700 Years of Falling Interest Rates, 1310-2018

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Valuethinker
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by Valuethinker » Mon Apr 15, 2019 7:49 am

packer16 wrote:
Sun Apr 14, 2019 3:48 pm


I am basing my view on the historical data as provided by SimpleGift, Damodaran & Siegel. There are others who think there will be lower returns but IMO to date they have been proven wrong.
Except since 2000? And in international stocks.
I also become more skeptical of the lower return hypothesis as the market IMO is becoming more efficient over time & the longer the returns stay high, the more wrong the lower return hypothesis is proven.
An efficient market though knows that, and moves more or less instantaneously to a higher valuation reflecting the greater returns available. Since valuations are high (but not necessarily very high) against historical norms one could argue the market has moved there - priced in the potentially higher returns.
One item the lower return hypothesis folks do not account for is the value of the unforecasted advances in technology that create large amounts of wealth.
Wealth = stock (static). Profits = flow. Markets are valued on expectations of future profits. The problem is that gains in one part of the market are compensated for by losses somewhere else. The disruptive effect of Amazon, Google, Apple etc. If consumers spend $1000+ on a smartphone they didn't spend that on something else.

However profits have grown. Part of that is simply buying back shares - EPS grows even if profits don't. Another part is record high EBIT margins for US companies:

- for financial stocks we have to be very careful. Finance is simply intermediation. Vanguard & ishares' demolition of the profits of conventional asset managers simply moves numbers around - might actually shrink the market for financial services in revenue terms. Similarly a bank's profits are an estimate of the returns it made from lending and from securities trading - a profit made from someone else in the financial system. What we saw in 2008 was the massive writeoff of much of the alleged profits of the financial intermediation sector over the previous few years - look at the size of the banks' writeoffs which were multiples of annual profit.

- non financial it's quite real. But it is strikingly pronounced in a group of technology-related companies.

Companies have profited from holding down wages while increasing revenues. However productivity growth has not been stellar (since 2000, there's actually a break point around the 1973 oil crisis, and we've never caught back up to the 1946-1973 growth rates in productivity, except for a short period in the late 1990s).

You have full employment in the USA, practically. You have the entire world going through a demographic shift towards aging. You have a pause in globalisation (and maybe a stop or in fact retrograde). These are not bullish for the ability of capital to keep taking value from labour.

In that scenario, profits don't grow as fast, or even fall, in aggregate. On the other hand, AI & robotics mean capital continues to win v. labour.
Although this effect is not consistent over time it does occur but is lumpy. The benefit of these advances accrue to equity holders. I agree incumbents will be hurt by innovation, but suppliers also benefit. One way to see the aggregate benefit is to look at the market cap of entire stock market. This clearly has increased over time despite the losses by the incumbents.

Packer
The ratio of stock exchange value to GDP has grown. That's the market saying that a greater share of GDP in the long run will go to profits/ the owners of capital. But we've had nearly 40 years of that trend - can it keep going? It's certainly much lower in (most) other countries.

On who benefits. The evidence is that private companies do, on average, better than public companies. Public company profits grow by less than profits for all companies.

That's consistent with a world where Venture Capitalists and Founders manage to extract the benefits of their new processes & technologies. Then, when they (with insider information) foresee the flattening out of that trajectory, they IPO or sell to listed companies (GE used to be a great buyer).

Quoted investors in other words don't have access to the fastest growing parts of the corporate world.

Just on technology

Think about something truly revolutionary since the 1960s. Containerization. The US Military, with its establishment of a 550,000 man force in Vietnam, an underdeveloped country, needed to move vast amounts of freight to a country without modern ports. And they turned Cam Ranh Bay into one of the world's largest ports by financing what became Sea Containers.

The impact of containers & containerization on the modern world cannot be underestimated. 10% of more of goods used to be lost, damaged or stolen in shipment and in port. Longshoreman used to be one of the largest and most powerful unions. The rise of modern China as a manufacturing power would have been literally impossible without containers. Ditto WalMart, the world's largest retailer. Containers are the blood vessels of the modern world.

Who benefited? Well shipping companies consolidated down to a few huge players, which don't make much money (volatile, capital intensive industry). Railroads benefited in some countries (USA in particular). Truck companies benefited.

The real beneficiary was consumers who got goods cheaper and faster from around the world. The economy as a whole grew because of higher productivity (same input, more outputs). Now that meant they had more money to spend so perhaps they spent it somewhere else. But it's hard to see any direct beneficiary in the transportation industry itself.

Frank2012
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by Frank2012 » Mon Apr 15, 2019 3:25 pm

SimpleGift wrote:
Sat Apr 13, 2019 2:24 pm
In response, I've slowly been increasing the credit quality of my "safe assets," i.e., transitioning from munis and corporates to mostly Treasuries now — though maybe I'm just getting older and more conservative.
Although no one can tell what the future holds, if SimpleGift's conjecture proves to be true (i.e., low inflation but greater risk of really big black swans!), then one should not hold TIPS or TIP funds either, correct?

I suppose a decent portfolio would be Total World Stock and a Treasury Fund.

This is a great discussion that SimpleGift has started!

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SimpleGift
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by SimpleGift » Mon Apr 15, 2019 4:49 pm

Frank2012 wrote:
Mon Apr 15, 2019 3:25 pm
SimpleGift wrote:
Sat Apr 13, 2019 2:24 pm
In response, I've slowly been increasing the credit quality of my "safe assets," i.e., transitioning from munis and corporates to mostly Treasuries now — though maybe I'm just getting older and more conservative.
Although no one can tell what the future holds, if SimpleGift's conjecture proves to be true (i.e., low inflation but greater risk of really big black swans!), then one should not hold TIPS or TIP funds either, correct?

I suppose a decent portfolio would be Total World Stock and a Treasury Fund.
My sense is that it all depends on one's overall allocation. Those with stock-heavy portfolios could do just fine with Total World Stock and a nominal Treasury fund, since their large equity allocation will likely provide decent inflation protection over the long haul, overcoming any temporary high inflation spikes.

TIPS would still have a place in balanced or bond-heavy portfolios, though, since TIPS are designed to protect against unexpected inflation. Forecasts may be for low inflation in the decades ahead, but any portfolio with 50% or less in equities is highly vulnerable to inflation risk, and should benefit from a healthy dose of TIPS as insurance, in my view.

In disaster scenarios, I believe the liquidity issues with TIPS are in the past and they'd hold up as well as nominal Treasuries (?).

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packer16
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by packer16 » Tue Apr 16, 2019 9:01 am

Valuethinker wrote:
Mon Apr 15, 2019 7:49 am
packer16 wrote:
Sun Apr 14, 2019 3:48 pm


I am basing my view on the historical data as provided by SimpleGift, Damodaran & Siegel. There are others who think there will be lower returns but IMO to date they have been proven wrong.
Except since 2000? And in international stocks.
I also become more skeptical of the lower return hypothesis as the market IMO is becoming more efficient over time & the longer the returns stay high, the more wrong the lower return hypothesis is proven.
An efficient market though knows that, and moves more or less instantaneously to a higher valuation reflecting the greater returns available. Since valuations are high (but not necessarily very high) against historical norms one could argue the market has moved there - priced in the potentially higher returns.
One item the lower return hypothesis folks do not account for is the value of the unforecasted advances in technology that create large amounts of wealth.
Wealth = stock (static). Profits = flow. Markets are valued on expectations of future profits. The problem is that gains in one part of the market are compensated for by losses somewhere else. The disruptive effect of Amazon, Google, Apple etc. If consumers spend $1000+ on a smartphone they didn't spend that on something else.

However profits have grown. Part of that is simply buying back shares - EPS grows even if profits don't. Another part is record high EBIT margins for US companies:

- for financial stocks we have to be very careful. Finance is simply intermediation. Vanguard & ishares' demolition of the profits of conventional asset managers simply moves numbers around - might actually shrink the market for financial services in revenue terms. Similarly a bank's profits are an estimate of the returns it made from lending and from securities trading - a profit made from someone else in the financial system. What we saw in 2008 was the massive writeoff of much of the alleged profits of the financial intermediation sector over the previous few years - look at the size of the banks' writeoffs which were multiples of annual profit.

- non financial it's quite real. But it is strikingly pronounced in a group of technology-related companies.

Companies have profited from holding down wages while increasing revenues. However productivity growth has not been stellar (since 2000, there's actually a break point around the 1973 oil crisis, and we've never caught back up to the 1946-1973 growth rates in productivity, except for a short period in the late 1990s).

You have full employment in the USA, practically. You have the entire world going through a demographic shift towards aging. You have a pause in globalisation (and maybe a stop or in fact retrograde). These are not bullish for the ability of capital to keep taking value from labour.

In that scenario, profits don't grow as fast, or even fall, in aggregate. On the other hand, AI & robotics mean capital continues to win v. labour.
Although this effect is not consistent over time it does occur but is lumpy. The benefit of these advances accrue to equity holders. I agree incumbents will be hurt by innovation, but suppliers also benefit. One way to see the aggregate benefit is to look at the market cap of entire stock market. This clearly has increased over time despite the losses by the incumbents.

Packer
The ratio of stock exchange value to GDP has grown. That's the market saying that a greater share of GDP in the long run will go to profits/ the owners of capital. But we've had nearly 40 years of that trend - can it keep going? It's certainly much lower in (most) other countries.

On who benefits. The evidence is that private companies do, on average, better than public companies. Public company profits grow by less than profits for all companies.

That's consistent with a world where Venture Capitalists and Founders manage to extract the benefits of their new processes & technologies. Then, when they (with insider information) foresee the flattening out of that trajectory, they IPO or sell to listed companies (GE used to be a great buyer).

Quoted investors in other words don't have access to the fastest growing parts of the corporate world.

Just on technology

Think about something truly revolutionary since the 1960s. Containerization. The US Military, with its establishment of a 550,000 man force in Vietnam, an underdeveloped country, needed to move vast amounts of freight to a country without modern ports. And they turned Cam Ranh Bay into one of the world's largest ports by financing what became Sea Containers.

The impact of containers & containerization on the modern world cannot be underestimated. 10% of more of goods used to be lost, damaged or stolen in shipment and in port. Longshoreman used to be one of the largest and most powerful unions. The rise of modern China as a manufacturing power would have been literally impossible without containers. Ditto WalMart, the world's largest retailer. Containers are the blood vessels of the modern world.

Who benefited? Well shipping companies consolidated down to a few huge players, which don't make much money (volatile, capital intensive industry). Railroads benefited in some countries (USA in particular). Truck companies benefited.

The real beneficiary was consumers who got goods cheaper and faster from around the world. The economy as a whole grew because of higher productivity (same input, more outputs). Now that meant they had more money to spend so perhaps they spent it somewhere else. But it's hard to see any direct beneficiary in the transportation industry itself.
Thanks for your responses. I think using since 2000 is to short a time to look at these longer term trends. International markets also create some issues as some provide more return to investors (Dutch/British markets) versus other who provide less return.

What this may imply is that the market is not as efficient in the long-term (projecting future innovations) as it is in the short & intermediate terms. I agree that the market has moved higher but not in such a way that returns have declined as projected by static P/E models such as CAPE. This to me implies that static P/E models appears to have underestimated future returns at least since these projections have been made. So it appears to have missed some growth that made the current P/Es not as high as they appear.

You bring up a good point about stock versus flow, however, the stock keeps on getting bigger unless it is destroyed by war, famine or epidemic. So even though public companies may not grow as fast a private ones, the overall size of the investment pie is bigger & thus they will get there piece of the larger stock.

Packer
Buy cheap and something good might happen

garlandwhizzer
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by garlandwhizzer » Tue Apr 16, 2019 12:00 pm

An immense amount of wealth has been created by economic growth in the US and worldwide for that matter over the last 2 or 3 decades. That wealth has been concentrated more and more in the investing class. So many investment dollars seeking attractive risk adjusted returns that the prices of essentially all investment assets have been driven up. The prices of stocks have been bid up relative to long term historical averages and the prices of bonds (with help from FED) have likewise been bid up, hence their yields pushed down by this demand. I suspect that this is why traditional markers like PE1 and PE10 have gradually and persistently risen over time. Likewise bond yields have fallen for decades due to decreasing inflation and FED policy, This situation may persist for a long time. In the absence of severe recession or a black swan, the days when US PE averaged about 16 may not return. Reversion to that mean may never occur in a persistent way in the future. Most expect that this trend will reduce the long term returns of both stocks and bonds but I believe that downside risk is limited by the vast amounts of safe liquid assets looking for opportunities. Even after a 10 year bull market huge sums of money still sit on the sidelines in totally safe assets like MMF, CDs, ST Bonds which, if employed in equity, could keep driving the market even higher.

Garland Whizzer

Frank2012
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by Frank2012 » Wed Apr 17, 2019 5:05 pm

SimpleGift wrote:
Sat Apr 13, 2019 2:24 pm
In response, I've slowly been increasing the credit quality of my "safe assets," i.e., transitioning from munis and corporates to mostly Treasuries now — though maybe I'm just getting older and more conservative.
SimpleGift, that is very interesting...so you are willing to sacrifice the tax efficiency of municipal bonds in return to the extra safety of treasuries? Are you really willing to pay more taxes by dropping your munis for treasuries? I'm not being critical, but I'm interested in your conviction and concern about fat tail risk such that you would trade munis for treasuries.

Also, are you using a treasure mutual fund or buying treasuries directly?

Thanks!

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SimpleGift
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Re: 700 Years of Falling Interest Rates, 1310-2018

Post by SimpleGift » Wed Apr 17, 2019 5:53 pm

Frank2012 wrote:
Wed Apr 17, 2019 5:05 pm
SimpleGift wrote:
Sat Apr 13, 2019 2:24 pm
In response, I've slowly been increasing the credit quality of my "safe assets," i.e., transitioning from munis and corporates to mostly Treasuries now — though maybe I'm just getting older and more conservative.
SimpleGift, that is very interesting...so you are willing to sacrifice the tax efficiency of municipal bonds in return to the extra safety of treasuries? Are you really willing to pay more taxes by dropping your munis for treasuries? I'm not being critical, but I'm interested in your conviction and concern about fat tail risk such that you would trade munis for treasuries.

Also, are you using a treasure mutual fund or buying treasuries directly?
Hi Frank — Our decision to upgrade the credit quality of our bond portfolio, moving from a muni-heavy allocation to a more Treasury-heavy allocation, has as much to do with our stage in life as it does with increased concern about left-tail risk in the financial markets these days.

Yes, as asset prices of both stocks and bonds have drifted into historically high territory in recent years, it seems plausible to us that the risk of financial breakdowns like 2008 has increased. However, we're also about 15 years into retirement now and are fortunate to have "enough" at this stage of life. So replacing munis with Treasuries just allows us to sleep a bit better at night.

PS. We use Vanguard Admiral Treasury funds (both nominal and inflation-protected), primarily for the convenience. And don't overlook that Treasury income is tax-exempt at the state level, which can help a lot in high-tax states.

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