Are value stocks safer or more risky?

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Are value stocks safer or more risky?

Post by Lauretta »

According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
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Re: Are value stocks safer or more risky?

Post by alex_686 »

Historically, value stocks have had higher returns and have a higher total variance for total returns.

I should note that Fama's definition of value is objective, while Buffet's definition of value is more subjective. For example, Buffet looks for companies that have "moats", or low competition. So we are not exactly comparing apples to apples here.
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Re: Are value stocks safer or more risky?

Post by lazyday »

Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
An ideal Boglehead might say that stocks are almost never "undervalued" because the market prices stocks appropriately. Stocks should be valued at their true intrinsic value, including compensation for risk.

A value stock is considered value because of low price compared to book value and/or other measures. And for it to have low price, it must be risky.

I'm not an ideal Boglehead, and I believe that sometimes markets reach extremes where some assets are undervalued compared to other assets. For example, in early 2000, smallcap US stocks seemed cheap compared to largecap US stocks. Today, ex-US largecap stocks seem cheap compared to US stocks. My belief is that US companies are less risky than ex-US companies, but the stocks are so expensive that US stocks are more risky than ex-US stocks.
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Re: Are value stocks safer or more risky?

Post by KyleAAA »

They are using 2 completely different and unrelated definitions of value stocks.

Buffett defines a value stock as one whose market price is substantially lower than its intrinsic value. That doesn't mean it's a low-PE or low-PB stock; indeed, it could be quite expensive by any traditional measure and still be a value stock by Buffett's definition. If Buffett believes Amazon is worth twice its current price, it's a value stock to him even though the forward PE is currently 73.

FAMA/French define a value stock as one with a low absolute P/B ratio. The stock could still be quite expensive compared to the company's intrinsic value in Buffett's estimation, but it's a value stock because FF define value stocks as low P/B regardless of value.

Buffett's value stocks and FF's value stocks sometimes, but not always, overlap. It's really apples to oranges.
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Re: Are value stocks safer or more risky?

Post by livesoft »

Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
My view is that both views are legit, but not necessarly at the same time points.

I am a big believer in buying shares of value index funds when they have dropped from a higher price.

I am not a believer in buying shares of individual value companies when they have dropped from a higher price.
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Re: Are value stocks safer or more risky?

Post by nedsaid »

Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
There is truth to both views though I lean more towards Buffett. What Buffett is talking about is pricing risk. Value suffers from depressed prices and lower investor expectations. In my mind, low expectations are easier to beat than high expectations. The academic view, I believe, focuses on what I call fundamental risk. That is Value companies tend to have more volatile earnings and more leverage on the balance sheet. Companies that have run into some sort of problem. What they call the "bad company" theory.

There are also several ways to look at Value. I look at it as buying good or excellent companies at (hopefully) temporarily depressed prices. Good companies with (hopefully) temporary problems. Others have the cigar butt theory, getting a few puffs out of discarded butts. I think of it more as buying fine Cuban Cigars on sale. Buffett with Charley Munger's influence has gone away from picking up cigar butts to buying those fine cigars when they go on sale. As Munger famously said, "It is better to buy a great company at a good price than to buy a good company at a great price." There is also a Growth At A Reasonable Price (GARP) school of thought.

The Benjamin Graham approach to Value is analyzing companies one by one from the bottom up. There is rigorous financial analysis but intangible and unmeasurable factors are taken into account also. Securities are analyzed and purchased one by one. The academic approach to Value is screen for such things as Price to Book Value, Price to Earnings, Price to Sales, Price to Cash Flow. The academic approach buys all the stocks that fit the criteria, I call it the Costco approach of buying in bulk. Academics look at Value as about 30% of the market.

My take is that Value stocks are less risky. Indeed, Value tends to be less volatile than the market except in times of crisis or recession. That is where the "bad company" or fundamental risk comes in. Simply, I believe that low expectations are easier to beat than high expectations. Fewer people care if a company with low expectations miss on earnings. If a famous growth stock with infinite expectations priced into the stock suffers an earnings miss, the disappointment can be catastrophic.
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Re: Are value stocks safer or more risky?

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lazyday wrote:My belief is that US companies are less risky than ex-US companies, but the stocks are so expensive that US stocks are more risky than ex-US stocks.
Thanks! that really makes a lot of sense to me! :D I cannot help feeling nervous when I invest in an S&P500 ETF because of the high CAPE: it feels it could fall a long way...And historical 10 yr returns starting from high valuations have been quite low with the risk of large DD. In contrast I confess I feel safer buying EU or even EM stocks, precisely because of the reasons you give.
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Re: Are value stocks safer or more risky?

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nedsaid wrote:
Lauretta wrote:
There are also several ways to look at Value. I look at it as buying good or excellent companies at (hopefully) temporarily depressed prices. Good companies with (hopefully) temporary problems. Others have the cigar butt theory, getting a few puffs out of discarded butts. I think of it more as buying fine Cuban Cigars on sale. Buffett with Charley Munger's influence has gone away from picking up cigar butts to buying those fine cigars when they go on sale. As Munger famously said, "It is better to buy a great company at a good price than to buy a good company at a great price." There is also a Growth At A Reasonable Price (GARP) school of thought.
Thank you for these excellent points. This is a point I have been wondering about for a while, because I read some time ago a piece arguing that the original cigar butt method of screening for the cheapest stocks has historically worked better than buying quality companies at good prices (the argument is half way down the article, when comparing Buffett an Graham)
http://blog.alphaarchitect.com/2014/05/ ... gs.Hr6xHZI
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Re: Are value stocks safer or more risky?

Post by stlutz »

The real answer is that it varies.

Generally value and growth stocks have different types of risks. Growth stocks tend to have "price risk". That is, they are generally good companies with good growth prospects. Say, Tesla. But, a lot of good things are priced into that stock. So, they mostly likely will continue to grow and become a "Big Four" automaker, but they could still fail to meet investor expectations and thus the stock does poorly.

Conversely, value stocks tend to have "company risk". Perhaps they don't have good growth prospects or their businesses are highly cyclical or unpredictable. With these stocks, the risk mostly derives from the fact it's very uncertain how the company itself will perform. You likely aren't overpaying for the stock when you buy it, but that doesn't help if the company's business shrinks by half.

Now, sometimes both types of risk can become concentrated in the value or growth category. The classic example is 1999 where there were a lot of dot-com companies with no real prospects of becoming profitable companies selling at astronomical prices. These stocks had both price risk and company risk. The boring old value stocks didn't actually have either.

The reverse can also occur, where value stocks are selling a discount to the market, but not a big enough one--you can still overpay for a "value" stock.

In short, this question at any given time involves a lot of debate. And that's why there is a stock market with prices that change every day. When somebody says that it's always the case that value/growth is riskier, they are generally making of an ideological point in an attempt to prove that their favorite stocks should always be expected to beat the market. The real world of course doesn't work that way.
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

stlutz wrote: Generally value and growth stocks have different types of risks. Growth stocks tend to have "price risk". That is, they are generally good companies with good growth prospects. Say, Tesla. But, a lot of good things are priced into that stock. So, they mostly likely will continue to grow and become a "Big Four" automaker, but they could still fail to meet investor expectations and thus the stock does poorly.

Conversely, value stocks tend to have "company risk". Perhaps they don't have good growth prospects or their businesses are highly cyclical or unpredictable. With these stocks, the risk mostly derives from the fact it's very uncertain how the company itself will perform. You likely aren't overpaying for the stock when you buy it, but that doesn't help if the company's business shrinks by half.
That's an excellent way to put it. I tend to use the shorter but less descriptive, "good companies generally are not good stocks and visa versa". Since I'm a minority passive shareholder I'm very worried about price risk that I'm not being compensated for. I'm ok buying company risk that I am compensated for.
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Re: Are value stocks safer or more risky?

Post by Northern Flicker »

According to Buffett, the higher the margin between the price of undervalued stock and its value,
We don't ever know the true value of a stock, (with the exception of when it goes to zero). If we did, the ERP for that stock would disappear.
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Re: Are value stocks safer or more risky?

Post by harvestbook »

My philosophy on value index funds is that I better hold them for at least 15 years to get any perceived benefit or avoid any temporary underperformance. And even then, I have some timing risk on the back end, but I hope to hold enough diversification to not be forced to sell before I want to. Equities make money off of risk, so I want some additional risk in my value index so I can earn additional reward (theoretically.)
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Re: Are value stocks safer or more risky?

Post by whodidntante »

Fama and Buffett don't agree on the definition of value.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
Many of the stocks which Buffett invested in were not "value" stocks as Fama & French would have defined them.

Value stocks in FF are much closer to the original Graham & Dodd, e.g. buying a company for less than the value of its working capital. Such companies are often cheap because they have poor business models, significant debt leverage or other problems. Buffett would not buy those types of stocks. It's broadly understood that FF value stocks also have greater volatility, and that this is a risk story, i.e. the higher returns come with greater risk.
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Re: Are value stocks safer or more risky?

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Valuethinker wrote:

Many of the stocks which Buffett invested in were not "value" stocks as Fama & French would have defined them.
hi Valuethinker good to hear back from you! I came across a paper by people at AQR according to which Buffett has had 'a tendency of buying stocks that are cheap in the sense of having a high book value relative to their market value.' I thought this was in agreement with the Fama & French study on value.
Here's the paper
http://docs.lhpedersen.com/BuffettsAlpha.pdf
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Re: Are value stocks safer or more risky?

Post by Lauretta »

stlutz wrote:The real answer is that it varies.

Generally value and growth stocks have different types of risks. Growth stocks tend to have "price risk". That is, they are generally good companies with good growth prospects. Say, Tesla. But, a lot of good things are priced into that stock. So, they mostly likely will continue to grow and become a "Big Four" automaker, but they could still fail to meet investor expectations and thus the stock does poorly.

Conversely, value stocks tend to have "company risk". Perhaps they don't have good growth prospects or their businesses are highly cyclical or unpredictable. With these stocks, the risk mostly derives from the fact it's very uncertain how the company itself will perform. You likely aren't overpaying for the stock when you buy it, but that doesn't help if the company's business shrinks by half.

Now, sometimes both types of risk can become concentrated in the value or growth category. The classic example is 1999 where there were a lot of dot-com companies with no real prospects of becoming profitable companies selling at astronomical prices. These stocks had both price risk and company risk. The boring old value stocks didn't actually have either.

The reverse can also occur, where value stocks are selling a discount to the market, but not a big enough one--you can still overpay for a "value" stock.

In short, this question at any given time involves a lot of debate. And that's why there is a stock market with prices that change every day. When somebody says that it's always the case that value/growth is riskier, they are generally making of an ideological point in an attempt to prove that their favorite stocks should always be expected to beat the market. The real world of course doesn't work that way.
thanks for all these great points. :) I like what you say about ideology: I have noticed that some people tend to be a bit dogmatic and try to fit everything into a single theory, but like you say the real world is more complex than that.
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Re: Are value stocks safer or more risky?

Post by tadamsmar »

I think the question of whether Buffet and Fama use the same definition of value is a bit complicated.

Probably most or all of the Buffet's value stocks would pass Fama's value test.

But it seems to me that Buffet looks into why the PE ratio is low. Sometimes he even goes in and attempts to improve the company.

It like Buffet adds some additional criteria on top of Fama's.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

Lauretta wrote:
Valuethinker wrote:

Many of the stocks which Buffett invested in were not "value" stocks as Fama & French would have defined them.
hi Valuethinker good to hear back from you! I came across a paper by people at AQR according to which Buffett has had 'a tendency of buying stocks that are cheap in the sense of having a high book value relative to their market value.' I thought this was in agreement with the Fama & French study on value.
Here's the paper
http://docs.lhpedersen.com/BuffettsAlpha.pdf
He invested in Washington Post, Amex etc. when they were on their downers for various reasons, I believe.

He wants to buy good companies at reasonable values. Not simply very cheap stocks. Nowadays he mostly buys whole businesses.
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Re: Are value stocks safer or more risky?

Post by nisiprius »

The conventional thinking, with which I personally am prepared to agree with, is that stocks and stock mutual funds that fall in one of the "value" boxes of a Morningstar style box diagram--that is to say they "load on the value factor" as defined by the Fama and French reserach--are more risky than the stock market as a whole. The thinking further goes that either there is additional reward that is simply commensurate with the extra risk, or that perhaps it is somewhat more than commensurate with the extra risk for reasons that are debated. The conventional thinking does not jibe with actual real-world results over the last decade or so, during which it is often said that "the value premium has been missing in action" with, again, debate on whether this is normal and do be expected, or whether it's a challenge to the idea of value factor superiority.

"Value" in the sense of Warren Buffett, and in the sense of the way the term was used before the 1990s, means something different. It means an individual stock, chosen not by applying the simple and objective metric used by Fama and French, but by diligent fundamental analysis and business understanding behind a particular company and a particular stock. The claim is that the stocks Buffett picks are safer than stocks in general.

W. C. Fields' character, in an old movie--"Never Give a Sucker an Even Break", I think--is understood to be a gambler who cheats at cards. In once scene, a very innocent mark, invited to a card game with Fields, asks "Is this a game of chance?" Fields replies "Not the way I play it. No." The idea, then, is that for a Warren Buffett, or someone with similar talents, although the businesses he invests in look risky, they are not risky--for him. (I don't mean that Buffett cheats, I mean that the value stocks he picks are not the same thing as the ones you or I could pick by running a simple stock screening utility, investing in the Vanguard Small-Cap Value Index Fund, or investing in the DFA Small-Cap Value Portfolio.)
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Re: Are value stocks safer or more risky?

Post by Random Walker »

I believe that Buffet was effectively using a profitability /quality screen on value stocks before profitability became a recognized factor. I also believe that once account for size, value, and profitability, his apparent ability to add benefit beyond known factor exposure is no different than would be expected from random. To his credit though, he was looking at profitability / quality before the academics uncovered it's explanatory power.

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Re: Are value stocks safer or more risky?

Post by aegis965 »

Random Walker wrote:I believe that Buffet was effectively using a profitability /quality screen on value stocks before profitability became a recognized factor. I also believe that once account for size, value, and profitability, his apparent ability to add benefit beyond known factor exposure is no different than would be expected from random. To his credit though, he was looking at profitability / quality before the academics uncovered it's explanatory power.

Dave
I think there's more than factor exposure. His portfolio is very concentrated, sometimes highly leveraged (he uses LEAPS and stuff from what I've heard). IMO there must have been some unquantifiable qualitative insight involved.

The following is from his 1967 letter to partners:
Warren Buffett wrote:Interestingly enough, although I consider myself to be primarily inthe quantitative school (and as I write this no one has come back from recess—I may be the only one left in the class), the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight.” This is what causes the cash register to sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side—the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions, but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.
I may be biased.
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Re: Are value stocks safer or more risky?

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alex_686 wrote:Historically, value stocks have had higher returns and have a higher total variance for total returns.

I should note that Fama's definition of value is objective, while Buffet's definition of value is more subjective. For example, Buffet looks for companies that have "moats", or low competition. So we are not exactly comparing apples to apples here.
I just looked at this using Portfolio Visualizer. For the past 45 years, value stocks have higher returns and lower standard deviation than the overall market. I compared large cap value to large cal, mid cap value to mid cap and small cap value to small cap. More return, less risk. Seems like a better deal. Try it yourself.
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Re: Are value stocks safer or more risky?

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Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
Buffett is correct.

The academic theory is incorrect.
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Re: Are value stocks safer or more risky?

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Lauretta wrote:According to Buffett, the higher the margin between the price of undervalued stock and its value, the lower is investors' risk. Thus value stocks are safer than more richly priced ones.
The academic view (e.g. Fama) seems the opposite: value stocks have a potentially higher reward because they are riskier.
Which view is held by investors here Bogleheads and why?
Lauretta:

Value stocks and growth stocks alternate in their performance (risk & return). Total Stock Market Index Fund holds both. It is cheaper, more tax-efficient and requires no rebalancing.

Strive for simplicity, not complexity.

Best wishes.
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Re: Are value stocks safer or more risky?

Post by Avo »

knpstr wrote:The academic theory is incorrect.
When do you go to Stockholm?
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Re: Are value stocks safer or more risky?

Post by Lauretta »

Avo wrote:
knpstr wrote:The academic theory is incorrect.
When do you go to Stockholm?
:D :D :D yes that's a fair point; however I heard that Paul Samuelson, who also won a Nobel Prize, had his own money managed by Berkshire!! :D Besides, other Nobel Prize winners like Shiller think differently from Fama.
Finally I don't base my choices in other areas based on Nobel Prizes, so I think I shouldn't when to comes to finance. e.g. Italo Calvino was a truly great writer IMO and he never got a Nobel prize in Literature. By contrast Bob Dylan did - but I didn't start listening to his songs just because of that! :D :D :D
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Re: Are value stocks safer or more risky?

Post by Lauretta »

Random Walker wrote:I believe that Buffet was effectively using a profitability /quality screen on value stocks before profitability became a recognized factor. I also believe that once account for size, value, and profitability, his apparent ability to add benefit beyond known factor exposure is no different than would be expected from random. To his credit though, he was looking at profitability / quality before the academics uncovered it's explanatory power.

Dave
That's a great point. The understanding at which I have arrived is that it seems best to first screen for value and then for profitbility. This way you capture the value effect and then select a sub-set of good profitable companies and thus hopefully avoid the so called 'value trap'. At least that's what I've come to understand at present, considering the evidence.
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Re: Are value stocks safer or more risky?

Post by MathWizard »

On the whole, neither, since the market prices in the risk.

They do represent an opportunity.



Exxon after the Valdez disaster (oil spill) looking like it might be facing crushing fines and costs
for the cleanup. The press was especially bad.

The drop in share price included investor's estimates of the costs to Exxon both in true cost, and loss of brand.
In hindsight, the investor's estimates of costs was too high, so Exxon represented a value stock.

You had to believe that the investor's estimates were off, but due to press really liking to report on
bad events, this probably happens a lot.

It would be interesting to know if BP prices followed a similar path after the Deepwater Horizon spill.
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Re: Are value stocks safer or more risky?

Post by Lauretta »

stlutz wrote: Growth stocks tend to have "price risk". That is, they are generally good companies with good growth prospects. Say, Tesla. But, a lot of good things are priced into that stock. So, they mostly likely will continue to grow and become a "Big Four" automaker, but they could still fail to meet investor expectations and thus the stock does poorly.
.
I can't help feeling that Tesla is a extremely risky stock. I saw a program in which the commentator asked what would happen to the stock if Mr Musk were hit by a bus - or rather by an electric car... Then, even assuming that Mr Musk is a genius and he doesn't get hit by a bus, we know that geniuses often fail. Leonardo da Vinci is considered a universal genius but probably not many people know that the great majority of projects that he begun turned out to be failures.
I personally feel more comfortable with stocks that have been 'beaten down' and about which people are perhaps overly pessimisitic, rather than with stocks that have so many positive assumptions priced in. I read a book that mentioned the story of the stock of a company created by Ross Perot. The PER got so high that even though the company did well, the stock eventually plummetted.
Though like you say in your post, in the end it depends on each case and it's not possible to generalise.
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Re: Are value stocks safer or more risky?

Post by Lauretta »

KyleAAA wrote:
Buffett defines a value stock as one whose market price is substantially lower than its intrinsic value. That doesn't mean it's a low-PE or low-PB stock; indeed, it could be quite expensive by any traditional measure and still be a value stock by Buffett's definition. If Buffett believes Amazon is worth twice its current price, it's a value stock to him even though the forward PE is currently 73.

.
good point, thanks. In other words if I understand you correctly Buffett for example would not use the PE only, but also introduce his estimate of earnings growth in order to decide whether a company is cheap or not.
Do you know if Ben Graham's method on this point is more similar to that of Fama French or to Buffett's?
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Lauretta wrote: good point, thanks. In other words if I understand you correctly Buffett for example would not use the PE only, but also introduce his estimate of earnings growth in order to decide whether a company is cheap or not.
Do you know if Ben Graham's method on this point is more similar to that of Fama French or to Buffett's?
Graham's definition of value is more similar to Buffett's. You do an active analysis and compare estimates. Buffett's big addition to Graham was the importance of positive branding as an asset. Other than that they use the same evaluation technique for stocks.

In terms of portfolio design he isn't much like either but I'd say closer to Fama French. He loves bonds and sees them as key to the portfolio. Graham was a bigger fan of diversification abroad than Buffett.

Graham has never heard of passive benchmarks and by diversification he meant something like 20 stocks. Mutual funds existed and he does talk about them but he advocates individual stock picking over fund investing. He believes beating the market through stock picking is fairly easy and something an individual can do in their spare time, because they don't face the pressures of institutional investors.

Graham was a huge fan of cyclicals during the wrong periods in the business cycle. He believed much more strongly in reversion to the mean over the business cycle than either. Fama French would likely automatically catch cyclicals but they don't set out to get them. Buffett tends to avoid them.

Graham is a much bigger believer in DCA to control risk, if a stock is on your list you DCA into it over time. Both of the other two more aggressively buy at a good price.

Unlike either Graham is a huge fan of highly distressed debt: bonds with a serious threat of default or in default. Buffett does buy them but he doesn't specialize in them. Fama French (DFA) doesn't have a distressed bond offering at all. That being said SEC has been really harsh on open ended mutual funds (and etfs) that use distressed debt so for a USA fund investor this is hard to invest unless you are accredited or want to do it directly. CEFs do have some options. So this might not be DFA's fault since they don't sell CEFs. OTOH they aren't even advocates of regular junk debt.

Graham liked duration risk while Fama French tend to stay 5 years or less.

Unlike either Graham is a much bigger believer in the importance of dividends. He advocated a strong equity income bias.

I think the fund that most likely comes closest to Graham on the stock (and when they were allowed the bond side) is 3rd Avenue Value certainly not DFA. Buffett in the early days was kinda close. But Buffett at this point is facing the kind of institutional problems that Graham wrote about magnified.
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Re: Are value stocks safer or more risky?

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Avo wrote:
knpstr wrote:The academic theory is incorrect.
When do you go to Stockholm?
I personally don't give much weight to the notion that all Nobel Prize winners are worthy of the award. Look at some of the winners in other categories.
Beyond that, the logic "they won a Nobel prize, so they must be right" is faulty. Every single prize winner could admit as much.

Common sense can tell the theory/hypothesis is incorrect or at a minimum not wholly correct, as Buffett has explained for many years. His explanation detailing why is written many times over both in his annual letters and opinion pieces.

Relevant to this thread, recently (2014) Buffett wrote how bonds are the "far riskier" investment for the long term investor, which he says the great majority of us should be, as compared to equities.

Here is the quote from Buffett's 2014 letter:
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however,
currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock
portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That
lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for
risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from
synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.
Emphasis Buffett's
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Re: Are value stocks safer or more risky?

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jbolden1517 wrote:
Unlike either Graham is a huge fan of highly distressed debt: bonds with a serious threat of default or in default. Buffett does buy them but he doesn't specialize in them. Fama French (DFA) doesn't have a distressed bond offering at all. That being said SEC has been really harsh on open ended mutual funds (and etfs) that use distressed debt so for a USA fund investor this is hard to invest unless you are accredited or want to do it directly. CEFs do have some options. So this might not be DFA's fault since they don't sell CEFs. OTOH they aren't even advocates of regular junk debt.
Thanks for these explainations! :) I haven't thought of junk bonds at all so far, because I have thought of bonds as the safe, stable part of the portfolio (actually for me it's cash at present because of the low or even negative rates in the eurozone). Do you think active management might bring some benefit when picking junk bonds (to distiguish between true bargains and bonds that will likely default)? In Europe I saw some good articles about M Hasenstab from Templeton. He is based in the US but his fund is accessible to European investors.
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Lauretta wrote:
Thanks for these explainations! :) I haven't thought of junk bonds at all so far, because I have thought of bonds as the safe, stable part of the portfolio (actually for me it's cash at present because of the low or even negative rates in the eurozone). Do you think active management might bring some benefit when picking junk bonds (to distiguish between true bargains and bonds that will likely default)? In Europe I saw some good articles about M Hasenstab from Templeton. He is based in the US but his fund is accessible to European investors.
IMHO the worst bubble in the world right now is European bonds. So I don't think you are doing the wrong thing at all in being worried about it.

As far as junk. I don't think you can really distinguish true bargains from bonds that default. I think passive is fine here. As an asset class I think bond investors are often heavily overcompensated for risk. Think of it this way. If I'm a bank I can make good money longing a bond and shorting the underlying government debt (especially now). The ECB is going to buy my short (its synthetic government debt after all from a bank and the ECB loves this stuff). And I can play the credit spread between a high quality corporate and a government bond earning 30 basis points. I can easily do this on 40::1 leverage because this trade is so safe. That's a 12% return with no duration risk and very tiny credit risk. The sort of return the ECB is quite happy about and bank auditors are quite happy about. Now if 10% of those bonds start to have even a little bit of trouble and say widen the spread to 50 basis points, that's no big deal. I lost 80 basis points if I hold, and I'm only making 11.6%. But I might be worried about this getting worse and ticking off the auditors, so I dump them cheap at 60 basis points off, I'm still at 10.8% for the year and go buy safer stuff. Everyone is happy. But I'm dumping them to another finance house that lets say shorts the government bond and carries these 60-300 basis point bonds at 8::1 leverage (note they probably sell the short to the bank who sells corresponding synthetics to the ECB, your bond market is wild). They are less safe but they are making 14% on this carry. That finance house might dump them at say 500 basis to a 1::1 leveraged carrier like a junk mutual fund. You don't want to be on leverage so you can carry very iffy debt they can't.

That's how the prices get set in the market. People dumping bonds on average below fair price because their leverage structure makes it profitable for them to buy high, sell low for that specific fraction of the portfolio. Now of course there are bonds that start out iffy and they just carry risk premiums similar to the ones being dumped down the chain.

Let's see what this looks like for a mutual fund at the bottom of this chain. Say you are getting 8% interest for the junk debt and 4% go into default each year. Default doesn't mean 100% off, they might just need to take a quarter off from payments and resume. If you were carrying at 40::1 leverage and had to make a corresponding payments on your shorts, this would be a big problem, but you aren't. There is no leverage. A junk bond might not pay, sit for a year and then liquidate at 50% of principle. Etc... So say you lose 1/2 of that 4% and earn 6% on the fund. That's a lot better for you than a high quality bond fund Euro debt bond fund.

I should also mention there is one big difference for a European junk investor than an American junk investor. Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds. Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt. So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.

In terms of volatility, there is more selling down the chain and defaults go up somewhat as the economy weakens so mutual fund NAVs drop when stocks drop. Junk bonds are worse for diversification but increase the expected return tremendously.

In general I think junk is a terrific investment especially when the economy is bad. But I want to throw in this disclaimer. I don't know the specifics of the European junk bond market well enough to know if now is the right time to do this. Might want to wait till the bond bubble pops (which should be horrific given its size). I also would also look at euro denominated EM bonds. Again, those aren't buy recommendations those are look recommendations. I have no opinion on the valuations of low quality euro debt positive or negative. As a USA investor I pick up currency risk on euro investments which changes our respective risks. While I'm happy to overweight European stocks I'm not even looking at the bonds. But that doesn't mean it doesn't make sense for you.

So that's my $.02.
Last edited by jbolden1517 on Sat Aug 05, 2017 8:15 am, edited 1 time in total.
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Re: Are value stocks safer or more risky?

Post by knpstr »

Random Walker wrote:I believe that Buffet was effectively using a profitability /quality screen on value stocks before profitability became a recognized factor. I also believe that once account for size, value, and profitability, his apparent ability to add benefit beyond known factor exposure is no different than would be expected from random. To his credit though, he was looking at profitability / quality before the academics uncovered it's explanatory power.

Dave
I'm a little confused, why do you think that he invested upon "profitability" before it was a recognized factor? How is that not common sense? Who doesn't want to invest in a profitable, quality company since the dawn of publicly traded markets?
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Re: Are value stocks safer or more risky?

Post by stlutz »

I think referencing Buffet when talking "value stocks" isn't really helpful because picking value stocks isn't really what Buffett/Berkshire does. They are really more of a non-diversified hedge fund that is very much unlike the what a the managers of a value fund like VG Windsor II do.

When he made his investment in Goldman Sachs back in '08, he didn't just decide he liked the company and place and order for 10 million shares at the market. Instead, he made a hardball deal with them where he got special preferred shares and warrants that he made a lot of money from. It's one thing to look for a stock selling for $20 that you think is worth $30. Buffett makes deals where he can buy that stock for $15. And he can do that because he has a few billion laying around that others can use. Few can do what he does in that regard.

He has also made leveraged bets on interest rate moves, and moves in commodities prices.

Buffet is a businessman more than a stock picker. His investing advice might be interesting, but he didn't get rich by buying and holding value stocks or by holding an S&P index fund.
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Re: Are value stocks safer or more risky?

Post by Desert »

By any reasonable definition of risk, value stocks are higher risk. Their expected return is also greater. Buffet is operating in a totally different space than the rest of us.
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Re: Are value stocks safer or more risky?

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jbolden1517 wrote:Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds. Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt. So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.
Thanks for all these explainations! :happy Yes like you say in Europe governements intervene much more - there's a very different relationship between the individual and the state. I remember spending time in Dubai after the financial crisis and feeling quite puzzled because on television there they were talking of the risk that some European banks (including a French bank) might go bankrupt. This was so different from what the media were saying in France where I was living. For French people it was unthinkable that the state would 'allow' that. I think particularly the French have a myth of an all powerful state that will always be able to intervene and 'protect' its citizens and businesses...
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Lauretta wrote:
jbolden1517 wrote:Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds. Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt. So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.
Thanks for all these explainations! :happy Yes like you say in Europe governements intervene much more - there's a very different relationship between the individual and the state. I remember spending time in Dubai after the financial crisis and feeling quite puzzled because on television there they were talking of the risk that some European banks (including a French bank) might go bankrupt. This was so different from what the media were saying in France where I was living. For French people it was unthinkable that the state would 'allow' that. I think particularly the French have a myth of an all powerful state that will always be able to intervene and 'protect' its citizens and businesses...
The French state has the available credit to bail out its banks if it wanted to. I'm just not sure why they want to. Italy and Greece were really shocking to me though. The governments didn't have great credit. There the state was under tremendous pressure, the population was suffering. Letting the banks fail would have made things so much better for the people. It's not like its that hard to get new banks with clean balance sheets created. It is weird too because when I talk to Europeans they seem to get that they are bailing out the very rich and connected at the expense of having to live with austerity. They have governments and a society which are much more concerned with the general welfare of the population and not creating massive inequality than ours. This whole position seems entirely out of character. But not denying it exists.

Anyway.... Glad this discussion about junk helps. It is always worth looking at.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

Random Walker wrote:I believe that Buffet was effectively using a profitability /quality screen on value stocks before profitability became a recognized factor. I also believe that once account for size, value, and profitability, his apparent ability to add benefit beyond known factor exposure is no different than would be expected from random. To his credit though, he was looking at profitability / quality before the academics uncovered it's explanatory power.

Dave
I am broadly in agreement with this (it's also been suggested he grabbed the "low volatility" anomaly before it was discovered in research).

I think though that there probably is still alpha in his stock selection, arising from his long experience of managements and the ruthlessness of his investing style, taking no prisoners with emotions.

The other thing is his funding side. The insurance business which started with GEICO is the basis of his very cheap cost of funding. He borrows from the insurance market at a very low cost of capital, and invests at a higher one. Thus creating an effective money machine. If you said "borrow at 3, invest at 9 (per cent)" you'd get the picture.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

Lauretta wrote:
jbolden1517 wrote:
Unlike either Graham is a huge fan of highly distressed debt: bonds with a serious threat of default or in default. Buffett does buy them but he doesn't specialize in them. Fama French (DFA) doesn't have a distressed bond offering at all. That being said SEC has been really harsh on open ended mutual funds (and etfs) that use distressed debt so for a USA fund investor this is hard to invest unless you are accredited or want to do it directly. CEFs do have some options. So this might not be DFA's fault since they don't sell CEFs. OTOH they aren't even advocates of regular junk debt.
Thanks for these explainations! :) I haven't thought of junk bonds at all so far, because I have thought of bonds as the safe, stable part of the portfolio (actually for me it's cash at present because of the low or even negative rates in the eurozone). Do you think active management might bring some benefit when picking junk bonds (to distiguish between true bargains and bonds that will likely default)? In Europe I saw some good articles about M Hasenstab from Templeton. He is based in the US but his fund is accessible to European investors.
High Yield bonds are much more equity like in their behaviour. They have equity risk.

There are anomalies there-- bonds just below BBB- tend to be "cheap" relative to the lowest level of Investment Grade bonds (thanks to Alex_686 for pointing this out). But it's not clear if there are low cost managers who exploit this successfully.

If you buy into HY bonds you are buying into volatility. And spreads of HY over investment grade bonds are at low levels compared to historic. You are not being paid much for taking that additional risk.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

jbolden1517 wrote:[

I should also mention there is one big difference for a European junk investor than an American junk investor. Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds.
You mean Ireland? The Finance Minister is dead, we don't know the full logic behind Linehan's decision so to do. Iceland did not, by contrast.

Did the bondholders of any American bank lose money in the bailout?

The issue in Italy was about small investors in the bonds-- retail investors. The big investors are being "bailed in" to the restructurings, and will take significant pain.
Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt.
In the case of Greece the economy would have stopped, dead, had the banks not been rescued in some form. In the case of Cyprus, large deposit holders (more than 100k) did indeed take a significant haircut (60%).

Italy? Starting a panic in the banking system was not a good idea.
So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.
In the "zombie bank" sense, yes. It's clear that the German position is, and the European regulators also take that position, that in future bondholders of banks will be "bailed in" ie converted to equity and heavily diluted. I wouldn't bet that they will be made whole in future bank resolutions.

http://www.telegraph.co.uk/investing/bo ... ring-deal/

55% dilution on the retail note holders, There's £13.5m set aside for retail investors who are being offered this deal. I accept this is not part of the Eurozone but it gives you a feeling of the kind of pain that might be inflicted.
In terms of volatility, there is more selling down the chain and defaults go up somewhat as the economy weakens so mutual fund NAVs drop when stocks drop. Junk bonds are worse for diversification but increase the expected return tremendously.
Increase expected returns relative to stocks? Or just to bonds?
In general I think junk is a terrific investment especially when the economy is bad.
I would put it another way. They are investments only when the economy is bad, i.e. if you can time the bottom of the credit cycle.

But I want to throw in this disclaimer. I don't know the specifics of the European junk bond market well enough to know if now is the right time to do this. Might want to wait till the bond bubble pops (which should be horrific given its size). I also would also look at euro denominated EM bonds. Again, those aren't buy recommendations those are look recommendations. I have no opinion on the valuations of low quality euro debt positive or negative. As a USA investor I pick up currency risk on euro investments which changes our respective risks. While I'm happy to overweight European stocks I'm not even looking at the bonds. But that doesn't mean it doesn't make sense for you.

So that's my $.02.
Because the ECB has been buying IG corporate debt, sub IG/ HY has seen rises in prices as investors chase yields. Spreads over IG are at very low levels compared to historic. You are not being paid much for taking the higher risk of HY debt.

The market is less liquid and less efficient than its US counterpart. In theory, that should throw up opportunities.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

jbolden1517 wrote:
Lauretta wrote:
jbolden1517 wrote:Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds. Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt. So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.
Thanks for all these explainations! :happy Yes like you say in Europe governements intervene much more - there's a very different relationship between the individual and the state. I remember spending time in Dubai after the financial crisis and feeling quite puzzled because on television there they were talking of the risk that some European banks (including a French bank) might go bankrupt. This was so different from what the media were saying in France where I was living. For French people it was unthinkable that the state would 'allow' that. I think particularly the French have a myth of an all powerful state that will always be able to intervene and 'protect' its citizens and businesses...
The French state has the available credit to bail out its banks if it wanted to. I'm just not sure why they want to.
The disruption of one of Credit Agricole, BNP Paribas or SocGen went under? This would be like one of JP Morgan, BancAmerica or Citigroup going under. Faced with similar situations, the US government lent money to all the major banks, and bailed out several of its largest financial institutions? FNMA, FMAC, AIG etc?
Italy and Greece were really shocking to me though. The governments didn't have great credit. There the state was under tremendous pressure, the population was suffering. Letting the banks fail would have made things so much better for the people. It's not like its that hard to get new banks with clean balance sheets created.
You mean a good bank bad bank split, with the government resolving the bad bank assets. A la NAMA in Irish Republic? Or Sweden in 1990s?

There are all kinds of reasons why governments don't want to run banks. And Italy and Greece even more so-- where corruption is severe, and it's unlikely those skillsets exist in government.

The danger is the situation is Japan like. Zombie financial institutions which stagger on.

But we should understand that Lloyds Bank, Chase Manhattan Bank and many others were in this position at the end of the 1970s when the Third World debt crisis hit. There was too much government debt for it simply to be written off-- the banks would have been in negative equity, and collapsed. So the situation became a lengthy workout, eventually with the creation of "Brady Bonds" so the debts could be sold off by the banks to investors. The problem was too big to just write off.
It is weird too because when I talk to Europeans they seem to get that they are bailing out the very rich and connected at the expense of having to live with austerity. They have governments and a society which are much more concerned with the general welfare of the population and not creating massive inequality than ours. This whole position seems entirely out of character. But not denying it exists.

Anyway.... Glad this discussion about junk helps. It is always worth looking at.
I do not think it's the whole story that European bank bailouts in the southern tier are simply bailing out the rich. The question is if deposit holders and bond holders are to take the pain, then who? And what will the macroeconomic effect be.

If the US, say, decided that in future bank insolvencies there would be no recovery for depositors over $250k or for bond holders (or massive dilution of same) then that really would change the risk-return on banks. Smaller and weaker banks would lose deposits very quickly. One could start a bank run simply by that act. AFAIK no depositor (of any size) has been out in a US bank insolvency since the 1930s? Even Continental Bank?
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Re: Are value stocks safer or more risky?

Post by Random Walker »

Valuethinker,
Agree with you on the leverage-borrowing from insurance.

Knpster,
Everyone "likes" growth companies. That's why they tend to be over priced and have lower future expected returns. That being said, I agree with you-sort of perplexes me. But my understanding is that Buffet's alpha is all explained away when you account for the exposures with a model that accounts for market, size, value, profitability.

Dave
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

Random Walker wrote:Valuethinker,
Agree with you on the leverage-borrowing from insurance.

Knpster,
Everyone "likes" growth companies. That's why they tend to be over priced and have lower future expected returns. That being said, I agree with you-sort of perplexes me. But my understanding is that Buffet's alpha is all explained away when you account for the exposures with a model that accounts for market, size, value, profitability.

Dave
Re growth stocks (especially small cap growth)

It's the lottery ticket effect, most likely. The returns are right skewed so even though the median return is lousy, there is the possibility of the next Microsoft, Facebook etc.

The other issue is the "low vol" effect. Which basically boils down to Buffett can make money using leverage, against a portfolio of value stocks. Most fund managers cannot use leverage, so achieve that effect by gravitating towards higher risk & volatility stocks, which are de facto usually the growth stocks. At least that seems to be the most reasonable explanation.
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Valuethinker wrote:
jbolden1517 wrote: I should also mention there is one big difference for a European junk investor than an American junk investor. Your governments are terrified of bank bonds going into default. For some reason it is considered unthinkable and the governments will take on debt directly to prevent the banks from defaulting on their bonds.
You mean Ireland? The Finance Minister is dead, we don't know the full logic behind Linehan's decision so to do. Iceland did not, by contrast.
True I should have given Iceland as a counter example. Excellent point.
Valuethinker wrote: Did the bondholders of any American bank lose money in the bailout?
Oh absolutely. 80% of defaults in 2008 (measured by volume of money defaulted on not issuance) were FIRE and banking. The big 3 among those were: Lehman Brothers, Washington Mutual, GMAC.
Valuethinker wrote: The issue in Italy was about small investors in the bonds-- retail investors. The big investors are being "bailed in" to the restructurings, and will take significant pain.
I guess that may be a structural difference. Small American investors are really only meaningful players in municipal bonds. Small American bond investors (who don't really count for much of the market anyway) in other sectors mostly hold bond funds not bonds. We are having municipal defaults in Ohio but those aren't big enough to make national news. It will be interesting as many American municipal bonds go into default to what extent if any the government distinguishes between small holders and larger holders. I suspect they won't. That would be very out of character for the USA government.
Valuethinker wrote:
jbolden1517 wrote: Greece and Italy being a good example, both should have let their banks go bankrupt and not imperiled their sovereign debt.
In the case of Greece the economy would have stopped, dead, had the banks not been rescued in some form. In the case of Cyprus, large deposit holders (more than 100k) did indeed take a significant haircut (60%).
Agree on Cyprus. Disagree on Greece. First off I think Greece did go through a pretty nasty depression and the economy for years continues to struggle. They got all the suffering for the cure but none of the cure. I think Greece after a massive wave of defaults would have an economy with lots of equity and not a crushing burden of debt. They have terrific natural advantages and the people without a crushing debt burden would now be free to utilize those in a healthy and growing economy. Think Thailand as a reasonably similar situation.
Valuethinker wrote:
jbolden1517 wrote: So you end up with a very likely profit any time a bank starts getting distressed. 98% of the time you get paid in full, 2% you go through a default and likely get paid some.
In the "zombie bank" sense, yes. It's clear that the German position is, and the European regulators also take that position, that in future bondholders of banks will be "bailed in" ie converted to equity and heavily diluted. I wouldn't bet that they will be made whole in future bank resolutions.
I would. They have tons of bank debt. When they start adding a risk premium to it, it will sell off sharply. The sell off will scare the regulators (and the small investors) and they will back down. Everyone will punish the reckless "the next time" after a bailout. Policy can shift but if you aren't willing to have panics then you aren't willing to have a market.
Valuethinker wrote: http://www.telegraph.co.uk/investing/bo ... ring-deal/

55% dilution on the retail note holders, There's £13.5m set aside for retail investors who are being offered this deal. I accept this is not part of the Eurozone but it gives you a feeling of the kind of pain that might be inflicted.
Might being operative. If I'm reading this right for a fund holder not a bad deal. They are holding X year 11% bonds on which they had already collected full. They have 6 years remaining. At European interest rate a government guaranteed 11% bond for 6 years is worth about double principle. And they are getting 45% of that. Basically they more than break even on the remainder of the bond after having collected. Of course on all the rest of their stuff they continue to collect.
Valuethinker wrote:
jbolden1517 wrote: In terms of volatility, there is more selling down the chain and defaults go up somewhat as the economy weakens so mutual fund NAVs drop when stocks drop. Junk bonds are worse for diversification but increase the expected return tremendously.
Increase expected returns relative to stocks? Or just to bonds?
Depends how much credit risk you take on and if you carry the better stuff on leverage (some American CEFs use limited leverage, hedge funds use more). But yes I think you can easily have stock like returns and terrible quality debt. Right now hedge funds are buying all the worst stuff up and putting pressure on prime brokerages not to sell to others. They are more valuable customers then retail investors. The SEC is making it hard for open ended mutual funds to carry very junky debt (liquidity issues so the NAV redemption promise...). But with the ETF explosion retail investors have a vehicle that could easily handle it they like. And there are always CEFs. I'm confident the American economy will expand the quantity of terrible quality debt to meet the obvious demand 8-) Again no idea about the situation in Europe.
Valuethinker wrote:
jbolden1517 wrote: In general I think junk is a terrific investment especially when the economy is bad.
I would put it another way. They are investments only when the economy is bad, i.e. if you can time the bottom of the credit cycle.
You don't have to time it well. What's the worst that happens if you are too early you take a year of defaults on already depressed bonds where the defaults are priced in? And if you are a little too late you end up with high yield and a low default rate so you get good interest rates plus capital appreciation.
Valuethinker wrote:
jbolden1517 wrote: But I want to throw in this disclaimer. I don't know the specifics of the European junk bond market well enough to know if now is the right time to do this. Might want to wait till the bond bubble pops (which should be horrific given its size). I also would also look at euro denominated EM bonds. Again, those aren't buy recommendations those are look recommendations. I have no opinion on the valuations of low quality euro debt positive or negative. As a USA investor I pick up currency risk on euro investments which changes our respective risks. While I'm happy to overweight European stocks I'm not even looking at the bonds. But that doesn't mean it doesn't make sense for you.

So that's my $.02.
Because the ECB has been buying IG corporate debt, sub IG/ HY has seen rises in prices as investors chase yields. Spreads over IG are at very low levels compared to historic. You are not being paid much for taking the higher risk of HY debt.

The market is less liquid and less efficient than its US counterpart. In theory, that should throw up opportunities.
Interesting. Given an even less liquid market than the USA (which is saying a lot) how do European funds calculate NAV?
jbolden1517
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Valuethinker wrote:
jbolden1517 wrote: The French state has the available credit to bail out its banks if it wanted to. I'm just not sure why they want to.
The disruption of one of Credit Agricole, BNP Paribas or SocGen went under? This would be like one of JP Morgan, BancAmerica or Citigroup going under. Faced with similar situations, the US government lent money to all the major banks, and bailed out several of its largest financial institutions? FNMA, FMAC, AIG etc?
FNMA and FMAC were quasi-governmental agencies. One can talk about whether quasi-governmental agencies should exist or not. But I wouldn't treat them as private companies. AIG was a different story. That was a true bailout. Here were the terms. They got an $85b line of credit. This credit was secured by the stock in AIG-owned subsidiaries in the form of warrants. The Fed got an 79.9% equity stake in the company. IMHO those terms were rather harsh. If European governments were doing that sort of thing to banks I don't think you all would have a bubble.
Valuethinker wrote:
jbolden1517 wrote: Italy and Greece were really shocking to me though. The governments didn't have great credit. There the state was under tremendous pressure, the population was suffering. Letting the banks fail would have made things so much better for the people. It's not like its that hard to get new banks with clean balance sheets created.
You mean a good bank bad bank split, with the government resolving the bad bank assets. A la NAMA in Irish Republic? Or Sweden in 1990s?
No I mean a real honest god old fashioned bank failure. With one of two options:
a) The shareholders are wiped out. The bondholders now own a well capitalized bank. They can then issue stock, sell it and get whatever it is worth. Or if that wouldn't go far far enough to make the bank sound (extremely unlikely you all have honest accounting, unlike say Chinese bank debt)

b) The (whatever the European equivalent of the sheriff is) sells the land, buildings, furniture, any financial assets. Any debt owned by the bank is auctioned off in blocks to other financial institutions to take over administration of. Highest bidder gets it, nothing fancy (these solvent bidders should be given a little time to raise cash to buy the debts). The depositors get to split up the money as partial repayment of their deposits. If there is enough to make the depositors and short term creditors (like employees) whole the bondholders split up the remainder.

Let the bear do his thing by converting debt into equity. You all need less debt and more equity. I can think of few things that would solve European malaise faster than rapid liquidation. Inflation would also be a really good alternative that would accomplish much the same thing.
Valuethinker wrote:
jbolden1517 wrote: But we should understand that Lloyds Bank, Chase Manhattan Bank and many others were in this position at the end of the 1970s when the Third World debt crisis hit. There was too much government debt for it simply to be written off-- the banks would have been in negative equity, and collapsed. So the situation became a lengthy workout, eventually with the creation of "Brady Bonds" so the debts could be sold off by the banks to investors. The problem was too big to just write off.
The problem with Greece and other such countries is that they have turned this bank debt into sovereign debt. The USA in the 1970s was in a much sounder position than those governments are.
Valuethinker wrote: I do not think it's the whole story that European bank bailouts in the southern tier are simply bailing out the rich. The question is if deposit holders and bond holders are to take the pain, then who? And what will the macroeconomic effect be.
The macro economic effects would be a higher growth, higher interest rate economy. The vast majority of bonds would now carry a risk premium so investors get higher returns. They are consequently able to demand higher returns on equity which forces higher corporate efficiencies. European savers start getting real interest rates. Those who take on more risk get richly rewarded. Investors start caring a lot about bank balance sheets and high risk banks can now take on high risk loans (like small business lending) with everyone understanding the risks. Conversely those banks with excellent balance sheets are able to borrow well below market cost and generate return playing the spreads. Your financial sector booms. Etc..
Valuethinker wrote:
jbolden1517 wrote: If the US, say, decided that in future bank insolvencies there would be no recovery for depositors over $250k or for bond holders (or massive dilution of same) then that really would change the risk-return on banks. Smaller and weaker banks would lose deposits very quickly. One could start a bank run simply by that act. AFAIK no depositor (of any size) has been out in a US bank insolvency since the 1930s? Even Continental Bank?
Depositors no. But bank deposits are much less important to the USA than they are in most of the rest of the world. What the USA government has done is had a policy of punishingly low deposit interest rates with much better rates available through brokerages. Thereby they have gotten depositors to accept risk of loss. The problem of course now is money markets play the same role in the USA as banks do in most of the world. A run on money markets freezes up the USA economy. So brokers have moved to punishingly low interest rates on their cash on deposit often with FDIC insured money markets being the default with things like ultra short bond funds taking the role previously occupied by money markets...

This IMHO is a good system. It creates small gradations of risk with the risks fully disclosed and mostly well understood and known. Ultimately of course you can never permanently solve the problem of deposits. There is far too much on demand deposit for the economy to absorb usefully. Those depositors are unwilling to take on risk. Someone has to borrow short and lend long to make the economy work. And sometimes the demand for on demand deposits exceeds the profits from the spread. I think having depositors have a "share price" on their deposits and thus during panics decide if they want to sell and lock in the loss or ride out the panic, be made more than whole, but take on risk of further decline in the short term is the best way to go. I kinda like our evolving solution.
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Re: Are value stocks safer or more risky?

Post by Valuethinker »

jbolden1517 wrote:
Valuethinker wrote:
jbolden1517 wrote: The French state has the available credit to bail out its banks if it wanted to. I'm just not sure why they want to.
The disruption of one of Credit Agricole, BNP Paribas or SocGen went under? This would be like one of JP Morgan, BancAmerica or Citigroup going under. Faced with similar situations, the US government lent money to all the major banks, and bailed out several of its largest financial institutions? FNMA, FMAC, AIG etc?
FNMA and FMAC were quasi-governmental agencies. One can talk about whether quasi-governmental agencies should exist or not. But I wouldn't treat them as private companies. AIG was a different story. That was a true bailout. Here were the terms. They got an $85b line of credit. This credit was secured by the stock in AIG-owned subsidiaries in the form of warrants. The Fed got an 79.9% equity stake in the company. IMHO those terms were rather harsh. If European governments were doing that sort of thing to banks I don't think you all would have a bubble.
FNMA and FMAC were private companies. They weren't quasi government in any legal sense? The market treated them in practice as if they were, but they were not.

AIG? You are ignoring the systemic effects of a failure to make good on the CDS. AIG would have defaulted on the CDS and gone bankrupt. The shareholders got off lightly.
Valuethinker wrote:
jbolden1517 wrote: Italy and Greece were really shocking to me though. The governments didn't have great credit. There the state was under tremendous pressure, the population was suffering. Letting the banks fail would have made things so much better for the people. It's not like its that hard to get new banks with clean balance sheets created.
You mean a good bank bad bank split, with the government resolving the bad bank assets. A la NAMA in Irish Republic? Or Sweden in 1990s?
No I mean a real honest god old fashioned bank failure. With one of two options:
a) The shareholders are wiped out. The bondholders now own a well capitalized bank. They can then issue stock, sell it and get whatever it is worth. Or if that wouldn't go far far enough to make the bank sound (extremely unlikely you all have honest accounting, unlike say Chinese bank debt)
They don't though, because bondholders rank behind depositholders? The deposit guarantee agency sells off the assets, pays off as much of the deposits as it can (somebody will be short) and the bondholders will get little (or nothing).

Your last sentence implies you understand what a bank run is? This would have kicked off the mother of all bank runs. that's the problem with liquidationism and why it failed in the 1930s, but left Treasury Secretary Morgenthau with his famous quote.

I am really not sure what your point was with that last sentence, otherwise. Or did you mean that it's part of b)?

b) The (whatever the European equivalent of the sheriff is) sells the land, buildings, furniture, any financial assets. Any debt owned by the bank is auctioned off in blocks to other financial institutions to take over administration of. Highest bidder gets it, nothing fancy (these solvent bidders should be given a little time to raise cash to buy the debts). The depositors get to split up the money as partial repayment of their deposits. If there is enough to make the depositors and short term creditors (like employees) whole the bondholders split up the remainder.

Let the bear do his thing by converting debt into equity. You all need less debt and more equity. I can think of few things that would solve European malaise faster than rapid liquidation. Inflation would also be a really good alternative that would accomplish much the same thing.
I agree with you re inflation. However one thing the ECB can't do is print money to do the bank bailouts. Nice if it could. The shock to confidence might still be deflationary, though.

If the depositors are short, there is trouble. As I understand it with the Italian bondholders, the retail ones are being bailed out (which has hardened the German stance to future measures), but the larger investors are "bailing in".

On the Greek default the issue was the scale of it and the Greek Central Bank, again, cannot print money to just absorb the bank debts & pay off the depositors. The mistake made was in the first Greek default (see IMF criticism of same) was not to push bigger losses on bondholders-- but those were French and German banks, and those governments did not want to have to bail out those banks. Now, much of the debt is held by the Troika (ECB, IMF, stabilization fund) and the loss would fall directly on the taxpapers of the Eurozone (including the Greek taxpayers ;-)).
Valuethinker wrote:
jbolden1517 wrote: But we should understand that Lloyds Bank, Chase Manhattan Bank and many others were in this position at the end of the 1970s when the Third World debt crisis hit. There was too much government debt for it simply to be written off-- the banks would have been in negative equity, and collapsed. So the situation became a lengthy workout, eventually with the creation of "Brady Bonds" so the debts could be sold off by the banks to investors. The problem was too big to just write off.
The problem with Greece and other such countries is that they have turned this bank debt into sovereign debt. The USA in the 1970s was in a much sounder position than those governments are.
No one was seriously suggesting in the early 1980s that the US government would backstop Chase Manhattan Bank. Or the UK government Lloyd's. The scale of that would have been too large.
Valuethinker wrote: I do not think it's the whole story that European bank bailouts in the southern tier are simply bailing out the rich. The question is if deposit holders and bond holders are to take the pain, then who? And what will the macroeconomic effect be.
The macro economic effects would be a higher growth, higher interest rate economy.
Why?
The vast majority of bonds would now carry a risk premium so investors get higher returns. They are consequently able to demand higher returns on equity which forces higher corporate efficiencies.
Systemic effects again. More cuts to employment and investment => more unemployment, less spending. And so on in a downward spiral. Unless fiscal policy picks up the slack.
European savers start getting real interest rates. Those who take on more risk get richly rewarded. Investors start caring a lot about bank balance sheets and high risk banks can now take on high risk loans (like small business lending) with everyone understanding the risks. Conversely those banks with excellent balance sheets are able to borrow well below market cost and generate return playing the spreads. Your financial sector booms. Etc..
I think you get stuck in a slump. Japan for example.

Higher interest rates are an effect of stronger economic growth, not a cause. Note also the zero interest rate lower bound bites in the Eurozone. 0 per cent on a deposit account isn't a bad rate, if your economy is overall teetering on the edge of deflation (it is not in Germany, but in some of the southern tier it is) and is in stagnation (Italy) due to the nasty combination of the zero lower bound on wage and price flexibility, and the need for a real exchange rate depreciation (given that a nominal exchange rate depreciation is blocked by membership in the Eurozone).

The Eurozone has been quite creative on negative interest rates (they didn't tell us in school this was possible! -- who knew?) but in the absence of a stimulative fiscal policy across the Eurozone, cheap money is not enough.
Valuethinker wrote:
jbolden1517 wrote: If the US, say, decided that in future bank insolvencies there would be no recovery for depositors over $250k or for bond holders (or massive dilution of same) then that really would change the risk-return on banks. Smaller and weaker banks would lose deposits very quickly. One could start a bank run simply by that act. AFAIK no depositor (of any size) has been out in a US bank insolvency since the 1930s? Even Continental Bank?
Depositors no. But bank deposits are much less important to the USA than they are in most of the rest of the world. What the USA government has done is had a policy of punishingly low deposit interest rates with much better rates available through brokerages. Thereby they have gotten depositors to accept risk of loss. The problem of course now is money markets play the same role in the USA as banks do in most of the world. A run on money markets freezes up the USA economy. So brokers have moved to punishingly low interest rates on their cash on deposit often with FDIC insured money markets
FDIC insured money markets? Is there such a thing?

I don't think depositors, even depositors of more than $250k, are really ready for/ able to deal with, a meaningful loss on their deposits.

And the "too big to fail" problem of financial institutions is worse than it was.
being the default with things like ultra short bond funds taking the role previously occupied by money markets...

This IMHO is a good system. It creates small gradations of risk with the risks fully disclosed and mostly well understood and known. Ultimately of course you can never permanently solve the problem of deposits. There is far too much on demand deposit for the economy to absorb usefully. Those depositors are unwilling to take on risk. Someone has to borrow short and lend long to make the economy work. And sometimes the demand for on demand deposits exceeds the profits from the spread. I think having depositors have a "share price" on their deposits and thus during panics decide if they want to sell and lock in the loss or ride out the panic, be made more than whole, but take on risk of further decline in the short term is the best way to go. I kinda like our evolving solution.
I am really not sure what you are describing.

The shadow banking system is still there, and it's still a risk point.
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packer16
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Re: Are value stocks safer or more risky?

Post by packer16 »

I agree the two definitions & approaches are different. What I find amusing about the academics and all the Saturday morning quarterbacks is they think they have found the secret of Buffet's outperformance. His outperformance is not due the weighting on certain non-fundamentally derived factors, if you look at his portfolio you can plainly see he used an understanding of the underlying economics of these businesses to select them. If you think that you are doing anything but data mining when you invest on factors that are based on past performance with no fundamental rationale than you are fooling yourself. Some observe that value firms have higher returns because they are riskier (higher debt and slower cash flow growth), however,if that is the case why not screen directly on these fundamental factors versus the emperically derived value factor.

Packer
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jbolden1517
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Re: Are value stocks safer or more risky?

Post by jbolden1517 »

Valuethinker wrote:
jbolden1517 wrote: FNMA and FMAC were quasi-governmental agencies. One can talk about whether quasi-governmental agencies should exist or not. But I wouldn't treat them as private companies. AIG was a different story. That was a true bailout. Here were the terms. They got an $85b line of credit. This credit was secured by the stock in AIG-owned subsidiaries in the form of warrants. The Fed got an 79.9% equity stake in the company. IMHO those terms were rather harsh. If European governments were doing that sort of thing to banks I don't think you all would have a bubble.
FNMA and FMAC were private companies. They weren't quasi government in any legal sense? The market treated them in practice as if they were, but they were not.
I don't think that's true. https://en.wikipedia.org/wiki/Governmen ... enterprise
Congress creates a corporation asserting that it exists as a national priority. They exist as a matter of law not because someone set them up. The Federal government has a long history of guaranteeing the debts of these institutions. They borrow often at government rates or close to them. The government never objects to this. On paper say "there are no guarantees" and then for a century the government has acted as if there were. In fact they have often acted better with GSE then they have with lower quality government debts (like state debts). I'm going to say the market isn't wrong in saying these entities are quasi-governmental.
Valuethinker wrote: AIG? You are ignoring the systemic effects of a failure to make good on the CDS. AIG would have defaulted on the CDS and gone bankrupt. The shareholders got off lightly.
They would have gone bankrupt. And in bankruptcy the shareholders would have discovered they had quite a bit of equity. Penalties for default or no. The liquidity returned and AIG was extremely solvent just weeks after the bailout. The penalties AIG shareholders got were worse than what would likely have happened in a bankruptcy. There was a lawsuit over this, no one disputes that the liquidity returned quickly and the problem was short term. In exchange for the short term fix AIG shareholders got severely diluted.
Valuethinker wrote:
jbolden1517 wrote:
Valuethinker wrote: Italy and Greece were really shocking to me though. The governments didn't have great credit. There the state was under tremendous pressure, the population was suffering. Letting the banks fail would have made things so much better for the people. It's not like its that hard to get new banks with clean balance sheets created.
You mean a good bank bad bank split, with the government resolving the bad bank assets. A la NAMA in Irish Republic? Or Sweden in 1990s?
No I mean a real honest god old fashioned bank failure. With one of two options:
a) The shareholders are wiped out. The bondholders now own a well capitalized bank. They can then issue stock, sell it and get whatever it is worth. Or if that wouldn't go far far enough to make the bank sound (extremely unlikely you all have honest accounting, unlike say Chinese bank debt)
They don't though, because bondholders rank behind depositholders? The deposit guarantee agency sells off the assets, pays off as much of the deposits as it can (somebody will be short) and the bondholders will get little (or nothing).[/quote]

If there is enough to pay off the deposit holders there is no reason for them to be paid out. The bank is now solvent without the debt from the bonds. The bondholders own a solvent bank.
Valuethinker wrote: Your last sentence implies you understand what a bank run is? This would have kicked off the mother of all bank runs. that's the problem with liquidationism and why it failed in the 1930s, but left Treasury Secretary Morgen though with his famous quote.
We had a lot of success with liquidation prior to the depression. I'm not sure that liquidationism (as you are calling it) failed. What failed was engaging in liquidation without
a) Providing lots of credit to prevent the liquidity problem from spreading
b) Not proving support to the economy to absorb the macro economic shocks.

America has a long tradition of successfully managing bank failures both before and after the 1930s. 1907 was a better example of this being handled well. Bankruptcy wasn't the problem. 25% unemployment was the problem.
Valuethinker wrote: I am really not sure what your point was with that last sentence, otherwise. Or did you mean that it's part of b)?
My point was that for European banks I believe that minus the bond debt those banks are highly solvent. Once the bondholders get equity in exchange for their bonds you have extremely healthy banks that could easily cover the deposits. I was contrasting this with another example, China, where I'm not sure that's true.
Valuethinker wrote:
jbolden1517 wrote:
b) The (whatever the European equivalent of the sheriff is) sells the land, buildings, furniture, any financial assets. Any debt owned by the bank is auctioned off in blocks to other financial institutions to take over administration of. Highest bidder gets it, nothing fancy (these solvent bidders should be given a little time to raise cash to buy the debts). The depositors get to split up the money as partial repayment of their deposits. If there is enough to make the depositors and short term creditors (like employees) whole the bondholders split up the remainder.

Let the bear do his thing by converting debt into equity. You all need less debt and more equity. I can think of few things that would solve European malaise faster than rapid liquidation. Inflation would also be a really good alternative that would accomplish much the same thing.
I agree with you re inflation. However one thing the ECB can't do is print money to do the bank bailouts. Nice if it could. The shock to confidence might still be deflationary, though.
I'm not sure I understand. I may not get the distinction between the ECB and the FED. As far as I understand it the ECB can't outright purchase bonds officially. But through repos it can essentially purchase bonds in unlimited quantities. Especially if they deliberately target lenders likely to go in default so they get the bonds and the economy gets the cash. How is that not printing money?
Valuethinker wrote: On the Greek default the issue was the scale of it and the Greek Central Bank, again, cannot print money to just absorb the bank debts & pay off the depositors. The mistake made was in the first Greek default (see IMF criticism of same) was not to push bigger losses on bondholders-- but those were French and German banks, and those governments did not want to have to bail out those banks. Now, much of the debt is held by the Troika (ECB, IMF, stabilization fund) and the loss would fall directly on the taxpapers of the Eurozone (including the Greek taxpayers ;-)).
Exactly the debt is now essentially public debt. Where before it was private debt.
Valuethinker wrote:
jbolden1517 wrote:
The macro economic effects would be a higher growth, higher interest rate economy.
Why?
Because debt gets converted into equity. While new debt is stimulative old debt has a depressing effect on economic activity. Debt holders reward companies for cutting costs and slowly growing their balance sheets. Equity holders want growth and a high rate of return, and are willing to accept risk to get it. By destroying large quantities of debt and turning it into an equity asset you change the incentive structure for business in the aggregate and create a more vibrant economy.

Moreover some of that debt is hopefully held by the ECB. Which means a permanent injection of high powered money (cash essentially) into the economy.
Valuethinker wrote:
jbolden1517 wrote:
The vast majority of bonds would now carry a risk premium so investors get higher returns. They are consequently able to demand higher returns on equity which forces higher corporate efficiencies.
Systemic effects again. More cuts to employment and investment => more unemployment, less spending. And so on in a downward spiral. Unless fiscal policy picks up the slack.
Why does a solvent institution have to cut employment in a way an non-solvent one doesn't? What is the cause of this drop in demand you are predicting? The USA has a long history of more bankruptcy than Europe. Has this resulted in us having a slower growing economy with a higher unemployment rate on average?
Valuethinker wrote:
jbolden1517 wrote:
European savers start getting real interest rates. Those who take on more risk get richly rewarded. Investors start caring a lot about bank balance sheets and high risk banks can now take on high risk loans (like small business lending) with everyone understanding the risks. Conversely those banks with excellent balance sheets are able to borrow well below market cost and generate return playing the spreads. Your financial sector booms. Etc..
I think you get stuck in a slump. Japan for example.
Japan has deflation not bankruptcy. They don't allow bankruptcy. The lack of bankruptcy and the demographics is why they got stuck in a slump.
Valuethinker wrote:Higher interest rates are an effect of stronger economic growth, not a cause.
I think the equation works both ways. A higher real interest rate is a result of more demand for capital. More demand for capital raises the real interest rate.
Valuethinker wrote: Note also the zero interest rate lower bound bites in the Eurozone. 0 per cent on a deposit account isn't a bad rate, if your economy is overall teetering on the edge of deflation (it is not in Germany, but in some of the southern tier it is) and is in stagnation (Italy) due to the nasty combination of the zero lower bound on wage and price flexibility, and the need for a real exchange rate depreciation (given that a nominal exchange rate depreciation is blocked by membership in the Eurozone).
I agree you have a deflation problem in addition to a banking problem. A nominal interest rate of 5% with -2% deflation would be devastating. I'm not advocating that. But see above.
Valuethinker wrote: The Eurozone has been quite creative on negative interest rates (they didn't tell us in school this was possible! -- who knew?) but in the absence of a stimulative fiscal policy across the Eurozone, cheap money is not enough.
You have an anti-stimulative policy across the Eurozone. Aggressive bankruptcy is just one aspect of becoming more stimulative. But it can be done in isolation and helps in isolation.
Valuethinker wrote:
jbolden1517 wrote: If the US, say, decided that in future bank insolvencies there would be no recovery for depositors over $250k or for bond holders (or massive dilution of same) then that really would change the risk-return on banks. Smaller and weaker banks would lose deposits very quickly. One could start a bank run simply by that act. AFAIK no depositor (of any size) has been out in a US bank insolvency since the 1930s? Even Continental Bank?
Depositors no. But bank deposits are much less important to the USA than they are in most of the rest of the world. What the USA government has done is had a policy of punishingly low deposit interest rates with much better rates available through brokerages. Thereby they have gotten depositors to accept risk of loss. The problem of course now is money markets play the same role in the USA as banks do in most of the world. A run on money markets freezes up the USA economy. So brokers have moved to punishingly low interest rates on their cash on deposit often with FDIC insured money markets
[/quote]

FDIC insured money markets? Is there such a thing? [/quote]

Yes. I'm not sure what this is technically. I'm not a banker. But for example I've had a small account at TD Ameritrade. Prior to 2008 they had about 6 money market accounts that I could use as my default for cash balances. If memory serves: Treasure bills, FDIC insured money market, standard money market, municipal money market and some others I don't remember. Now they mostly don't offer options. The default is an account where they put money into a variety of banks ($250k increments) in my name. Fidelity does the same thing. Merrill Edge my cash is insured by Lloyds up to $1.9m. Of course they all have better interest money markets and other vehicles you then can either sweep into or buy. For example Merrill Edge has a load waived Money Market from Lord Abbott.

I don't hold a lot of cash, but other Bogleheads do. I invite any reading to jump in here. Mostly I don't care about 10 basis points on my cash position so I don't follow this stuff closely. But the short answer is, yes there has definitely been a change at the ground level about how this is handled by brokerages.
Valuethinker wrote:
jbolden1517 wrote:I don't think depositors, even depositors of more than $250k, are really ready for/ able to deal with, a meaningful loss on their deposits.
I don't think there are many if any banks in the USA or Europe where that would happen. But if it did good. You would have something like what we had in the USA in the 1970s and early 1980s where higher risk institutions (Savings and Loans) pay high interest rates and lower risk institutions (banks) pay lower interest and depositors decide if they want more interest in exchange for risk. As a stock / bond investor you know that model works
Valuethinker wrote: And the "too big to fail" problem of financial institutions is worse than it was.
Agree. But that's another topic.
Valuethinker wrote:
jbolden1517 wrote: being the default with things like ultra short bond funds taking the role previously occupied by money markets...

This IMHO is a good system. It creates small gradations of risk with the risks fully disclosed and mostly well understood and known. Ultimately of course you can never permanently solve the problem of deposits. There is far too much on demand deposit for the economy to absorb usefully. Those depositors are unwilling to take on risk. Someone has to borrow short and lend long to make the economy work. And sometimes the demand for on demand deposits exceeds the profits from the spread. I think having depositors have a "share price" on their deposits and thus during panics decide if they want to sell and lock in the loss or ride out the panic, be made more than whole, but take on risk of further decline in the short term is the best way to go. I kinda like our evolving solution.
I am really not sure what you are describing.

The shadow banking system is still there, and it's still a risk point.
I'm describing the shadow banking system in positive terms.
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