Finance.

My portfolio

If you’ve been following me on StockClubs (1), an app that I’ve invested in, you may remember that I flattened my portfolio on September 2021, which worked out well initially with 2022 being a terrible year for stocks in general. However, at the end of 2022, I also initiated a bunch of shorts thinking the weakness will persist, but of course the market gods just laughed in my face and the market ripped higher (2).

As September 2023 rolls around, I’m getting that uneasy feeling again in the pits of my stomach, and if you’re still following me on StockClubs, you’ll note that I bought a put spread, betting that markets will be quite a bit weaker by mid November.

Why, why, tell me why

To be clear, I have a spotty track record at best at timing the markets, and unless you like losing money, it may not be prudent to follow in this fool’s quest. But here are some of the issues weighing on my mind:

Liquidity

In an earlier post, I noted that liquidity is draining from the markets. While I was waffling a bit and undecided on how that’d affect markets, I am beginning to warm to the idea that on the net, this would be market negative, especially the double whammy of student loan payments resumption and tightening monetary conditions.

Inflation

Another concern is that of inflation, the boogeyman from 2021/2022 that may be making a comeback. In 2021, inflation was an issue, but it didn’t really kick into high gear until late 2021 into early 2022, especially after the Russian invasion of Ukraine.

A large part of this was due to the huge spike in crude oil prices after the invasion, but which also started coming down around mid June 2022. As you can see from the graph below, inflation (orange line) looks almost like a slightly lagged, and very exaggerated version of crude oil price (candle bars):

Crude oil futures prices vs US CPI YoY inflation, weekly bars. Courtesy of TradingView.

Right now, it appears that crude oil prices is moving up again, but unlikely early 2023 when crude was around the same levels now, crude oil prices in July 2022 was much lower than crude oil prices in January to June 2022:

Crude oil futures prices, weekly bars. Courtesy of TradingView.

As a result, the drag of crude oil prices on year over year CPI is likely to be much less muted in July than for the first half of the year.

One way of visualizing crude oil prices’ impact on CPI inflation is by comparing CPI inflation (orange line) to core PCE inflation (teal line) and core CPI inflation (blue line) — core PCE inflation and core CPI inflation exclude the effects of food and energy prices:

Differences in inflation measures. Courtesy of TradingView.

As can be seen, the core inflation measures are much less affected by the spike in energy prices from February 2022 to June 2022. This in turn suggests that while the core measures may continue their down trends, headline CPI inflation may see moderate its decline, and may even inflect slightly higher for July. CPI inflation measures are due this Thursday, August 10th.

Weakening earnings

Earnings for the S&P500 has been weakening steadily since early 2022:

S&P500 earnings, monthly. Courtesy of TradingView.

While the weakening seemed to have plateaued in early 2023, recent earnings report (especially from Apple, the largest company by market cap in the USA) seems to suggest that the weakening may be reaccelerating. To be clear, earnings season for 2023Q2 isn’t over, and the weakening may just my overthinking it.

Technicals

Unless you’ve been living under a rock, you’d know that the markets have done pretty well so far this year. Some may say too well — on a short term basis, it seems like the markets may be taking a breather, with a small plateau forming. A plateau that I’m betting (hoping!) will turn into a small correction in the near term.

Final words

As always, I want to be very clear that I cannot predict the future, and that this bet that the markets will go down is a very small part of my portfolio. This is, for now, a short term trade, which I may close out or reverse at any time. Follow at your own risk.

Footnotes

Disclaimer: I’m only listing 1 (out of 10+) of my brokerage accounts on StockClubs. While it is one of the largest brokerage account in terms of asset value, it is still less than 10% of my portfolio.
Yes, nobody can see the future. Sadly.

July 15, 2023: Weekend video binge – Michael Cembalest

by jankythoughts2July 15, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

One of the other JB‘s had an interview with the chairman of Market and Investment Strategy of JPMorgan, Michael Cembalest, touching on a variety of recent themes.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Michael Cembalest

Some time ago, I was given free (and apparently temporary) access to JPMorgan’s institutional research. During that time, I read eagerly the reports of Michael Cembalest, JPMorgan’s chairman of Market and Investment Strategy. Every single report put out by Michael was immaculately researched, with domain experts input, detailed deep dives and his own analysis to create a convincing narrative with actionable forecasts. It was great while it lasted.

When I lost access, I was sorely tempted to sign up for a JPMorgan private wealth account (which is not cheap!) just for continued access, but eventually decided against it. I’m a cheapskate, what I can say…

JB and Michael

One of the other JB’s (Joshua Brown in this case) had a chat with Michael, apparently his first media appearance. In this they talked about a myriad of recent themes, of note:

Inflation and the most recent CPI report [5m]
AI [33m 6s]
SPACs [43m]
Strategists are bearish [55m 24s]

The whole video is well worth a watch, here:

Hedging

by jankythoughts2July 14, 2023July 14, 2023Leave a comment

Foreword

While hedging is mentioned in finance a lot, it is, surprisingly, not very well defined. Despite its frequent use in finance literature, it seems that most people have a rather hazy mental model of what hedging is, or how it works.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

What is hedging

To try and make the discussion more concrete, I’m going to provide my own mental model of what hedging is. To put it simply, a hedge is simply an auxiliary position that reduces the risk of your main position, where “risk” is defined as the variability (i.e. variance) of the combined positions performance.

Types of hedging

In my framework, there are 2 main types of hedging:

Mechanical hedges

Mechanical hedges are positions which “mechanically” go down (or up) in value as your main position goes up (or down) in value. For example, buying a put to hedge your stock exposure is a mechanical hedge — the value of the put mechanically goes up or down as the value of the stock goes down or up.

Similarly, TIPS are a form of mechanical inflation hedge — as inflation (as measured by the CPI) goes up or down, the value of the bond mechanically goes up or down.

The key thing to note, is that the value of the hedge moves inversely to the main position, regardless of market conditions. This generally happens because there is arbitrage between the main position and the hedge, such that any spreads will be swiftly closed by market makers, and/or there is an authority (such as a regulator, a government, an exchange, etc.) that enforces that the hedge moves inversely with the main position.

Statistical hedges

Statistical hedges are positions which are known to generally go down (or up) in value as the main position goes up (or down) in value, though there is no guarantee for them to always do so.

For example, in the classic 60/40 portfolio, the 40% of the portfolio in bonds can be thought of as a hedge for the 60% of the portfolio in stocks. Over the short/medium term, the value of bonds tend to move inversely with the value of stocks.

Other types of statistical hedges generally involve what is colloquially known as “pair trades”. For example, the value of the Australian dollar tends to move with high correlation to the value of the Canadian dollar, as both countries are commodities exporters with fairly similar exports, so changes in commodity prices tend to affect both. Thus, AUDUSD (Australian dollar valued in US dollars) and USDCAD (US dollar valued in Canadian dollars) tend to move inversely with each other — it used to be profitable to trade these 2 in a pair trade that bets that any gaps in performance will eventually close.

Observations

Assuming you do not rebalance, your total position (main position + hedge position) cannot perform better or worse than your main position. The performance of your total position, absent rebalancing, is always of a smaller amplitude of your main position.
- If you find that your total position actually went up in value despite your main position going down in value (i.e. your hedge position went up in value more than your main position went down), then you’ve made a mistake — your main position is actually the hedge and vice versa.

If you rebalance smartly, then it is possible for your total position to perform better than your main position, and with lesser risk (i.e. smaller variance).
- This is a result of the Modern Portfolio Theory. In simple terms, when your main position goes down in value (and your hedge goes up in value), you’ll sell some of the hedge position to buy the main position, and vice versa. Assuming the main position generally increases in value over time (i.e. your main thesis is correct), then this essentially forces you to buy low and sell high, and over time, should outperform the main position, but with smaller variance.
If the value of the hedge consistently or generally goes down when the value of the main position goes down, then you’ve made a mistake — the “hedge” is simply not a hedge for the main position.
If the value of the hedge moves essentially randomly with regards to the value of the main position, then it can still be used as a hedge, but only if you rebalance diligently and size the positions properly.
- This is a result of the Modern Portfolio Theory.

My personal hedging

If you follow my positions on StockClubs (Disclaimer: I am an investor in the app, and only show 1 [of 10+] brokerage accounts in that app), then you’ll see that I very often sell calls against my stock positions. In a hand-wavy kind of way, these can be considered as hedges as well — the short call goes up in value (less negative) if the stock goes down in value.

One way of thinking about this, is that I’m giving up some upside for the stock position, to reduce some downside (if the stock goes down in value, the premium from selling the calls “absorbs” some of that loss).

June 25, 2023: Weekend video binge 2 – Economics fact check

by jankythoughts2June 25, 2023June 25, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

Anyone who talks to me about finance/economics, will know very quickly that I’m a stickler for definitions. It’s really annoying (to me) when people misunderstand economic/financial terms, and then applies the finding wrongly, leading to, often, ridiculous results. In that vein, this particular video hits home, and explains why over-simplifying can be dangerous.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Money & Macro

To quote Joeri,

People pretending that something is simple when it’s actually complicated, giving you a solution that is really easy to understand, but also horribly wrong. And in economics, that is especially dangerous because misunderstanding concepts like inflation, recessions and unemployment could lead to decisions that actually cause inflation, recessions and higher unemployment, ruining the livelihoods of millions of people.
Joeri, https://www.youtube.com/watch?v=eyCaXPcDvng

Final words

At any point in time, I am probably involved in at least one discussion thread somewhere, where I find myself oddly defending regulators, central banks or the law to some extent. This is ironic, given that for the most part, most folks working in finance (I work at a hedge fund currently) tend to really hate legal, compliance and regulations, because they often add to our work load with bizarre requests. Frankly, I am not immune to this sentiment.

However, while we can discuss and be critical of how the central banks have, generally, been late to fight inflation this cycle, and that regulators often are unable to follow up on every shenanigan that happens in the markets, I think such criticism should also be balanced with fairness.

Ultimately, we need to recognize that regulators, law makers and central bankers are human, and they cannot see the future any more than we can, and given their very limited resources (the SEC has around 4,000 (1) employees), it is somewhat understandable, if not desirable, that things fall through the cracks, or that shortcuts are taken.

So while we must hold them accountable, we must at least be reasonable. And being reasonable, in many of these discussion threads, starts with actually understanding the details of the financial, economic or legal nuances surrounding the issue, and trying to understand why the laws/rules are as they are.

Since laws/rules tend to be formed over time based on the latest expert opinions, then having a decent understanding, a correct understanding of finance and economics becomes paramount.

For a prior take on why definitions and understanding nuances are important, please see Code Review.

Footnotes

Original version said SEC had just over a thousand employees, which turns out to be false — they have around 4,000. See https://www.eeoc.gov/federal-sector/securities-and-exchange-commission-sec-0

June 24, 2023: Weekend video binge – Step-by-step fundamental analysis

by jankythoughts2June 24, 2023June 23, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

Richard over at The Plain Bagel made an excellent video about how to do fundamental analysis on a stock. Highly recommended if you are having trouble falling asleep, or are just a data nerd.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

The Plain Bagel

One of my favorite Youtube channels, Richard is, unlike me, an actual financial advisor, though based in Canada.

Here is his excellent video on the high level steps he takes for doing fundamental analysis. It is pretty thorough (he is a professional after all!), and I have to admit that I skip some (ok, fine, many) steps when I do fundamental analysis, but this is a good list to keep in mind.

June 13, 2023: Inflation – wrap up

by jankythoughts2June 13, 2023June 13, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

Almost exactly 2 years ago, I made a post about inflation at the time, with some guesses on what will happen in the 2 years hence, i.e. ending around now. Let’s see how badly I did, now that the latest inflation print is out (4% for May 2023).

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Background

On June 6th, 2021, I made the first in the series of inflation related notes. That was followed quickly by a clarification on August 30th, 2021, and then an update on April 30th, 2022.

Keeping score

In the three posts, I made some guesses on what would be coming next:

Given Janet Yellen’s press conference, at the time, I suggested that the Fed may be getting ready to hike in 2022-2023.
- Score: 1
- As we now know, the Fed started hiking March of 2022, 9 months after the first post.
I guessed that it would be unlikely for the US to get high inflation in the “next 1-3 years”, where high inflation is defined as 5-10% inflation.
- Score: 0
- As we now know, inflation got to a peak of ~9% since then, and it’s only been 2 years.
I further guessed that if it did get to high inflation, it’ll probably be transitory (1-2 quarters).
- Score: 0
- Inflation was above 5% for almost 2 full years — it hit 5% in May 2021, and just went below 5% in April 2023. Data here.
I also guessed that we’ll hit medium inflation (2.5% – 5%) and maybe stay there 4-5 quarters, up to 2 years.
- Score: 0
- We’ve been in medium (or higher!) inflation for 2 full years now.
I suggested that certain “bare necessities” stocks would perform better in this inflationary regime.
- Score: 0.5
- The performance of the 4 bare necessities proxies are below. While 3 of the 4 clearly outperformed SPY, the last one (real estate) flunked, badly. The average of the 4 also comes to around 3% returns, much below SPY’s 6.46% return.
- That said, I wanted to point out that in the original post, I didn’t actually say real estate, but “multi-family housing”, and at least the multi-family funds that I’m holding are performing much better (they aren’t losing money for one thing…). However, I’m still giving myself a score of 0.5 because not all multi-family housing is doing well — while the funds I happen to have invested in are doing OK, multi-family housing on the west coast is doing horrendously, and quite a few of them are very likely losing money.

XLV, SLP, XLU, XLRE performance (dividend+split adjusted) from 6/6/2023 to 6/13/2023, courtesy of TradingView.

So, a score of 1.5 out of 5. Not too bad! If I saw a Yelp review of a restaurant with 1.5 stars out of 5, I’ll definitely go there… if I’m severely constipated and need help to “smooth things out”.

Excuses, excuses

Now that we’ve established I’m terrible at guessing what the future portends, let’s do my favorite part of the exercise — giving excuses for why I suck at this.

In terms of the inflation guesses, the main excuse I have is… Russia, Russia, Russia! Not predicting that Russia would invade Ukraine, and that the war would drag on for more than a year, and thus lead to chaos in supply chains, was probably the biggest miss.

In terms of stocks performance, there are 2 main misses:

I did not foresee the Fed ramping up so fast and so much.
- The Fed going from 0% to 5% in around a year is a very dramatic move, essentially the fastest pace of hiking ever.
I did not realize how many real estate businesses were using adjustable rate mortgages.
- I was thinking with my personal mortgage in mind, and thought that given the historically low rates, everyone would be eager to get a fixed rate mortgage.
- Instead, a large number of real estate businesses were actually using adjustable rate mortgages, so the rate hikes hit them really hard.

Summary

While I made a mess of the guessing game, my personal portfolio has done pretty well — most of the stocks I’ve picked are doing better than the SPY (1), while my private equity multi-family real estate funds are all doing pretty OK as well.

That said, it should be noted that the private equity funds doing well is quite a bit of luck — I missed the crucial adjustable rate mortgages issue, but luckily most of the funds I’m invested in used fixed rate mortgages, or were not too terribly affected.

So, the lesson from all this is… being lucky is important for financial success. If you are not lucky, work harder at being lucky. 🙂

Footnotes

If you follow me on StockClubs (disclaimer: I invested in this app, and I’m only showing 1 out of 10+ brokerage accounts on the app), you’ll realize that I had a few short bets (via puts) with varying degrees of success. I’m excluding those from the analysis, because they were mostly “for fun” bets, and the net result of all of them is around $0 (I used the winnings to buy a bunch of puts on QQQ/BITO that did not work out).

June 4, 2023: Weekend video binge

by jankythoughts2June 4, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

Some have read the prior note, and gone away with a distinctly bearish read. Perhaps this will disabuse you of the notion.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Alf and Andreas

Alf and Andreas just had a podcast where much of it discusses some of the same liquidity issues I’ve listed in the prior note – “Liquidity worries”. In it, they discuss some of the issues in much more detail than I am able, and give thought to the nuances of each. Well worth a watch if you are sure that the markets will go down (or up) due to these issues.

TL;DR: The world is more complicated than that.

Stockclubs

As I’ve noted in “Liquidity worries” and “Synthetic bonds“, I have no clue what the markets will do next, so I’m mostly in a holding pattern right now.

To see what my portfolio looks like, you can use Stockclubs, an app which I’ve invested in, which shows 1 (out of 10+) of my brokerage accounts.

May 31, 2023: Liquidity worries

by jankythoughts2May 31, 2023Leave a comment

Foreword

This is a quick note, which tends to be just off the cuff thoughts/ideas that look at current market situations, and to try to encourage some discussions.

The market has been floating on a gush of liquidity since 2009, and while the economy has grown by ~60% since then, stocks have climbed ~560% since the nadir in 2009. What happens if the liquidity spigot goes away? We may be about to find out.

As usual, a reminder that I am not a financial professional by training — I am a software engineer by training, and by trade. The following is based on my personal understanding, which is gained through self-study and working in finance for a few years.

If you find anything that you feel is incorrect, please feel free to leave a comment, and discuss your thoughts.

Double, double toil and trouble

Upcoming liquidity drains:

Quantitative Tightening
- Ongoing for a while now
Treasury General Account refilling
- When the debt ceiling is passed, the Treasury will need to sell a bunch of bonds to refill their bank account to the tune of $200-400B (1)
Resumption of student loan payments
- Currently estimated to resume end August
- Loans on adjustable rates will also likely resume at (the now much) higher rates
General downturn in consumer discretionary spending
- https://fred.stlouisfed.org/series/REVOLSL suggests that much of the fiscal largesse during the pandemic has been spent and consumers are loading up on debt again
Potential rate hikes
- Current estimates range from 1-2 cuts by end of year to 2-3 more hikes by end of year
- This is generally true of all major central banks, minus Japan and China
Potential recession
- Been predicted by various folks for, err.. 2 years now.
- While some commodities and business leaders are sounding the alarm, job numbers (which tend to be lagging) are still pretty strong

Predictions

Haha, fooled you — I don’t generally do predictions. It’s not hard to make a case for stocks going up or down based on the issues above, and I’m pretty sure whatever I say, the market gods will just laugh and the complete opposite will happen anyway.

So, I guess we’ll find out.

Footnotes

There are some who claim that the Treasury needs to sell over a trillion of bonds. A quick look at https://fred.stlouisfed.org/series/WTREGEN suggests that while the TGA had a peak of $1.8T during the pandemic, in recent years, the more normal amount is around $200-400B. I’m not sure if there’s something I’m missing, but $200-400B sounds more correct to me.